739 1 Technical Conference 2 RP-1999-0040 3 4 IN THE MATTER OF ss. 57 and 70 of the Ontario Energy 5 Board Act, 1998, S.O. 1998, c. 15, Sched. B; 6 7 AND IN THE MATTER OF a proposed Standard Supply Service 8 Code for electricity distributors. 9 10 11 12 13 14 15 16 17 TECHNICAL CONFERENCE 18 19 20 21 22 23 Hearing held at: 24 2300 Yonge Street, 25th Floor, Hearing Room No. 1, 25 Toronto, Ontario on Friday, July 16, 1999, 26 commencing at 9:02 a.m. 27 28 VOLUME 4 740 1 APPEARANCES 2 JENNIFER LEA Counsel, Board Technical 3 Staff 4 BRIAN HEWSON/ Board Technical Staff 5 UNA O'RILEY 6 JACK GIBBONS Pollution Probe 7 TOM ADAMS/ Energy Probe 8 MARK MATTSON 9 RICHARD STEPHENSON Power Workers Union 10 ROBERT POWER/ Various Intervenors 11 PETER BUDD/ 12 ALEXANDER GRIEVE 13 BRUCE MacODRUM/ Toronto Hydro Electric 14 MARK RODGER System Limited 15 ALAN MARK Municipal Electric 16 Association 17 TOM BRETT Independent Power Producers' 18 Society of Ontario, IPPSO 19 ELIZABETH DEMARCO Various interested parties 20 BRIAN McKERLIE Municipality of Chatham-Kent 21 ROBERT WARREN Consumers Association of 22 Canada. 23 DICK PERDUE Direct Energy and Enershare 24 Technology 25 DAVID POCH Green Energy Coalition, GEC 26 ZIYAAD MIA Coalition of Distribution 27 Utilities et al 28 741 1 APPEARANCES (Cont'd) 2 ALECK DADSON Enron Capital & Trade 3 IAN MONDROW Heating, Ventilation and Air 4 Conditioning Contractors 5 Coalition Inc., HVAC 6 Coalition 7 MARCEL REGHELINI Ontario Hydro Services 8 Company 9 ROGER WHITE/ Energy Cost Management 10 Incorporated, ECMI 11 RICK GROULX 12 MARK RONAYNE Competition Bureau 13 KEITH RAWSON TransCanada Power 14 ANDREW BARRETT Ontario Power Generation 15 Inc. 16 RICHARD BATTISTA Union Gas Limited 17 BARBARA BODNER Enbridge Inc. 18 AMIR SHALABY Ontario IMO 19 DAN PASTORIC Energy Advantage 20 JIM RICHARDSON/ Upper Canada Energy Alliance 21 PAUL FERGUSON 22 MICHAEL JANIGAN Vulnerable Energy Consumers 23 Coalition 24 GRAHAM HENDERSON Ontario Hydro Services 25 Company 26 27 28 742 1 INDEX OF PROCEEDINGS 2 PAGE 3 Preliminary matters 743 4 Questions of Mr. Adamson and Mr. Conway 743 5 Luncheon recess at 12:40 p.m. 859 6 Upon resuming at 1:40 p.m. 859 7 Presentation by Ms Fiona Woolf 861 8 Presentation by Mr. John Jenkins 878 9 Presentation by Mr. Gunars Ceksters 896 10 Questions of Ms Woolf, Mr. Jenkins 11 and Mr. Ceksters 903 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 743 1 Toronto, Ontario 2 --- Upon resuming on Friday, July 16, 1999 3 at 9:02 a.m. 4 MS LEA: Good morning. 5 Welcome to the SSS Technical 6 Conference. 7 We will be resuming again with the 8 panel of Mr. Adamson and Mr. Conway. 9 I don't have any preliminary matters 10 myself at this time. Does anyone else? 11 Okay. Thank you very much, then. 12 I think we are to Mr. Brett, please. 13 MR. BRETT: Thank you very much, 14 Ms Lea. 15 Good morning, gentlemen. 16 My name is Tom Brett. I represent 17 the independent generators, the Independent Power 18 Producers' Society of Ontario. 19 I just have a couple of questions of 20 clarification of your papers, which we thought were 21 very good. 22 The first question is: You touch in 23 your paper at one point, on page 5, in the second 24 paragraph, on the question of the usefulness of the 25 intermediate contract markets in helping to send a 26 signal to generators about when new capacity is maybe 27 required in the system. 28 Could you just comment on the 744 ADAMSON/CONWAY 1 relative usefulness of the spot market and the 2 intermediate markets in performing this function as far 3 as a signal to generators as to when new capacity is 4 required? 5 I mean, have a sense that what you 6 are saying here is that while the spot market may send 7 a signal, the intermediate contract and forward markets 8 might be sending a better signal. I just want to know 9 whether I understand that properly. 10 MR. ADAMSON: Yes. From my 11 perspective I think I would basically agree with that, 12 and for two reasons. 13 The spot market of the day obviously 14 may reflect very, very short-term phenomena of the day. 15 What is actually important for the 16 new entrant actually building generation is, in effect, 17 the revenue stream that he or she will get through the 18 project for merchant generation projects. So what is 19 really more important is expected values of market 20 revenues extending forward in time, not just for one 21 hour at a future time but across many hours, many 22 months, possibly many years going forward across that 23 time, because clearly that is what drives the financial 24 viability of a merchant generation project. 25 The power of intermediate markets in 26 these forms of new entry I think is quite strong, 27 because it is relatively -- it is always possible to do 28 forecasts of spot prices. We know that these types of 745 ADAMSON/CONWAY 1 forecasts are almost inevitably imprecise. 2 What is important about the forward's 3 prices and having liquidity and depth in those markets 4 is two things. The price signal more reflects the 5 actual risks that the generator is taking on of longer 6 term time horizons, expected values over those time 7 horizons which match his or her investment risk. So 8 really it is the appropriate price signal to look at, 9 if it's available. We hope to make it available, 10 partially through the design of this mechanism. 11 Secondly, it obviously allows one to 12 hedge those risks quite -- it actually allows one to do 13 something about some of those risks and to hedge them 14 at a reasonable cost, unlike the pure spot market which 15 really doesn't allow me as a new entrant generator to 16 do anything about my risk profile at the time when I 17 have to to make an investment. 18 I am returning slightly to the kind 19 of more practical view of the world as I have seen it 20 from various merchant and generation projects with 21 which I have participated, is that even though the 22 intermediate contract markets may not extend to the 23 life of the facilities that one is building, they are 24 considered as, by far, the best signal available for 25 the term that they do exist about the expectations of 26 prices, and that is for two reasons. 27 Market prices have a value over 28 somebody's opinion because they have actually been 746 ADAMSON/CONWAY 1 created by multiple sets of people, not just one person 2 and, in a sense, might be kind of distilling the wisdom 3 of more than one person, a whole group of people. 4 Secondly, I'm always more 5 comfortable, I guess, in a financing exercise with a 6 price that someone is actually willing to do business 7 with rather than someone is willing to just forecast. 8 You can hire me or another consultant 9 to forecast prices all you like, and obviously anyone 10 in the business tries to do as good a job as possible. 11 I'm always much more comfortable when someone is 12 actually willing to put their money where their mouth 13 is and actually trade at a price rather than simply 14 saying, "Well, here is a view of it. You do what you 15 want. I'm not assuming any of the risk of this. If 16 it's wrong, well, there you go." 17 I believe the generation markets and 18 the very critical interface between electric markets 19 and the capital markets, which mainly comes in merchant 20 plant finance, rely, to the extent that they can, on 21 what forward price signals there are. I am not aware 22 of any merchant plant financing with which I have been 23 involved where there has not been explicit 24 consideration to what type of forward prices are out 25 there in the market as a critical piece of evidence 26 that the revenue forecasts, which are in effect the 27 backbone of the financing plan, are consistent with 28 market expectations. 747 ADAMSON/CONWAY 1 It is one thing to take it to the 2 syndicated loan finance group of a major commercial 3 bank and say, "These are our experts' forecasts of 4 merchant plant revenues"; it is another thing to take 5 the same thing to a bank and say, "These are our 6 experts' forecasts of merchant plant revenues and these 7 are the actual forward prices which people are trading 8 in the market and you can actually see that these match 9 up." 10 MR. BRETT: Thank you. 11 Just switching gears a little bit, if 12 I may, to a separate related topic. 13 We have talked a lot about the 14 importance of forward contracts and intermediate 15 contracts of this market. Is there any danger that 16 focusing on this contract market will impede or destroy 17 the spot market, or in some sense damage it to the 18 point where it is not as useful as it should be? Could 19 you comment on the interrelationship between the two 20 markets? 21 MR. ADAMSON: One is always 22 worried -- I raised the Alberta experience yesterday in 23 some ways in sort of a cautionary note about an initial 24 market design which had created a spot market, the 25 Power Pool of Alberta, and then imposed these 26 contracts, vertical hedging contracts called the 27 legislated hedges, which almost insulated the 28 generators from real exposure to that market for the 748 ADAMSON/CONWAY 1 vast majority of their actual revenues. 2 That does tend to create this 3 extremely thin market where the incentives on players 4 may be magnified because their own financial outcomes 5 are not really dependent on what happens to it. That 6 to me is a very critical risk in terms of designing 7 these systems. 8 But let me point out the critical 9 features of those contracts is, that those are in no 10 way commercial contracts. Those were contracts created 11 at the point of restructuring in the Province of 12 Alberta for a very long term, basically life of plant, 13 covering the vast majority of capacity. So these were 14 contracts not based on any actual market dynamics at 15 the start but are almost like imposed over the top of 16 the market and tended to make, effectively, the Power 17 Pool of Alberta relatively thin. 18 Now, that is not what we are talking 19 about here. That is a risk, but that is not really the 20 same thing we are talking about here. 21 What we are talking about, in terms 22 of contracts between generators and other 23 counterparties and standard supply service providers, 24 are commercially-negotiated contracts and 25 commercially-negotiated contracts, like most of these 26 contracts, based on an interaction and an interplay 27 between the expectations of spot market prices and the 28 prices that people are willing to trade for. 749 ADAMSON/CONWAY 1 In these markets, like I believe most 2 commodity markets that exist, there is a whole 3 succession of prices, which I would describe as kind of 4 evolving together in a lock-step fashion, about 5 expectations of spot prices going forward and about 6 intermediate contract prices going forward. That is 7 how most commodity markets work. That is how the oil 8 spot markets work. Those have been kind of in 9 existence for a long time and, generally, actually seem 10 to work rather well. 11 So there is always the interplay 12 between: I always have the choice in a commercial 13 contract world of trading under a contract or retaining 14 the exposure to spot market prices. That relationship, 15 where spot prices and contract prices evolve over time 16 given the market's expectations of the future, is a 17 very different one than the kind of 18 artificially-imposed contract that I was mentioning or 19 the regulatorially-imposed contracts. They are not 20 necessarily artificial, they were created for a reason. 21 I just think they had an influence in the market that I 22 described in the Alberta case. 23 So while it is true I believe that 24 there would naturally be a substantial volume of power 25 traded under contracts, as I mentioned yesterday, I 26 think that is how these markets really should work. 27 There should be this kind of co-evolution of spot and 28 contract prices going forward. That is how we see 750 ADAMSON/CONWAY 1 markets work in a whole range of other commodities. 2 So I don't see any danger from this 3 scheme by saying we are trying to help intermediate 4 contract development; I don't see any danger that we 5 are harming the spot market. In effect, I think we are 6 kind of making the spot market part of the market 7 system that should exist anyway. 8 MR. BRETT: I take it that that 9 interplay in electricity markets has taken place in 10 other jurisdictions around the world where they have 11 restructured or are restructuring? 12 MR. ADAMSON: Yes. As I mentioned, 13 in most of these systems the vast majority of the power 14 is actually covered under some form of a financial or 15 physical risk-sharing agreement in conjunction with a 16 spot market, and that seems to be the way these things 17 kind of evolve. As I mentioned yesterday, I think it's 18 because it reflects the fundamental dynamics that there 19 are actually risks on both sides of the table. 20 MR. BRETT: If I may just switch 21 gears once more -- and this is really my last 22 question -- yesterday you sketched out sort of at a 23 broad level your proposal for a sort of, I will say, 24 benchmark/incentive scheme for competitive procurement 25 of electricity by the distributors. 26 What would it take, in your view, to 27 fill in the details of that proposal? How much work 28 would need to be done to flesh that out? I take it 751 ADAMSON/CONWAY 1 that some additional work would need to be done. 2 MR. ADAMSON: Oh, yes. As I 3 mentioned yesterday, this was not intended to offer 4 kind of a complete written out solution, nor was the 5 sort of time and resources made available to make such 6 a thing. Clearly, a critical issue I think for all of 7 us is we don't want to try to switch gears to something 8 that might cause any delay. 9 I think the basic principles of how 10 these systems work are quite well known in terms of 11 writing down the details in sort of elapsed time. I 12 think anyone who proceeded assiduously would be trying 13 to have kind of a reasonably detailed almost kind of 14 handbook of how it would work, which, given a 15 reasonably concentrated effort, would have, I don't 16 know, a month, six weeks for any kind of initial set of 17 comments from the industry participants. That is my 18 sort of very much off-the-cuff idea of how long it 19 would take to write things down. 20 Now, clearly, at that point there is 21 still a process of consultation to make sure everyone 22 is comfortable with how it has been designed, but the 23 good thing is that these types of incentive mechanisms 24 are not unknown. The principles are well known. So 25 it's certainly not like changing something really 26 complex in the spot market structure or transmission 27 pricing that would require a huge kind of design 28 process. 752 ADAMSON/CONWAY 1 MR. BRETT: Thanks very much, 2 gentlemen. Those are my questions. 3 MS LEA: Thank you, Mr. Brett. 4 Mr. Gibbons? 5 MR. GIBBONS: Mr. Adamson, I am Jack 6 Gibbons from Pollution Probe. I would like to ask you 7 one question about the mechanics of your fixed price 8 proposal. 9 Under your proposal, an LDC would 10 offer a fixed price and it would be based on their 11 portfolio of supply, which would include medium and 12 long-term contracts, and part of the supply portfolio 13 would probably be spot purchases. Is that reasonable? 14 MR. ADAMSON: Could you just repeat 15 the last line? I'm sorry, I just didn't hear. 16 MR. GIBBONS: The fixed price would 17 be a function of their supply portfolio, which would 18 include medium and long-term contracts and some spot 19 supplies? 20 MR. ADAMSON: Possibly. One has to 21 remember that you have to have a firm enough supply 22 contract portfolio in order to offer the price. So you 23 can't have huge -- you couldn't have a very substantial 24 spot component if you were trying to set a tariff 25 ex ante, if you will. You couldn't have a very large 26 weighting of spot prices, if at all. 27 MR. GIBBONS: So are you assuming 28 there would be no spots in the portfolio for the fixed 753 ADAMSON/CONWAY 1 price option? 2 MR. ADAMSON: You may be able to have 3 some, but you also are incorporating -- if you are 4 offering a fixed rate, I think the mechanics are 5 relatively clear, you can't incorporate a huge amount 6 of spot price exposure in the portfolio without 7 assuming risk. 8 MR. GIBBONS: Right. 9 MR. CONWAY: I think it's possible, 10 too, that a strategy a portfolio manager might use to 11 diversify the risk would be to try and offer portfolio 12 management services to competitive supply. So if we 13 were worried about volume volatility because of 14 movement between the two portfolios, there would be 15 some isolation by diversifying between the two, and it 16 may be therefore possible to use a much lower component 17 of spot in the portfolio itself. 18 MR. GIBBONS: Mr. Adamson, when you 19 said the spot component would be small, can you give me 20 sort of a ballpark figure? Would it be something like 21 5 per cent or 20 per cent? 22 MR. ADAMSON: I don't quite want us 23 to get ahead of the level of detail that I have 24 actually gotten on designing it up to this point. I 25 don't want to make kind of a numerical estimate because 26 I simply haven't done the type of analysis that I would 27 want to do in order to make sort of a precise numerical 28 number. 754 ADAMSON/CONWAY 1 I think the mechanism I have 2 described is reasonably clear about the potential risk 3 if one included a very large spot exposure. I don't 4 want to make a very precise numerical estimate simply 5 because I just don't feel like I have done my homework 6 to be able to make an assertion of that sort. 7 MR. GIBBONS: But is it reasonable to 8 assume it is likely that greater than zero per cent 9 will be spot? 10 MR. ADAMSON: It's likely to be 11 greater than zero? It has to be zero or greater. 12 I think we don't want to get ahead of 13 ourselves in specifying this. I really don't want to 14 design this on the fly while I sit up here. I think 15 the mechanics I have tried to lay out, my objective was 16 to present this as a concept and to explain the 17 incentives that create -- explain how it might work in 18 economic terms. 19 I don't want to get into trying to do 20 the precise -- I don't want to make assertions to you 21 before I have had a chance to do any homework on it. I 22 just don't think it will serve us well to try to kind 23 of design it on the fly. 24 So, in a sense, I am much more 25 comfortable trying to explain what I have been trying 26 to achieve here and how I envision it working. But in 27 terms of the numerical details, you know -- we should 28 always be careful about trying to simply do things off 755 ADAMSON/CONWAY 1 the cuff without having thought it through. 2 MR. GIBBONS: Okay. 3 Let's just assume for a moment that 4 there is a spot component and at the beginning of the 5 year they establish a fixed price based on an 6 expectation of what the spot price will be. Let's 7 assume at the end of the year that the actual spot 8 price is different from the expectation at the 9 beginning of the year, and there is a differential, 10 either that the LDCs electricity costs are higher or 11 lower than forecast and there will be a differential. 12 What happens to that differential? 13 Does that go to the account of the shareholder or is 14 that differential somehow passed on to the customers? 15 MR. CONWAY: I think it depends. You 16 could also hedge the spot price by buying a call 17 option, for instance, so it really depends how the 18 portfolio manager puts the portfolio together as to 19 whether there would even be a differential to start off 20 with. 21 MR. GIBBONS: Let's just assume that 22 there is a differential and that there is a potential 23 profit or loss. Does that go to the account of the 24 shareholder or are you suggesting that it be passed on 25 to the customer? 26 MR. ADAMSON: The objective was to 27 create a set of fixed prices for the customer and not 28 to back-stop all of the decisions of the procurer. If 756 ADAMSON/CONWAY 1 you allow a pass-through of all of these spot prices, 2 it seems to me we have kind of reverted to square one. 3 In any procurement mechanism design 4 exercise we always want to make sure the incentives are 5 pushed the right way, and I think those incentives 6 would be pretty blunt if we allowed any variation to be 7 returned automatically to the customer. 8 MR. GIBBONS: Thank you. Those are 9 my questions. 10 MS LEA: Thank you, Mr. Gibbons. 11 Mr. Poch. 12 MR. POCH: Thank you. 13 Mr. Adamson, I want to ask you about 14 the impact of the choice between spot price 15 pass-through and the fixed option where the MEUs are 16 actually procuring power on the ability, at least in 17 the next few years, of Ontario Power Generation to 18 exercise market power. 19 As a layman, it strikes me that if 20 you have people just at the whim of the spot market, 21 that would give more leeway to the dominant seller into 22 that market, as opposed to having a number of more 23 sophisticated procurers in the market negotiating 24 contracts. 25 Does that bear up under the scrutiny 26 of an economist? 27 MR. ADAMSON: As I mentioned 28 yesterday, from my view, none of these mechanisms are 757 ADAMSON/CONWAY 1 capable of addressing on their own a fundamental market 2 structure issue. Those have to be dealt with in a 3 broader and more decisive manner than what we are 4 trying to -- than the objective of this technical 5 conference. 6 I think we might make a few 7 observations, I guess. 8 We know that if there were to be a 9 substantial potential for abuse of market power in spot 10 markets, that is quite likely to extend to contract 11 markets as well and vice versa. So we might say that 12 while it is relatively -- maybe this is a problem that 13 exists across any mechanism that we have been 14 discussing here over the last few days, whether it is 15 spot or contract-driven or, indeed, Mr. Todd's kind of 16 RFP option-driven. 17 However, there is possibly a few 18 things which I think may tilt the playing field 19 somewhat toward the contractual mechanism. You 20 mentioned -- and it is one which I think is actually 21 relatively valuable -- that in the kind of pure spot 22 mechanism no one is actually kind of negotiating on 23 behalf of the customer. The standard supply service 24 providers are completely indifferent. You know, it is 25 effectively just a calculation. 26 One observation about how market 27 power is applied in these markets has really, I guess, 28 to do with the value of information. It seems to me 758 ADAMSON/CONWAY 1 that the spot price mechanism is not providing any kind 2 of countervailing force for accumulating information 3 and using it in an appropriate way that a procurement 4 mechanism might provide. 5 We might also think that the 6 contractual mechanism at least leaves scope for entry 7 by non-generation players into hedging markets. 8 Persons or organizations might find it possible to 9 offer some sort of risk-hedging services through 10 potentially being able to re-ensure some risk 11 themselves by potentially being able to deal with some 12 of the basis risk between Ontario spot prices and 13 prices in other markets, for example in western New 14 York state or into the NYMEX synergy market or other 15 related markets in the U.S. 16 Most importantly, I would argue that 17 getting these contract market offers, you may not cure 18 it in day one but it offers the best hope for bringing 19 in the only thing which is really going to help, which 20 is the fundamental market structural change, and that 21 is by getting some new entry into this market. 22 Without kind of an accelerated 23 process of market structural change, if we feel that 24 there is a significant potential market power problem, 25 the only cure for that is going to be entry. As I have 26 tried to say before, I do think the contractual 27 mechanism offers a wider scope for entry, particularly 28 by smaller market players. 759 ADAMSON/CONWAY 1 I think the field is actually tilted 2 to the contractual solution as opposed to the spot 3 price solution, in terms of how the kind of potential 4 for abuse of market power might play out. 5 MR. POCH: Thanks. I have a couple 6 of questions on your yardstick regulation model. 7 In such an approach, need we be 8 concerned about sweetheart deals with affiliated 9 generators or power brokers or cross-subsidy? 10 MR. ADAMSON: Yes. You would 11 potentially -- one would always be worried about a 12 self-dealing-type arrangement, and really the reason is 13 pretty clear. 14 I had on the little slide with the 15 coloured bars yesterday these kinds of risk-sharing 16 bands illustrated. If a standard supply service 17 provider was able to effectively get a non arm's-length 18 sweetheart deal, as you put it, with, say, an 19 affiliated generator, and try to include that in their 20 portfolio, would the benefit they were getting from 21 that, would the kind of profit they were getting from 22 that, be matched against the penalty of, say, including 23 a higher average cost in their yardstick? One couldn't 24 be -- it would be more difficult to ensure that that 25 wasn't happening. 26 So I think most procurement 27 mechanisms of any sort have some sort of protections 28 there. 760 ADAMSON/CONWAY 1 To give you an idea -- and I am not 2 quite sure I can remember all of the numbers and 3 percentages right, so perhaps Fiona can help me 4 later -- there were restrictions, for example, on the 5 ability of the regional electricity companies in 6 England and Wales to buy power for their franchise 7 customers from generation projects in which they had an 8 interest. It was partially just to try to sort of 9 control these types of -- to try to ensure that the 10 incentives from non arm's-length transactions didn't 11 distort things. 12 The good thing is that, in general, 13 this has not been the biggest problem in the world of 14 implementing it, at least from my experience. I think 15 the restrictions one would need would be pretty simple 16 and pretty easy to write down. 17 MR. POCH: Indeed, the legislation 18 contemplates that. It is just I am wondering if we 19 need any other special protections. 20 MR. ADAMSON: No. 21 MR. POCH: Okay. In the particular 22 example of yardstick comparative or relative 23 competition -- I forget the phrase you have used -- you 24 have this penalty and bonus regime. 25 If that proves to be problematic 26 under the legislation, can you offer us any other means 27 that keeps regulatory burden in check, any other means 28 of yardstick or other light-handed regulation, but that 761 ADAMSON/CONWAY 1 doesn't require the Board to take cash from one utility 2 and give it to another? 3 MR. ADAMSON: Yes. Let's be a 4 little -- and perhaps I should have been a bit more 5 precise in my terminology. When I say penalty and 6 bonuses, it need not be in a kind of legal sense. My 7 interest is just in the creation of economic incentives 8 for efficient procurement. That is probably a slightly 9 less loaded phrase. 10 To me, it was up on the slide and it 11 is kind of easier to almost explain in a conceptual 12 basis. 13 Let's think of them as economic 14 incentives for efficient procurement. Need that 15 involve money being transferred from one to another? I 16 don't think it does. 17 I think a kind of an accrual 18 mechanism within a utility's own account might -- I'm 19 sorry, a standard supply service provider's own account 20 might serve the same purpose by involving -- and I 21 think these types of accrual accounts are common in 22 almost every regulatory regime, of basically 23 recapturing, either way, the incentive payment in the 24 next period so that no money need flow from A to B or B 25 to A. It may simply be that your "bonus", your 26 incentive payment, comes next period but no money need 27 change hands. 28 From my very simplified reading of 762 ADAMSON/CONWAY 1 the Act -- and again, I would certainly defer to those 2 persons present who have the legal understanding of 3 it -- that system would not pose any problems. 4 MR. POCH: We have comparable systems 5 already in place in gas, as you suggest. 6 MR. ADAMSON: Yes. So it is very 7 similar to a PBR-type system really. It should be 8 thought of as being very similar to the PBR system 9 which is being employed in other aspects of the 10 electric industry here in Ontario. So it is certainly 11 not a foreign concept. 12 I think that the way that the monies 13 would move between periods could be relatively similar 14 to how one would have it in a PBR system. 15 MR. POCH: Right. Okay. 16 Moving on to a subject dear to my 17 heart, the environmental matters, green power, for your 18 information, the Energy Board has a statutory objective 19 to facilitate, to move towards more environmentally 20 benign energy sources. We are suggesting that the 21 Board require a bundling-in of green power, the exact 22 amount of which would be determined, presumably, 23 generically for the sector based on consideration of 24 costs and benefits and price impacts. It could be done 25 with a fixed requirement or through some incentive 26 approach. 27 Does such a requirement conflict in 28 any way with your proposal, assuming it's a small 763 ADAMSON/CONWAY 1 proportion of the fixed portfolio? 2 MR. ADAMSON: I think if you wanted 3 to implement a -- I guess your question is: Is it 4 possible to interface a green power requirement with 5 the standard supply service mechanism that I have 6 discussed? 7 MR. POCH: Yes. 8 MR. ADAMSON: Can those interface 9 together well? 10 I don't see why they can't. I think 11 if you wanted to have a green power portfolio 12 requirement, if that was a policy decision of the 13 province, I don't see why there couldn't be built into 14 the requirement of the standard supply service 15 providers to meet some kind of portfolio green power 16 requirement, if that is what was chosen to be done. 17 Again, in assuming some of this new 18 green power would be built rather than existing green 19 power, it might even help some -- the availability of 20 this risk hedging potential that I discussed earlier 21 might in fact help get some of it built. 22 But I don't see any fundamental 23 disconnect between the system I have described and a 24 green power portfolio requirement if the province 25 decided that that was the way it wanted to go and 26 wanted to implement that. 27 MR. POCH: Okay. I have one final 28 question. I am going to ask you to look at a document 764 ADAMSON/CONWAY 1 that I have obtained from your fair country. 2 I will hand it out. 3 --- Pause 4 MR. POCH: I have put in front of you 5 a document we pulled off the Web entitled "Databases 6 State Incentives for Renewable Energy", published under 7 a program called National Databases State Incentives 8 for Renewable Energy, initiated by the U.S. Department 9 of Energy. 10 I take it you are familiar with the 11 U.S. daily -- 12 MR. ADAMSON: Yes. 13 MR. POCH: This includes two tables, 14 one of which is State Financial Incentives to 15 Renewables and the second which is State Programs and 16 Regulatory Policy table. 17 I should indicate that this is 18 already about six months out of date, this particular 19 printout. 20 I am not asking you to verify every 21 circle and shaded square. I am really just putting 22 this in front of you to see if you can confirm, from 23 your experience south of the border, my impression, 24 which was that things like RPSs, or renewable portfolio 25 standards, or set-asides, or net metering, and so on, 26 which are regulatory supports for renewables, are a 27 fairly commonplace feature emerging in jurisdictions in 28 the States going through restructuring. 765 ADAMSON/CONWAY 1 MR. ADAMSON: Well, I can't say I am 2 intimately involved or knowledgeable of the 3 restructuring programs and legislation which, as you 4 have suggested yourself, is continuously changing in a 5 lot of the States. A lot of the States have relatively 6 early-stage restructuring proposals or draft 7 legislation on the table. 8 Certainly, some of the States I have 9 been involved in the restructuring of, they have had 10 pretty substantial discussions of green power 11 renewables issues. That is not an area that I 12 personally work on in terms of these restructurings. 13 We all have our specialties, even within this field. 14 So I am probably not a great person to confirm these 15 types of things. 16 MR. POCH: Well, I wouldn't ask you 17 to -- 18 MR. ADAMSON: These are certainly 19 issues that have been discussed in a lot of U.S. state 20 jurisdictions through the restructuring process. I 21 guess your sort of table from the Department of Energy 22 suggests, certainly, some of the States have included 23 in the -- some of the States have gotten further along 24 and included some form of these programs in their kind 25 of final regulatory restructuring design. 26 I am probably not the person to ask 27 about how all those work in detail because I'm just not 28 expert enough on it. 766 ADAMSON/CONWAY 1 MR. POCH: I wasn't going to get into 2 detail with you. I was really just asking you to 3 confirm my understanding that generally this is fairly 4 prevalent in the discussions and has been put in place 5 in a number of jurisdictions. 6 I take it that that general take on 7 it is in accord with your understanding? 8 MR. ADAMSON: Yes. Broadly speaking, 9 I agree with that statement. 10 MR. POCH: Okay. That is all the 11 questions, then. Thank you very much. 12 MS LEA: Thank you, Mr. Poch. 13 Is Mr. Rawson, or someone else from 14 TransCanada Power, here? 15 Okay. Thank you. 16 Mr. Ronayne? 17 MR. RONAYNE: I'm Mark Ronayne. I am 18 not a lawyer, I am an economist, a senior economist, 19 with the Competition Bureau, so I'm going to try not to 20 be -- I'm not going to focus on legal issues here, but 21 I would really like to get to the point of what you are 22 saying in this, Mr. Adamson, in particular. 23 I think you are saying that there are 24 various ways for dealing with the standard supply 25 service option and it is a matter of choosing sort of 26 the lesser amongst a bunch of evils. Is that -- 27 MR. ADAMSON: That is one way to put 28 it. I would say it is very important to recognize -- 767 ADAMSON/CONWAY 1 which I think I have put almost as one of the first 2 lines of my paper -- that there is a set of trade-offs 3 in designing this or almost anything, and we need to be 4 very cognizant of what those trade-offs are. So in a 5 very idiomatic way, I guess there is always the choice 6 of the least of evils. 7 MR. RONAYNE: Thanks. 8 MR. CONWAY: I would suggest that one 9 of the options is definitely evil. I'm not sure about 10 the others that we proposed. 11 MR. RONAYNE: Well, let's just say we 12 are in a world of, at best, second best, then, if we 13 can put it that way. 14 I just wanted you to clarify, 15 perhaps, one statement you just made a minute ago. 16 You said that under SSS nobody is 17 negotiating on behalf of the consumer if it's a spot 18 price pass-through mechanism. But that is in regard to 19 the standard supply option only, in that, as far as 20 negotiating on behalf of consumers and packaging energy 21 and waste that are acceptable to consumers, there 22 should be retailers in the marketplace that may be able 23 to perform that function. 24 MR. ADAMSON: Yes. As I think I 25 tried to draw a mental picture of yesterday, remember 26 that the smaller world of standard supply will be 27 surrounded by a kind of a broader universe of the 28 competitive retail market and that the provisions, from 768 ADAMSON/CONWAY 1 my reading of course, always leaves everyone the option 2 to move into that competitive retail market and so, 3 remember that we have focused our attention on the 4 standard supply service issue but it really is kind of 5 imbedded in the kind of larger competitive retail 6 market in the province, which, from my reading, the Act 7 makes perfectly clear is available to people to enter. 8 MR. RONAYNE: I haven't seen your 9 proposal anywhere else, the type of argument that you 10 are making, and I find it quite interesting, so I hope 11 you don't mind if I have a lot of questions. 12 MR. ADAMSON: I have an example of 13 it. 14 MR. RONAYNE: Oh, you do have an 15 example? 16 MR. ADAMSON: Yes. 17 MR. RONAYNE: For a standard supply 18 service? 19 MR. ADAMSON: Well, they don't call 20 it that. In Colombia, in South America, I think the 21 Ono test has the reputation among those of us who kind 22 of deal with this around the world as being one of the 23 more successful Latin American restructuring efforts. 24 They don't have standard supply because they don't have 25 retail competition. What they have is they have 26 distribution utilities that buy on behalf of their 27 customers for everyone, or virtually everyone. So it 28 is somewhat -- it is very economically similar to what 769 ADAMSON/CONWAY 1 we are talking about. 2 MR. RONAYNE: Is there retail access, 3 then, in that -- I wasn't clear. Is there retail 4 access in that -- 5 MR. ADAMSON: No, no retail, or maybe 6 only for a very small percentage of customers. 7 MR. RONAYNE: Okay. So no retail 8 access -- 9 MR. ADAMSON: Unfortunately, I'm 10 having to relay to you information provided by a 11 colleague who has worked a lot on the Colombian market 12 and has the great advantage of speaking Spanish and is 13 able to read all the documentation in the original, 14 unlike me, whose Spanish just mainly consists of words 15 from Mexican restaurants. 16 To give you a little description of 17 how it works, though -- and I think you will see the 18 analogy of what I am discussing here -- is the 19 distribution companies who provide the service in 20 Colombia buy power for their customers primarily under 21 contract, they are required to buy under contract, for 22 the majority of it, from the spot market, called the 23 "bolsa", in Colombia. 24 Now, the regulatory agency, whose 25 name I won't embarrass myself by trying to pronounce in 26 Spanish, allows them to pass through contract costs up 27 to a certain point. I think the number is about 70 per 28 cent, but I want to check this, in terms of the exact 770 ADAMSON/CONWAY 1 percentages. Some amount of it is the pass-through and 2 some amount of what they get to charge to their 3 customers is the average cost across all the 4 distribution companies out of the larger set of 5 distribution companies. So for that component of it 6 you will see it is quite similar to the example I had 7 up on the overhead yesterday of my airplane tickets 8 example, where if I allow Mr. Stephenson to charge me 9 the average price and he keeps the difference if he 10 manages to do it cheaper or pays the difference if he 11 is above the average it produces this quite strong 12 incentive to bring down the average purchase cost. 13 So the mechanism is actually really 14 quite parallel to the one I'm talking about in that it 15 does use an explicit comparative competition mechanism. 16 It is implemented in a slightly different way than the 17 one I have discussed but, really it is more of a -- as 18 much of a difference in how the way I have described is 19 a fundamental economic difference. So it is not a 20 mechanism that hasn't been tried. 21 It seems to have worked rather well 22 in Colombia. One thing I would really quite like to 23 note, because it highlights some of the issues that 24 some of the other people have brought, is that there 25 appears to be quite a strong contract market in 26 Colombia, despite a very widely varying bolsa price, 27 which is partially dominated by hydrological risk and 28 the risk of El Nino years which affect the weather in 771 ADAMSON/CONWAY 1 that part of the world rather substantially. Despite 2 that, the contract market is quite strong. There has 3 been a substantial amount of private investment in the 4 sector, of the sale of generation assets to foreign 5 companies from Chile, from the United States, from 6 Spain. 7 Interestingly, Colombia has one of 8 the first new entrant merchant generation projects 9 coming on line, and this is in a country which has had 10 a series of financial and economic crises and some 11 pretty substantial currency risks and pretty 12 substantial political risks. Even so, I mean there is 13 a pretty good contract market there, which is really 14 helping people who are looking at either building or 15 buying this merchant generation in Colombia. 16 So the mechanism does seem to be 17 aiding the development of the contract market in the 18 way I described. 19 Now, I certainly don't have with me 20 all the details of the exact implementation of the 21 Colombian system, but I could try to get them. 22 MR. RONAYNE: Is the difference 23 between Colombia and Ontario how they are dealing with 24 market power issues at the generation level? Is there 25 an issue in Colombia around having a large generator at 26 the centre of the system? Do they have something like 27 the market power mitigation program in place that is in 28 Place in Ontario? 772 ADAMSON/CONWAY 1 MR. ADAMSON: They don't really have 2 exactly the parallel problem. To my knowledge, there 3 is not an equivalent of the MPMA in Colombia, but they 4 also don't have the same market structural issues. 5 MR. RONAYNE: Fair enough. 6 MR. ADAMSON: In that sense, I think 7 the fundamental differences in market structure has 8 just meant that the issues are just different. 9 MR. RONAYNE: Thank you. 10 So then something that is very 11 different between Columbia and Ontario is the market 12 power monitoring mechanism or the agreement to deal 13 with market power. 14 So in that context, I guess my 15 question is, partly: What intermediate markets are you 16 exactly trying to develop in this marketplace where we 17 have the bulk of the power being capped annually at 18 3.8 cents, and that is going out likely 42 months, and 19 then going beyond that, perhaps up to 10 years before 20 that price cap is going to be removed? So that is kind 21 of a fixed price or a guaranteed price that Ontario 22 Hydro is going to get. They can get up to it and they 23 can't get less. 24 So I guess what I'm wondering about 25 is, given that is going to exist in the marketplace, 26 that the bulk of the power is going to be provided at 27 3.8 cents, what are you trying to build around that 28 3.8 cents through this proposal? 773 ADAMSON/CONWAY 1 MR. ADAMSON: I wasn't sort of 2 present at the birth of the formation of the MPMA so I 3 guess I'm a rather Johnny-come-lately to this. 4 My reading of the MPMA is it is not 5 actually a guaranteed price, it is more of the form of 6 a revenue cap, a kind of a revenue -- yes, kind of a 7 revenue cap arrangement. Part of my problem with it is 8 that it creates the rebate mechanism, as you suggested, 9 at this kind of specified price for a very considerable 10 period of time, a very considerable amount of 11 generation unless decontrol happens on a much faster 12 time schedule. 13 A problem, from my perspective, with 14 the way the thing is laid out, is I'm not sure it 15 absolutely guarantees the price at any particular hour, 16 it actually creates a revenue cap on an annual basis 17 across 8,760 hours based on a formulation of these 18 model "Q"s used, which I can't say I have fully come to 19 terms with exactly how these "Q"s were derived. 20 That can have some relatively 21 different incentives, in my mind, than, for example, 22 the legislated hedge mechanism that we talked about in 23 Alberta. 24 It is not clear that the price is 25 fixed at 3.8 cents, what is clear that on an annual 26 basis there is a formula for revenue capping. That, to 27 me, does not necessarily help to exactly specify prices 28 in any one hour, and in fact, as I think I alluded to 774 ADAMSON/CONWAY 1 yesterday, one would want to investigate carefully and 2 critically the incentive that creates on individual 3 hourly prices under that type of revenue capping 4 scheme. 5 MR. RONAYNE: I thought your concern 6 wasn't with the hourly prices but it is with the 7 intermediate markets. I mean, it wasn't with the spot 8 price. What you are trying to promote -- I mean, that 9 seems to me like it's a spot price issue in 10 interpreting the spot price concern. 11 What you are focusing on is annual or 12 longer type of contractual arrangements. Am I wrong in 13 that? 14 MR. ADAMSON: What I guess is, I'm 15 highlighting the fact that it is not the same as saying 16 that there is an offer price at 3.8 cents which goes 17 for a year. What there is is a mechanism which creates 18 specific incentives on the spot price. 19 A secondary issue, but I think a 20 direct economic consequence of the market structure and 21 the incentive created by the MPMA, is: What does that 22 mean to the contract market. 23 I agree with your assertion, what I 24 take to be your assertion -- and please let me know if 25 I'm saying something you don't agree with -- I agree 26 with your assertion that the potential for the abuse of 27 market power in the contract market is definitely 28 there. Can we have a really well operating 775 ADAMSON/CONWAY 1 intermediate market in a situation of very heavy 2 concentration for an initial period of time? I don't 3 think we can. 4 I would also point out that we also 5 don't, in that case, have much of a spot market either. 6 MR. RONAYNE: I don't think I said 7 that we did have a spot market. 8 --- Laughter 9 MR. ADAMSON: The two are sort of 10 dual. They are almost kind of mirror-type images of 11 each other. They coexist. 12 But I do agree with your assertion 13 that the potential for the ability get a good 14 intermediate market in Ontario will always be 15 constrained for some period of time if there is simply 16 not enough potential natural counterparties -- 17 e.g. generators -- in order to make their market 18 competitive. 19 MR. CONWAY: I would like to add a 20 comment also. 21 There are two schools of thought 22 about how the Market Power Mitigation Agreement should 23 be viewed, as to whether it is a cap or whether it is 24 actually a floor. 25 You will see in the study that we 26 filed yesterday that the cap only protects about 27 three-quarters of the market, 90 per cent or 85 per 28 cent of the Genco volume in the market. Therefore, at 776 ADAMSON/CONWAY 1 least a quarter of the market is unprotected. 2 The rest of the study goes on to say 3 that the volatility before market power mitigation is 4 probably going to be quite high. If you only have 5 three-quarters coverage, basically you have a quarter 6 of the volatility flowing through to the customer even 7 after market power mitigation rebates. 8 So my contention is that a quarter of 9 a very large number is still a large number. So there 10 is going to be some volatility in this market. 11 MR. RONAYNE: Well, we will get to 12 the volatility issue later, because I do want to 13 explore that and exactly what volatility you are 14 talking about. 15 You draw a distinction between -- 16 because you are talking about making a fixed price 17 offer available of some sort. Presumably, that is not 18 going to be a direct spot market price pass-through, 19 but it is going to be maybe a one-year or two-year or 20 three-year type of option. 21 So if we are talking about 22 comparative implications for one or the other, then we 23 are looking at what about over a year, or something 24 like that. What is going to happen from hour to hour 25 to hour in the spot market? There may be ways to deal 26 with that type of volatility, but I will get to that 27 later. 28 Mr. Conway, you said there is maybe 777 ADAMSON/CONWAY 1 25 per cent that won't be subject to the price cap or 2 the market power mitigation measure? That is what you 3 think? Is that who you are focusing on, then, for 4 intermediate markets, that other 25 per cent? The rest 5 is sort of guaranteed at 3.8 cents. 6 I'm trying to figure out what you are 7 getting at here in the intermediate market. 8 MR. CONWAY: Well, the rebate goes 9 back to all players in the market. What I'm saying is, 10 they are only going to get coverage to cover 11 three-quarters of the volatility they would have faced 12 without the Market Power Mitigation Agreement. So 13 virtually every customer exposed to spot is going to 14 see at least a quarter of what is happening in the real 15 spot market. 16 MR. RONAYNE: All right. 17 So you are saying that the volatility 18 for a consumer, then, is on the 25 per cent that is not 19 subject -- over an annual basis, it is the 25 per cent? 20 They have some possible downside? 21 MR. CONWAY: They have some downside, 22 and the upside -- 23 MR. RONAYNE: It is downside in the 24 sense that the price will be lower -- 25 MR. CONWAY: Right. 26 MR. RONAYNE: -- may be lower. 27 MR. CONWAY: Well, on a daily basis 28 they face the actual volatility. After the rebate they 778 ADAMSON/CONWAY 1 have some downside at 100 per cent of what is going on, 2 and the upside is constrained to a quarter of the 3 upside volatility. 4 Like I say, a quarter of upside 5 volatility in any electricity market I have seen is 6 still a pretty large number. 7 MR. ADAMSON: My problem is clearly 8 illustrated by this. There are a lot of ways to get 9 3.8 cents, in fact there is an almost infinite number 10 of -- there is almost an infinite number of ways with 11 8,760 hours to meet a revenue cap. 12 I will be the first to admit I have 13 not made nearly as detailed a study as Mr. Todd, but 14 just from reading the formula and from -- I mentioned 15 the experience of the offers' rather ill-fated 2.54p 16 cap in England and Wales. I can think of a lot of ways 17 to make that number happen. 18 MR. RONAYNE: I'm sure you can. 19 But I guess what I want to get at is, 20 if you have market power and you have a 3.8 cent cap, 21 your concern is going to be getting to that cap, and if 22 some times during the year you can't get it you will 23 probably try to recoup it later on. So you may end 24 up -- and I think this is partly your argument -- that 25 you may see, during some periods, very low prices 26 followed by abnormally high prices, higher than they 27 should be, which are the result of market power in 28 order to achieve the 3.8 cent cap. I will certainly 779 ADAMSON/CONWAY 1 accede that point. 2 But if there is a price cap, which is 3 an annual price cap, in place and a person is rational, 4 in some form of the word, I mean, I don't think it 5 takes rocket science to realize that, well, if they are 6 price capped at 3.8 cents and they are going to have to 7 rebate on the basis of a 3.8 cent price, then over a 8 year what I expect is that power I am going to get at 9 3.8 cents. 10 MR. CONWAY: That is exactly the 11 problem I am trying to address. It's a delusion. 12 MR. RONAYNE: I'm talking about for 13 the Ontario Hydro power, the OPG power. I'm not 14 talking about the other 25 per cent. 15 MR. CONWAY: The market is the total 16 market. So customers are going to see what is 17 happening in the total market, and OPG is not enough, 18 the rebate is not enough to cover the entire case. 19 MR. RONAYNE: So you are agreeing 20 with me, then, that it is the 25 per cent that is the 21 volatile part of the marketplace? 22 MR. CONWAY: No. The whole 23 marketplace is volatile. 24 MR. RONAYNE: On an annual basis. 25 MR. CONWAY: The whole market is 26 volatile. The rebate will tend to mitigate some of the 27 volatility, but it is not going to eliminate it. 28 As I said, the two schools of 780 ADAMSON/CONWAY 1 thought. I think one is delusional, which is the 2 3.8 cents as a cap. The other, probably more realistic 3 view of it, is that 3.8 cents is the floor and that the 4 excursions above 3.8 cents are likely and that the 5 customers are not going to see a full mitigation of 6 those excursions. 7 MR. RONAYNE: There is something in 8 that that would explain to me -- is there analysis that 9 you have done to say that this price cap in the market 10 power mitigation proposal on the table in Ontario is 11 not going to work as intended? 12 MR. CONWAY: I don't know what intent 13 it was. It was intended to give some mitigation to the 14 exercise of market power. In other words, it is really 15 just trying to leash or harness market power to some 16 extent. 17 MR. RONAYNE: Fair enough. 18 MR. ADAMSON: So I think the hope is 19 that price will be around 3.8 cents, but if you go 20 through the analysis that was conducted in the study I 21 referred to, you will find out that there are lots of 22 occasions where a price could go above 3.8 cents net 23 after market power mitigation. 24 MR. RONAYNE: Thank you. 25 MR. ADAMSON: One of my concerns 26 about it, Mark, is that, as I said, I think there are a 27 lot of ways to get that number to come out. 28 Let's assume your assumptions and say 781 ADAMSON/CONWAY 1 that the annual average for that volume will sort of -- 2 well, that needle will be pegged at 3.8 cents. Let's 3 just take that as your assumption -- as an assumption, 4 not necessarily your assumption, that on the annual 5 average basis there will be that 3.8 cents. 6 Now, even under that I suggest we may 7 still have a problem. It is the problem that, 8 particularly under a spot market mechanism, for anyone 9 facing daily prices, these are not just revenue 10 numbers, these are meant to be prices, and prices are 11 supposed to send signals which are allocatively 12 efficient. These are supposed to send signals about 13 when people should consume electricity. 14 So we impose this cap, or this 15 mechanism, and kind of guarantee this average, but we 16 need to be very careful -- well, if I was asked, and 17 since I'm up here I guess I have a microphone and I 18 guess I'm talking about it anyway -- we need to be 19 careful in looking at a system so that there is no 20 incentive for prices to be distorted, because what 21 would potentially worry me is a system where, even 22 though we met kind of an average target, there was the 23 potential, for example, for substantial exertion of 24 market power in specific periods to raise mid-merit and 25 peak prices and suppress off-peak prices, or any one of 26 a number of scenarios one might conjure up. 27 And why is that important? Well, 28 because it really greatly affects -- if you think that 782 ADAMSON/CONWAY 1 behaviour exists and if you think it potentially occurs 2 and continues, it would greatly affect the average unit 3 revenue received by a new entrant generator into the 4 market. If I believe that new entry is not very likely 5 at every point across the price duration curve, it is 6 really probably actually only concentrated in one or 7 two areas, probably pretty near base load for a 8 combined cycle plant. Anything that affects the 9 average unit revenues at those types of capacity 10 factors or artificially suppresses them can have a very 11 strong anti-competitive effect. 12 If I got to dictate prices -- and 13 this again is my assumption -- I would be looking very 14 hard to ensure that I earned most of my 3.8 cents over 15 time during the period of which this mechanism existed 16 in periods which were very unlikely to be attractive 17 for a new entrant to enter at those types of capacity 18 factors. 19 I might be trying to shape the market 20 outcome for the purposes of, over the longer term, 21 ensuring that my competitive position wouldn't be 22 eroded over time because, from a pure capital 23 efficiency standpoint, I think it's pretty clear to all 24 of us that a lot of the likely new entrant generation 25 technologies really can't occur at every capacity 26 factor. No one is going to be able to afford to build 27 a combined cycle plant that's going to operate on a 28 40 per cent capacity factor. The average unit revenue 783 ADAMSON/CONWAY 1 requirement is so much higher than had it ran at a much 2 higher capacity factor. 3 So remember that there are still some 4 effects about what the shapes of prices are, as well as 5 their kind of annual averages under the MPMA, because 6 it can still have competitiveness effects in the market 7 which could affect the investment decisions and again 8 these are meant to be prices for consumption. We are 9 going to have people responding to hourly prices, we 10 know there is going to be industrial load out there and 11 we don't want those massively distorted. It's just 12 purely allocatively inefficient. 13 I think there are some broad lessons 14 and some broad experience to be gained through a little 15 historical excursion in looking into the effects of 16 some of these mechanisms that have been in other 17 jurisdictions, such as England and Wales. 18 MR. RONAYNE: Thanks for that long 19 answer. 20 MR. ADAMSON: Sorry that turned into 21 a lecture. 22 MR. RONAYNE: I want to move on to 23 something else. No, maybe I just have one final 24 question on that. 25 The times when you expect 26 excursions -- load demand times that you would expect 27 in the market tend to be more competitive when 28 Ontario -- well, Ontario is a winter peak area, so 784 ADAMSON/CONWAY 1 let's say in the summer or in the fall, because you are 2 further down the supply curve, competition would tend 3 to be more intense in the sense that, depending on who 4 the competitors are, you may have a more competitive 5 market then, as opposed to a peak where much more of 6 Ontario Hydro's or OPG's capacity would be dispatched 7 in the wintertime. 8 Do you think the excursions might, 9 anyway, kind of track what would happen normally in a 10 marketplace but maybe make it more volatile? Let's say 11 during periods that would be low-priced periods, under 12 a competitive scenario, the prices would still be low, 13 but during the high-priced periods, peak periods, 14 prices would be significantly higher. I am not exactly 15 sure what you would expect to have happen here. 16 MR. ADAMSON: I think you are 17 basically probably familiar with my approach of 18 thinking about these markets from the Alberta 19 experience. Things are very heavily affected by the 20 shape of the supply curve. In very broad terms, 21 though, I think I would probably be in agreement with 22 your statement that the ability to influence prices is 23 clearly correlated to demand and in high demand 24 periods, which, as you suggest, is winter in Ontario, 25 then pricing power is much likely to be increased. 26 A very nice little way to cut through 27 and think about this is to think about the relationship 28 between, effectively, reserve margin and the size of 785 ADAMSON/CONWAY 1 the largest player. One very clear illustration of 2 market power is if the reserve margin is smaller in an 3 hour -- let's say the amount of excess operable 4 capacity, so you would need to account for maintenance 5 and whatever. If the amount of excess capacity in an 6 hour is -- if the excess of that capacity is smaller 7 than the largest player, then that largest player has 8 got to be called. 9 Just think about it as a simple 10 Cournot game. If that largest player has to be called, 11 then he or she gets to set the price that's called. 12 Obviously, the way to think about it in terms of your 13 seasonal picture is that, generally, of course in 14 simple terms, that hourly reserve margin is going to be 15 much, much lower in these peak periods. So are the 16 number of hours going to be much higher? Yes, the 17 number of hours of significant potential pricing power 18 are likely to be much higher when demand is higher. 19 MR. RONAYNE: Thanks. 20 I gather your area of expertise 21 includes really investment measuring risks and that 22 sort of thing, measuring risks for new proposals. You 23 could help me on this because I think the resource 24 costs of what you are proposing are one of the things 25 that go into the equation here. 26 I am just wondering, to be able to 27 provide a portfolio of contracts and do a good job at 28 it, the way that you are proposing that maybe MEUs or 786 ADAMSON/CONWAY 1 others will be doing for the MEUs, what sorts of costs 2 and systems would be involved? 3 I guess the other issue, I suppose, 4 is also human capital, which is extremely important, 5 and I guess expertise in doing this sort of thing. 6 Would you agree? What would you need, really, to do 7 this job well, besides Seabron Adamson maybe? 8 MR. ADAMSON: I wouldn't claim any 9 expertise in terms of the costs or investment 10 requirement for trading in portfolio management. There 11 is a lot of trading operations already existent around 12 the world. Their scope differs a lot from each other. 13 Their systems requirements, their level of effort 14 requirements vary an awful lot between each other. So 15 I wouldn't in any way want to say that I was an expert 16 at this. Barry is a much better person maybe to 17 address that. 18 I think if you were to do a rough 19 kick at the numbers, the costs for a handling franchise 20 service, kind of the equivalent of standard supply 21 service, by the RECs in England and Wales for doing 22 this has not been extraordinarily high, nor have they 23 found it extraordinarily beyond their capabilities. 24 You have to remember that these were publicly-owned 25 bodies as well, when all this kicked off, and probably 26 in many ways were not the quality of the institutions 27 here in Ontario, by any stretch of the imagination. 28 I haven't done any kind of -- before 787 ADAMSON/CONWAY 1 I came up here, I wanted to try to do sort of a 2 rough-cut analysis of what it might cost for a standard 3 supply service provider to undertake these functions, 4 but I think you would need some more time and effort to 5 do a good illustration of it. 6 What I would say is that there do 7 seem to be entities similar to the ones that we are 8 talking about in the world. They are using very small 9 percentages of the actual retail electricity costs in 10 performing these functions. It doesn't seem to me to 11 have been extraordinarily burdensome, so I think we 12 could take a bit of comfort from that. 13 If we took the entire cost of what is 14 called the supply price control in England and Wales, 15 for example, down to the level of the customer's bill, 16 it doesn't add up to much. That includes all the 17 billing activities that have to be done, anyway, under 18 any one of these schemes and call centre management and 19 stuff, which are certainly the most expensive parts of 20 direct supply businesses. 21 So I didn't have a number of what is 22 my cost, but I would note that institutions 23 in -- distribution entities in a number of 24 jurisdictions of quite different characteristics, 25 ranging from England and Wales to Latin America to 26 Australia, seem to be undertaking these kinds of 27 functions and I haven't seen that the cost has been 28 extraordinary. 788 ADAMSON/CONWAY 1 You are going to make a comment on 2 this, are you? You are probably better placed than I 3 am. 4 MR. CONWAY: I think the cost of 5 set-up really depends on how you do it. If you are 6 putting a procurement operation together by extending 7 an existing trading floor, set-up costs are probably 8 quite low. You are talking about the incremental 9 labour cost and a few more desks on the trading floor. 10 To build a small procurement shop is 11 in the order of magnitude of $4 million or $5 million 12 to set it up and $2 million or $3 million to run it 13 annually. 14 MR. RONAYNE: You were asked 15 yesterday about your views on the types of choices that 16 should be made available, and you said that you don't 17 have an opinion on that. 18 I just want to ask, on pain of having 19 to give up your economist's card, which you have put at 20 risk a couple of times: In a competitive market, is 21 not a spot market price pass-through option very 22 important to have on the table? If that spot market 23 is -- 24 MR. ADAMSON: Yes. I think if it can 25 be incorporated into the provider's systems and 26 stuff -- and I don't see any reason why it couldn't, 27 but I am not a systems expert -- that to me seems to 28 be -- 789 ADAMSON/CONWAY 1 If I was going to have two options, I 2 would have a base fixed rate kind of option that every 3 one of these providers could offer, and a spot price 4 pass-through for those who wanted to check that box. 5 My sense is that we don't want too 6 many rates. It just creates a lot of complexity and it 7 creates a lot of system costs and so on and so forth. 8 But two does not sound unduly difficult for people to 9 handle, one fixed rate and one spot price pass-through, 10 and, I don't know, check the box. 11 MR. RONAYNE: In fact, would you add 12 what the spot price, having that sort of pass-through 13 mechanism, could play -- I think you have said this in 14 Alberta -- in promoting demand-side responsiveness? 15 Having access to real time rates could play an 16 important role in mitigating market power? 17 MR. ADAMSON: Demand-side response 18 is, obviously, critical in mitigating market power. At 19 peak in the system it is by far the best control. It 20 is almost a requirement. 21 I do believe that an awful lot of the 22 people on standard supply service rates are not going 23 to be in a position to respond to the prices, 24 especially since you actually don't get the prices 25 until after the fact. It is hard to see the value of 26 these prices after they have already happened. 27 Remember that we are actually mainly interested, in 28 terms of the value of either market power or just sheer 790 ADAMSON/CONWAY 1 production efficiency in demand-side response, in a 2 number of peak periods and we are going to -- even 3 under the spot price pass-through we are talking about 4 offering averages of prices, but we are still not 5 getting that very sharp price signal. 6 I think most of the load that is 7 really critical for that is just going to have jumped 8 out of this process entirely, moved over to the 9 competitive retail market, moved over to interval 10 metering, and then they could be responding to these 11 prices, day one, as they see fit. 12 I think the option of the spot price 13 pass-through, in terms of including it if it can be 14 done at a reasonable cost as maybe one of two options 15 in the standard supply service providers, offers a sort 16 of insurance mechanism. You know, if I think it is 17 possible that my portfolio provider will do a very bad 18 job and whatnot, I can check this and take that as my 19 option, despite the incentive you have put on him. 20 I don't personally imagine that most 21 standard supply service customers are going to be able 22 to react to the prices that much and I am not very 23 confident that monthly prices, presented to me after 24 the fact, are really going to create much demand-side 25 response anyway. 26 I think it can be valuable, but not 27 exactly for the reasons that you have suggested. 28 MR. RONAYNE: Thank you. 791 ADAMSON/CONWAY 1 Mr. Conway, I would like to address a 2 couple of questions to you, if I could, at this point. 3 Mr. Adamson talked about counterparty 4 contracting. I was just trying to kind of get settled 5 in my mind what exactly the role of ENERconnect might 6 be in this marketplace and in facilitating this type of 7 standard supply service operation. 8 Doing this counterparty contracting 9 maybe for municipal utilities, would you see that as a 10 role for ENERconnect in the marketplace? 11 MR. CONWAY: There are three broad 12 groups of services that are required to make this thing 13 work. There are day-to-day operational services that 14 you need to do to just participate in the market, like 15 scheduling, like settlement. There are services that 16 you will need when you go to market, in terms of 17 forming a request for proposal, assessing the people 18 you want to ask to bid on it, assessing their credit 19 capability, assessing their bids later and coming up 20 with a conclusion on which is the best to go with. 21 Those are two kinds of broad groups 22 of services. I think that some people will not even 23 want to do that. They will basically just want to get 24 a fixed price contract, in which case we will do that 25 as well. 26 MR. RONAYNE: I guess, in order to 27 help you to be good at this, you have also retained the 28 services of Enron as an experienced party in this type 792 ADAMSON/CONWAY 1 of thing as well. Is that right? 2 MR. CONWAY: That was the essence of 3 some of my comments yesterday. 4 MR. RONAYNE: I don't want to get 5 into anything that is confidential, I just want to try 6 to understand what the mechanism on operation is here. 7 MR. CONWAY: Don't worry, I won't. 8 MR. POCH: He used to work for Hydro. 9 He knows about secrecy. 10 --- Laughter 11 MR. RONAYNE: They will be a 12 potential competitor, right? There is nothing in the 13 arrangement that would prevent them from being a 14 potential competitor in the intermediate markets? Do 15 you see that as -- 16 MR. CONWAY: I guess already we have 17 bumped into our problem, haven't we? 18 MR. RONAYNE: Okay. That's fine. I 19 will leave that. 20 Under the yardstick competition, I am 21 just wondering about what is going to happen here. 22 Where is the competition going to come from? Where are 23 the intermediaries going to come from in this 24 marketplace? 25 You have some kind of market power 26 mitigation proposal in place of around 3.8 cents, 27 one-year rate, which is persisting on over a number of 28 years. It has yet to be determined, but certainly 793 ADAMSON/CONWAY 1 probably up to three and a half and I suspect actually 2 significantly longer than that. 3 Where are the competitors coming from 4 in this marketplace? 5 MR. CONWAY: That was also part of my 6 comments yesterday. I guess, in general, there are a 7 lot of power marketers who are happy to act as 8 intermediaries in Ontario and elsewhere in North 9 America. 10 As I was saying, there was recently a 11 request for an expression of interest issued by the G6 12 Utilities and that was broadly responded to. In 13 that -- and, actually, I am not quite sure how 14 confidential this is, so I will be careful what I say, 15 but -- 16 MR. RONAYNE: I don't want to put any 17 pressure on you to say anything that is confidential. 18 MR. CONWAY: That process is not 19 confidential, so I wouldn't worry about it. 20 Thank you. Now I will have to 21 stretch my memory to remember everything. 22 --- Laughter 23 MR. CONWAY: There was a broad mix of 24 both generators and power marketers responding to that 25 request. 26 MR. RONAYNE: Thanks. 27 I think we have already talked a bit 28 about the right entry conditions, Mr. Adamson, a little 794 ADAMSON/CONWAY 1 bit, you know, what sort of thing you want from the 2 spot market. But what other things do you think? 3 You are an economist and you have 4 worked on these things. There is a lot of talk about 5 promoting competition for its own sake, but I presume 6 you would rather -- I mean, promoting competitors for 7 their own sake. But an economist would usually say, on 8 threat of losing your card, competition not 9 competitors. Do you have sense of what you would want 10 to have as the right entry conditions so that you are 11 not just trying to put competitors in the marketplace? 12 MR. ADAMSON: I certainly don't want 13 to be seen to be -- we have to go out and create some 14 competitors, whether or not it is efficient to do so. 15 The objective -- the whole program is 16 market-based restructuring, in my mind -- fundamentally 17 has to come down to that of efficiency, of prices for 18 consumers, of what is offered to consumers. That 19 usually moves on to the premise that competitive forces 20 are a good way of doing that, of creating productive 21 efficiency, creating dynamic efficiency. 22 I think that last point is what I 23 would address my comment to. 24 I don't want to, like, we've got to 25 go out and create a bunch of competitors, create a 26 bunch of new entries, if it's not required. If it 27 turns out that the province has a massive generation 28 surplus, we don't want to subsidize the creation of 795 ADAMSON/CONWAY 1 building a lot of plants just to have some more 2 competitors. 3 I like your phrase "it is 4 competition, not competitors". It is competition 5 towards an objective, which is dynamic efficiency. 6 What I do want, though, is that -- it 7 seems like we may, over a period of time, be nearing a 8 serious decision point in which the new entry may be 9 economically and financially justified. I think we are 10 actually going to hear from someone who is going to 11 talk about the Lakeview Plant a bit. I guess it 12 somewhat depends on obviously what happened to the 13 nuclear program here in the province, about how much 14 new generation is going to be required. 15 So I don't want to be seen as we have 16 to go out and create some new competitors. But at the 17 same time, what we do want to create is the conditions 18 in which competitors are given the best chance of 19 entering, as they see fit. I do think that that helps 20 dynamic efficiency and is a powerful -- the potential 21 of entry is always a powerful check on the behaviour of 22 incumbents. 23 What I am trying to get at is: Let's 24 try to make sure that those signals are there. Let's 25 try to make sure that those signals aren't distorted. 26 Then we are leaving it open to other people to put 27 their money where their mouth is and dig the hole in 28 the ground. 796 ADAMSON/CONWAY 1 But I do think, and particularly in a 2 market like this which is starting off with a great 3 deal of kind of uncertainty, if one thinks that new 4 entry is possible and wants to make sure the conditions 5 are right, we do need to consider how what we do now -- 6 or how rather what you do now -- is going to affect the 7 actual commercial realities of investors and their 8 ability to attract financing. 9 The capital markets are, in some 10 ways, a fairly fickle beast. Yes, Ontario is a big 11 part of the Canadian market, but the capital market is 12 not particularly Ontario-specific. There are lots of 13 other merchant generation projects going around. The 14 terms under which that capital will be attracted are 15 very, very dependent on how the institutional side of 16 restructuring occurs. 17 MR. RONAYNE: Thanks. 18 I would like to go to your slides 19 from yesterday. 20 MS LEA: Mr. Ronayne, it is about 21 time for our morning break. Do you know how much 22 longer you will be? 23 MR. RONAYNE: It could be a while 24 yet. 25 MS LEA: With that threat, then, I 26 think we will take 15 minutes, please. We will return 27 at ten to 11:00. 28 --- Upon recessing at 10:35 a.m. 797 ADAMSON/CONWAY 1 --- Upon resuming at 10:50 a.m. 2 MS LEA: Welcome back. 3 I think, Mr. Ronayne, you have more 4 questions. 5 One moment, though. I have two 6 administrative matters. 7 The first is that Mr. Mondrow, on 8 behalf of the HVAC Coalition, does not plan to come and 9 give an oral presentation. If parties do have 10 questions of clarification, they can contact him. His 11 telephone number is on the intervenor list. 12 Secondly, the IPPSO panel has elected 13 to come on Monday rather than attempt to be squeezed in 14 today. The order of proceedings on Monday is at 15 9:00 a.m., Toronto Hydro. Mr. Rawson for TransCanada 16 Power will follow that. I expect that will probably 17 take us to close to the morning break, and then the 18 panel of IPPSO members will follow right after the 19 morning break. 20 Thank you. Mr. Ronayne. 21 MR. RONAYNE: Thank you. I know I am 22 running rather long, so I am going to try to be as 23 quick as possible here. 24 If I can go to your slides from 25 yesterday and the presentation, you made the point that 26 low-income customers are likely the most risk-averse 27 customers. 28 Are they also the ones that are also 798 ADAMSON/CONWAY 1 likely to have the highest marginal utility of income 2 as well? They are vulnerable on maybe both sides of 3 the equation here. 4 MR. CONWAY: Sorry. We are just 5 trying to find which one you are referring to. 6 MR. ADAMSON: I think you mean 7 slide 3, "Economic Principles". 8 MR. RONAYNE: I'm sorry. Right. It 9 was around there. 10 MR. ADAMSON: Yes. Some parties are 11 especially averse, such as low income consumers. Okay. 12 MR. RONAYNE: Is it fair to say also 13 that they are also the ones with the highest marginal 14 utility of income? 15 MR. ADAMSON: Yes, I would say 16 probably so. 17 MR. RONAYNE: Thanks. 18 You referred, I think, yesterday to 19 textbooks that you are basing your analysis on. I 20 think in the earlier material you filed you indicated 21 that there were some articles but that you had not 22 pulled them together yet. 23 Can you give me some indication of 24 what those might have been, or what things we would 25 look at to sort of get the foundation for your 26 analysis? 27 MR. ADAMSON: In terms of thinking 28 about transaction costs? 799 ADAMSON/CONWAY 1 MR. RONAYNE: Well, transaction 2 costs, role of intermediate markets. It was, I think, 3 specifically in regard to the role of intermediate 4 markets and promoting economic efficiency. 5 MR. ADAMSON: I think there is 6 probably a very wide range of industrial organization 7 literature. Probably an easy way to start would be any 8 standard industrial organization textbook, like Lafont 9 and Tirole. 10 I would I think particularly push you 11 to thinking a bit -- I don't have the exact titles and 12 everything today, and I will certainly try to write 13 them down for you and fax them to you, if you want -- 14 on the transaction costs literature, some of the 15 writings of like Williamson. That would be one of the 16 key authors in that area. Oliver Hart at Harvard on 17 roles of contracts, at least partially from a 18 transaction cost framework. 19 I think a good starting point would 20 be any of the sort of basic texts in the industrial 21 organization literature: Krouse. 22 Do you know that book, Clement 23 Krouse? 24 MR. RONAYNE: Krouse, no, I don't 25 know. Lafont and Tirole, I certainly do. 26 MR. ADAMSON: Lafont and Tirole, yes, 27 that is kind of one on everybody's book shelf. 28 I think you could start there. 800 ADAMSON/CONWAY 1 I think another book you might want 2 to look at, just because it has some quite good 3 analysis, and even includes a basic discussion on kind 4 of comparative competition mechanisms, is the Theory of 5 Incentives and Procurement in Regulation. 6 Are you familiar with that book? 7 Another Lafont and Tirol book. But that specific book 8 is really a very good one for anyone who wants to think 9 about these questions from an economic perspective. 10 MR. RONAYNE: Thanks. 11 MR. ADAMSON: I will try to get a 12 list together for you, if you want, and send it to you. 13 MR. RONAYNE: Well, if you think 14 there are any that are of particular interest. 15 MR. ADAMSON: Yes. I will look at 16 the ones that I sort of "yellow stick". 17 MR. RONAYNE: In the course of your 18 presentation you talked about a new entrant and the 19 possibility of new entry at the generation level, and 20 possibly being able to guarantee a lower price. 21 The price is for the commodity, 22 right? That is what you are talking about? 23 MR. ADAMSON: That a new entrant 24 might under the right contractual terms be able to 25 offer a lower like energy price? Is that what you are 26 talking about? 27 MR. RONAYNE: Yes. Let me clarify 28 the circumstance for the question. 801 ADAMSON/CONWAY 1 You indicated, I think, that in any 2 new -- or perhaps it could be anybody else, I 3 suppose -- 4 MR. ADAMSON: A provider. 5 MR. RONAYNE: Somebody who is taking 6 power from a new entrant in the marketplace and at a 7 price which would be possibly just the price that would 8 be paid to the generator could be less than say the 9 forward price for that power. 10 MR. ADAMSON: Remember, we are always 11 talking about expected values of prices. 12 MR. RONAYNE: Yes. 13 MR. ADAMSON: And expected values of 14 prices under imperfect information. What the 15 scenario -- and I think this also related a bit to the 16 comments of Mr. Adams yesterday afternoon, I believe it 17 was. 18 Just place ourselves in the 19 hypothetical scenario that if I was able, as an 20 off-taker, to guarantee to contracted price, not 21 necessarily like a forward price in the conventional 22 sense, but a price of longer duration, I am clearly 23 reducing the risk for the new entrant generator who has 24 these substantial fixed and sunk costs. 25 We may well expect, or could expect, 26 that under those circumstances that the price that a 27 new entrant would be willing to receive -- the entry 28 price for a new entrant with a longer term off-take 802 ADAMSON/CONWAY 1 contract might be lower than the expected value of the 2 spot price, simply because it is a lower risk to the 3 new entrant. And I think probably the commercial 4 realities start to bear that out. The experience of 5 people who have been able to sign up long-term 6 industrial cogeneration deals in some of these markets 7 and just from a very simple basis thinking about how 8 that helps mitigate the merchant risk to the financing 9 of the project. 10 We are talking about durations rather 11 than just points forward in time. 12 MR. RONAYNE: I guess what I want to 13 get at is that the overall riskiness of the project 14 hasn't changed. What you had is a generator, who is a 15 risk-averse generator, entering into a contract where 16 he might get something lower than the spot price. But 17 the risk itself hasn't disappear, it has gone to 18 somebody else. 19 Whether it is priced in the 20 transaction or not, you could have a shadow price for 21 it, and the shadow price, including the risk for that 22 transaction, hasn't really changed. 23 MR. ADAMSON: Well, the risk may be 24 allocated more efficiently if we also have a 25 risk-averse off-taker. Just because one side has risk 26 and the other side has risk, if they are both 27 risk-averse there may actually be a more efficient risk 28 allocation -- maybe -- it doesn't necessarily have to 803 ADAMSON/CONWAY 1 be. It depends on who they are and where they stand. 2 But it may be that there is a more 3 efficient risk allocation if both parties, generator 4 and ultimate consumer, are in fact risk-averse. 5 So you might think there is a broad 6 price risk in the system as a whole which has to do 7 with exogenous parameters, but it is also very 8 important to think about who bears it, who wants to 9 bear it. And of course the attraction of contracts in 10 these markets is that in some ways some of the risks of 11 users and generators offset each other. 12 MR. RONAYNE: So you are saying there 13 may not be an equal and opposite transfer of risk. The 14 alternative is to go to the spot market. Let's just 15 say that the contract price was five cents, and the 16 spot market tanks to 2.5 cents. The capitalized value 17 of that project, then, has gone down to what the new 18 spot market price is, if you are going to put it up on 19 the market. 20 MR. ADAMSON: You are talking about 21 continuously revaluing over time the value of the 22 generation asset, the kind of economic value of the 23 generation asset? 24 MR. RONAYNE: I am talking about the 25 value of the generation asset around what is happening 26 to the spot market price and the alternative available, 27 the other alternatives that are available in the 28 marketplace. It doesn't necessarily have to be a spot 804 ADAMSON/CONWAY 1 market price. 2 MR. ADAMSON: I think the thing to 3 remember is that risk is a function of time, and 4 changes over time. It changes with the expectation of 5 the distribution of market outcomes at any point in 6 time. 7 So at the point in time that you and 8 I choose to contract, I might say I want a very 9 long-term fixed price of power that matches my 10 downstream, whatever I do, run a factory; and you might 11 say I have a significant sunk cost investment here, so 12 I am very worried about the price downstream. At that 13 point in time, there may be a positive welfare benefit, 14 I believe under the right circumstances, from us 15 signing a risk hedging contract. 16 Now, indeed, that, as you suggest, 17 does not prevent us from being wrong about either of 18 our expectations of what market prices are. You know, 19 the price may fall from 5 to whatever your example was. 20 But, at the time, given our joint expectations of 21 prices, distributions we put upon these prices, and our 22 level and our degree of risk aversement, it may be 23 welfare-enhancing to have a risk hedging mechanism set 24 up between us, at that time. 25 Now, over time that may change, 26 because it is always a function of "T" over that time. 27 But, practically -- and I think, again, the economic 28 literature supports this -- the contracts are decisions 805 ADAMSON/CONWAY 1 given risk as a function of time, but at that time, 2 evaluated at that time. 3 MR. RONAYNE: Thanks. 4 MR. ADAMSON: Risk is a function of 5 "T", evaluated at "T" sub whatever. 6 MR. RONAYNE: I would like to turn 7 quickly -- I'm going to try to be as brief as I can -- 8 to page 7 of your slides. You have a graph there. 9 At the last bullet you say: 10 "So if you start with a poor 11 allocation, it is likely to 12 continue for a long time." 13 (As read) 14 When you are talking about the poor 15 risk allocation, it is a function of time, right? I 16 mean, that is critical, that is critical to the 17 equation of whether this thing has net benefits or net 18 costs? 19 MR. ADAMSON: Yes. 20 MR. RONAYNE: So if you put somebody 21 on something that they are mobile off of and the risk 22 allocation isn't quite right, at least they are pretty 23 quick; when the time comes up, they can move to 24 something else that is better suited for them. I mean, 25 at least you can adjust or you can move quickly. That 26 would be a factor that would tend to reduce the 27 possible risk costs or the costs and risk terms of this 28 type of option. 806 ADAMSON/CONWAY 1 MR. ADAMSON: Of the fixed price 2 option? 3 MR. RONAYNE: Well, I'm not saying a 4 fixed price option. I am just saying an option that 5 you are mobile off of. When you make a decision that 6 you want to go to something else, you are mobile off 7 it -- and this one has a different risk portfolio -- as 8 opposed to a contract where you put in for one, two, 9 three or five years that has a risk portfolio that you 10 didn't like, in retrospect you didn't like, somebody 11 put you on it. 12 MR. ADAMSON: An option always has a 13 positive value. I think that is the root of what you 14 are saying. In fact, thinking about it, it is somewhat 15 analogous to a financial option. That option, the 16 right to jump between things, always has a zero or a 17 positive value, right? 18 I think I concur with your statement. 19 I think that's what -- 20 MR. RONAYNE: Even if you go through 21 an exercise that puts people on a contract that you 22 figure, well, on average, this is what they should be 23 on, this is what we think the risk profile is. Suppose 24 it's a three-year contract, either you make people 25 mobile off of that and create all kinds of other 26 problems or the cost of making that choice wrong is the 27 difference between what -- or the welfare between, 28 let's say, the risk profile that you would prefer to be 807 ADAMSON/CONWAY 1 on, in retrospect, times three years, as opposed to, 2 let's say, if it's the same differential and you can 3 move off in two months, then being mobile off will 4 reduce the absolute size of the risk, the loss to you 5 in going to a more preferred risk profile. 6 MR. ADAMSON: I think I follow you. 7 From my understanding -- and we 8 shan't repeat the whole thing again -- clearly, an 9 arrangement that locks people in for three years, if 10 that risk allocation were to be inefficient, would 11 involve a more substantial welfare loss than an 12 arrangement for that person than one where they had 13 either a shorter term or, you know, no term at all and 14 could switch it at will. 15 As I said, an option always has 16 positive value. 17 I don't want to characterize what we 18 are describing as being anywhere necessarily of the 19 term of anything like three years, nor are we 20 necessarily advocating a system that in any way, to 21 that degree, or possibly at all, restricts customer 22 mobility. Which seems to be a distinct policy 23 objective. As I mentioned before, there is probably a 24 trade-off in -- offering kind of complete customer 25 mobility is offering people an option, and that option 26 is never free, and that type of trade-off does need to 27 be incorporated into our thinking. 28 However, I'm certainly not 808 ADAMSON/CONWAY 1 thinking -- and I don't think Barry is thinking, but I 2 haven't talked to anybody about this -- that we are 3 talking about anything like a three-year lock-in 4 arrangement for the standard supply service. 5 MR. RONAYNE: Well, I -- 6 MR. ADAMSON: That would be quite 7 extreme. Even given the kind of policy decisions that 8 have been made, I don't see how you would even -- I 9 don't think it would be advantageous to even do a 10 one-year lock-in. I think we are talking about, you 11 know, much freer or potentially even completely freer 12 customer mobility to that and I think that that should, 13 in many ways, ameliorate the welfare loss concerns that 14 you have just expressed. 15 MR. RONAYNE: I have one quick 16 question, and I'm going to try to roll through these as 17 fast as I can. 18 Around the bands -- the mechanism 19 that you were talking about on comparison of the 20 yardstick purchase cost, if -- 21 MR. ADAMSON: What page are you at? 22 MR. RONAYNE: Page 10 of your slides. 23 If there is variance within the dead 24 bands, then that is picked up by the customer, whoever 25 is on system service costs? 26 MR. ADAMSON: Yes, effectively. 27 MR. RONAYNE: Okay. If there is 28 variance outside of the bands, the cost that is passed 809 ADAMSON/CONWAY 1 onto the SSS customer is dependent on what type of 2 penalty mechanism you have in place? 3 MR. ADAMSON: Let's call it a sharing 4 mechanism. 5 MR. RONAYNE: A sharing mechanism. 6 MR. ADAMSON: I think the literature, 7 and in fact even the terminology we referenced here, is 8 probably more related to PBR-type mechanisms. I mean, 9 really, this is not fundamentally economically greatly 10 different than a performance base rate-making 11 mechanism, somewhat similar to the -- and with some 12 parallels to the other ones we have heard about being 13 proposed. 14 So that would depend on the 15 risk-sharing formula which was incorporated into the 16 mechanism. 17 Again, I didn't want to make it so 18 abstract that you didn't get the advantage of an 19 example, but the idea of the 5 per cent dead band is 20 artistic licence not a design parameter. 21 MR. RONAYNE: I took it as such. 22 MR. ADAMSON: Okay. 23 MR. RONAYNE: I'm just trying to 24 figure out what I no longer have to do here. I had 25 this other list. 26 You mentioned the San Diego Gas & 27 Electric hearing which was -- or have you followed that 28 hearing since, in your -- and I'm not sure exactly what 810 ADAMSON/CONWAY 1 page of your report it was on. 2 MR. ADAMSON: I have looked through, 3 briefly -- I certainly have not participated in -- I 4 have looked through, and I won't even say I have gone 5 as far as really having completely studied it. 6 There was a filing, in the last few 7 months, I believe, by San Diego Gas & Electric, a kind 8 of incentive-based arrangement for their procurement. 9 MR. RONAYNE: I believe, in fact, 10 that the CPUC pronounced on that and they have actually 11 required San Diego Gas & Electric to go to a 12 straightforward spot price pass-through but -- were you 13 aware of that? 14 MR. ADAMSON: No, I'm not aware of 15 the recent CPUC decision. 16 As I was thinking about the policy 17 objectives that go back in the design of the California 18 market -- and this is something that I do have some 19 first-hand knowledge of -- we should also remember some 20 of the policy objectives of the initial design which 21 may be somewhat unusual and may not be completely 22 reflective of the circumstances here in Ontario. 23 An explicit objective is encapsulated 24 in the December 20, 1996 decision of the California 25 Public Utilities Commission which was that the 26 California Power Exchange needed to be partially 27 propped up, given the kind of rather substantial costs 28 that were incurred in setting the thing up -- to which 811 ADAMSON/CONWAY 1 we contributed -- so there was a requirement put on the 2 utilities to buy all their power from the Power 3 Exchange and not to bypass it. That was a relatively 4 California-specific policy objective and I don't think 5 that policy objective has completely gone away. 6 I would note -- and I think I do make 7 some reference to that in the paper -- that the 8 California experience of retail competition has not, in 9 the minds of many observers, been a stellar success. 10 If I can go to page 13 of your 11 proposal, starting with the sentence -- there is a 12 paragraph that begins with "Finally" and going down 13 towards the end of that it says: 14 "If this were a major policy 15 objective in the province and a 16 transparent adder, adjustable by 17 year, could be added for default 18 customers providing the 19 necessary level of cost savings. 20 Since the adder would be simple 21 and transparent, the 22 informational barriers faced by 23 retailers in luring customers 24 away from default service might 25 be lowered as well." (As read) 26 Do you think that is really something 27 that is supported by economics, providing that type of 28 adder? Would Alfred Khan, for example -- I mean, he 812 ADAMSON/CONWAY 1 was referred to in another submission. 2 MR. ADAMSON: I think Alfred Khan -- 3 and here I, again, don't want to put words in the minds 4 of those far more luminous than those of us present. I 5 think one thing he might support is transparency in 6 regulatory mechanisms. 7 Remember, we are talking about an 8 extremely, in my mind, artificial policy objective, but 9 it is one that has been discussed in considerable 10 detail in the United States in many of the proceedings 11 regarding the development of retail competition. 12 I believe I have seen even reference 13 to it in some of the materials -- and I couldn't tell 14 you which ones, in Ontario -- which is that whatever 15 price the default customer is supplied to be has got to 16 be high enough so that competitive retailers will have 17 a large enough margin to want to enter the market. In 18 other words, we are going to -- assuming, if you wanted 19 to go down this route -- we are going to, you know, try 20 to crank up the price enough to make it worthwhile to 21 pay for the TV ads to get people to switch. 22 Now, that to me I don't think Alfred 23 Khan would support, I don't think mainstream economists 24 would support, because it is purely allocatively 25 inefficient. We want prices to be cost reflective 26 because we think that is well for maximizing. 27 I was saying, if that was an 28 objective -- and when I kind of started this paper, 813 ADAMSON/CONWAY 1 which was some months ago now, there seemed to be 2 rumours of the desirability of artificially 3 kick-starting the retail competitive process. 4 The point I was trying to make is, 5 rather than have a Pennsylvania-style shopping credit 6 hearing, which effectively sets a price, and trying to 7 negotiate a price high enough so that as part of this 8 policy objective that retailers could come in and take 9 away load, you know, if you were going to try to do 10 that I would much prefer to have a transparent 11 mechanism of doing that than a nontransparent 12 mechanism. Where subsidies are going to be present, I 13 prefer transparent subsidies. 14 However, so that people can look at 15 them, people can say "Here is what I'm going to save", 16 and so that people can understand the costs of what we 17 are doing. 18 Now, I am not, under any 19 circumstance, arguing that that is what you ought to 20 do, but it seemed at the time that I started this that 21 there was a swell that, you know, "We have to do 22 something to make this retail market happen." 23 Now, I personally think that is the 24 wrong way to go. I think you should not try to 25 subsidize the artificial creation of the retail market 26 in this way. If you did try to once subsidize it, you 27 know, "Economics be damned. We are going to make 28 people want to switch", I prefer for it to be in a 814 ADAMSON/CONWAY 1 transparent mechanism. 2 MR. RONAYNE: Thank you. 3 Those are my questions. 4 MR. CONWAY: Actually, I think I 5 asked Seabron to consider that alternative, perhaps so 6 that you could ask your question and then we could 7 elicit some evidence on the subject. It was widely 8 debated at the Market Design Committee. 9 MR. RONAYNE: Okay. 10 Thank you very much. 11 MS LEA: Thank you, Mr. Ronayne. 12 Mr. White. 13 --- Pause 14 MR. WHITE: It is Roger White and I 15 am with ECMI, Energy Cost Management Incorporated, 16 representing a number of municipal electric utilities. 17 I heard this morning your comment 18 about what would give you a confidence level in 19 competition with respect to the scale or the size of an 20 individual player versus, let's call it the excess or 21 surplus capacity needs. Put it in your own words. 22 MR. ADAMSON: The hourly operating 23 margin. We just invented our own jargon. 24 MR. WHITE: In the absence of the 25 MPMA in Ontario, do you have any faith that a 26 competitive spot market would be created? 27 MR. ADAMSON: Well, based on that 28 principle from the discussion from Mr. Ronayne's 815 ADAMSON/CONWAY 1 question -- and again, I have not done any sort of 2 exhaustive study of potential market competitiveness, 3 but really just thinking about this in very broad 4 terms, as long as this kind of operating margin, the 5 excess generation in an hour over demand, so operable 6 capacity minus demand in the hour -- construct this as 7 a simple thought experiment, which is always a useful 8 thing to do in economics -- as long as that margin is 9 exceeded by the size of the largest player -- or a 10 player, not even the largest player, maybe more than 11 one -- if there is 20 per cent extra capacity -- if 12 there is 20 per cent more capacity than demand in an 13 hour and the biggest player is 40 per cent, he or she 14 has to be called, right. 15 Just think about it as a game where 16 we offer quantities into the market, a Cournot game. 17 In that circumstance, in that scenario, here she has to 18 be called. Without subject to some other constraint -- 19 you know, I'm putting poker cards down on the table, I 20 can write on my card whatever price I want and this 21 option mechanism has to call it. That's all there -- 22 you know. 23 So that to me is one very direct test 24 that one can look at in these markets, because it 25 follows from the very simplest analog to how the 26 clearly mechanism in the spot market works. Whenever 27 the largest players, larger than the excess margin in 28 an hour, he or she has to be called and write down what 816 ADAMSON/CONWAY 1 they want. 2 Going slightly further, because I 3 think that is a test which I think we could all see 4 relatively easily and which we could actually kind of 5 look at the hours in an Excel spreadsheet rather easily 6 and make our own judgments on that. 7 Just because that test doesn't follow 8 through, isn't exceeded in an hour, doesn't mean that 9 there is not a potential market power problem. As we 10 know, these -- let's say even if there were two 11 competitors who could supply that excess generation -- 12 so Barry and I could both write down on a piece of 13 paper a price for enough generation that would cover 14 that last increment of demand. 15 Just because there are two of us 16 doesn't mean that there is necessarily a problem. If 17 we did this game once we might be tempted to undercut 18 each other far enough to push ourselves back to a 19 purely competitive solution. This effectively -- as 20 you are well aware where I'm leading with this -- is 21 the classic prisoners dilemma problem of game theory 22 from a basic economic textbook. 23 But we are doing this day after day. 24 Barry and I start realizing: Well, gosh, you know, we 25 are not doing ourselves any favours by constantly 26 cutting ourselves, constantly shooting ourselves in the 27 foot by writing very little prices down on these pieces 28 of paper, and that in a repeated game that collusion 817 ADAMSON/CONWAY 1 can occur. 2 But if one player has the ability to 3 always have to be called, I think that is a quite 4 strong test. If multiple players have to be called I 5 think we are in an intermediate range where you would 6 need to do some more thinking. 7 If there are 10 players who can 8 supply all the residual demand, then I think maybe 9 there you are in a safe harbour, but if there is only 10 one, I think the results of that, when illustrated that 11 way, are often rather convincing to people. All of 12 this has been discussed, as your example was posed, 13 without any incentives put on Barry and I as the 14 hypothetical generators in this example, without the 15 incentive created from any form of market power 16 mitigation or regulatory constraint. 17 MR. WHITE: Thank you. 18 In the presence of the MPMA, you 19 indicated that there are a number of ways to meet a 20 price or revenue cap. Could one of those mechanisms be 21 withholding generation or scheduling generation 22 maintenance as you approach the end of the period if 23 your price was too high? 24 MR. ADAMSON: I guess you are sort of 25 referring to this little picture I was drawing of the 26 different price patterns. How does one assess prices 27 in these markets? Things come down to quantities in 28 the end. We know that prices and quantities are 818 ADAMSON/CONWAY 1 fundamentally linked in any market, you know those 2 little p's and q's that bedeviled us in school. 3 The analysis of market power in these 4 markets has focused on representing the electricity 5 spot market pools, whatever you want to call them, as 6 Cournot games, where people effectively affect the 7 queue that they offer to the market and the price 8 outcomes are a function of that. It's a representation 9 because I really have multiple variables here. I have 10 p knobs that I can turn and I have q knobs that I can 11 turn in any hour, subject to any external constraints, 12 but the p's and q's are interlinked. So I am just 13 visualizing it as leave the p's the same as cost base 14 can affect the q's. 15 Any time you are looking at bidding 16 in one of these markets, I think the way to represent 17 it is in the form of a Cournot game, where you are 18 effectively changing the quantities you offer. You can 19 either change the quantities or effectively be accepted 20 below the clearing price. I can do that by saying my 21 plant is broke, I can do that by saying I am just not 22 going to bid in this hour, I can do that by saying I am 23 going to bid, but at an extremely high price above what 24 I think the clearing price is going to be, I can bid -- 25 you know, there has to be a quantity effect because 26 prices and quantities are so interlinked in a market. 27 If you turn to any of the economic 28 literature on the subject, you will see representations 819 ADAMSON/CONWAY 1 of bidding in these markets in quantity terms. You 2 could start with Newberry & Green, you could look at 3 Von der Fehr & Harbourd, you could look at the type of 4 analysis -- the type of more numerical analysis that 5 was done in Alberta that I alluded to before. It's 6 representations of these markets in quantity bidding 7 terms. 8 MR. WHITE: Does the yardstick 9 mechanism that you have suggested, to sort of change 10 gears a little bit, drive risk-avoiders to larger 11 purchasing pools? 12 MR. ADAMSON: To avoiding...? 13 MR. WHITE: To avoid any potential 14 penalty if they consider that a higher risk. 15 MR. ADAMSON: For their procurement 16 function? 17 MR. WHITE: Yes. 18 MR. ADAMSON: You might think about 19 this in two ways. You might think, first off, there 20 may be in this procurement function -- there may just 21 be some pure economies of scale. Maybe Barry here can 22 oversee the shop for a greater number of people more 23 efficiently if he is doing it for a larger volume. We 24 don't all have to go and employ someone in his role. 25 So there may just be a pure economy of scale argument. 26 At a certain level, I suspect that 27 may be quite significant. I don't think that a 28 procurement function on behalf of 100 customers is 820 ADAMSON/CONWAY 1 going to be viable. It has to be a long way below any 2 minimum efficient scale. 3 We might also want to think about if 4 we are starting in a structure where there is a 5 potential competitiveness problem. Again harkening 6 back to the sort of thinking from an industrial 7 organization, we might be aware of a powerful -- one of 8 the only countervailing forces to monopoly power may be 9 a downstream monopoly and some form of grouping there 10 in trying to exert a kind of countervailing power may 11 be possible. The economic solution of that can be 12 rather indeterminate and very situational specific. 13 So I would argue that there is 14 potentially two reasons why people might be looking at 15 conducting procurement functions together: (a) it 16 simply may be a more efficient economies of scale type 17 argument and (b) if I am worried about the activities 18 of people upstream, I may be trying to protect myself 19 through a bit of size there. 20 One thing to note, though, is that 21 this is only about the provision of standard supply 22 service and needn't affect what the MEU's, for example, 23 do in their other businesses. The large businesses 24 continue, presumably, as they are because I believe the 25 Act specifically allows the procurement function to be 26 assigned to a third party. So quite possibly the wires 27 business could stay and run and assume some of the risk 28 for this and the third party provider may be larger 821 ADAMSON/CONWAY 1 than the size of an individual MEU. 2 MR. WHITE: The Ontario market seems 3 to have two dominant LDCs with, at the very least, SSS 4 responsibilities, even though maybe not SSS deliveries. 5 We have OHSC and we have the new Toronto Hydro, which 6 are conservatively 25 per cent of the market for each 7 of them, probably. 8 MR. CONWAY: Eighteen per cent for 9 OHSC. 10 MR. WHITE: Okay, I will accept that. 11 Does the existence of those two 12 dominant players influence your view of whether we can 13 have an effective competitive market to fill these 14 needs? 15 MR. ADAMSON: In any comparative 16 competitive mechanism, of course, the question is: Is 17 there a sufficient number of competitors? If there was 18 one person doing it for the entire province, it would 19 be pretty hard to create this kind of yardstick 20 benchmark, just taking it to a kind of extreme example. 21 If everyone else isn't aggregated up 22 into one other exact player, it's not uncommon to have 23 markets with one or two competitors and those markets 24 may prove quite competitive. It's not uncommon where 25 the largest competitor may have 25 per cent in the 26 market and you still have quite competitive outcomes. 27 One thing to remember, of course, is 28 that, unlike over the very short-term generation 822 ADAMSON/CONWAY 1 markets, procurement functions may -- the risk of 2 injury of a new procurer may be quite high. There is a 3 lot of people who are involved in this power marketing 4 business in North America. There is quite a lot of 5 people who offer risk management portfolio management 6 services. So if one of these participants tried to 7 extract an inordinate amount, then I suspect others 8 could come in relatively easily. 9 They already have a lot of the 10 systems and expertise. You know, if Enron was already 11 here, well, gosh, there is only about another X dozen 12 power marketers in North America that you could easily 13 probably attract into the market. So I don't think 14 anyone would be suggesting that there is sole control 15 over these types of skills available to the province of 16 Ontario. 17 MR. WHITE: You may choose not to 18 answer this question. Others have taken that 19 particular answer. 20 I continue to look for someone who 21 has thought through and is comfortable with the 22 mechanics for non-interval metered customers whose 23 meters are read at different times receiving SSS under 24 the Board proposal. Have you gone down that road to 25 think about whether the actual dollars that the LDC 26 would pay, which would be precisely time interval 27 locked, and the dollars that end consumers would pay, 28 how they would be reconciled given different meter 823 ADAMSON/CONWAY 1 reading dates within the pool? "No, I haven't" is a 2 good answer, but I would love to hear one. 3 MR. ADAMSON: Not in the context of 4 Ontario, but I must admit, unfortunately, I have. I 5 mean it's an absolute bug bear. I will give you a 6 little bit of the context. 7 Some is within I guess what was 8 referred to as the 1998 process in England and Wales 9 where they were offering retail competition under 10 profiles, which is in some ways not dissimilar to what 11 you are doing under this. Again in California, on 12 behalf of a client there, who was, indeed, going to be 13 facing the issue with both the PX price pass-through or 14 any other form of profile, it was how do you deal with 15 the fact that they don't read the meters at the same 16 times that the prices are calculated, and you can have 17 this extraordinarily complicated reconciliation 18 process. 19 Typically, the meters will go -- you 20 kind of read a neighbourhood at a time and, inevitably, 21 in a large enough system there is some bug bear that 22 says all the data got lost from one of these 23 neighbourhoods because the guy left his electronic 24 meter-reading box in a bar somewhere. You don't have 25 meter reading data for that month and you end up 26 estimating it. So, instead of a monthly cycle for this 27 guy, it's two months. 28 That is to say that this is common, 824 ADAMSON/CONWAY 1 but when you get that much data, there are data 2 problems. These companies are used to dealing with 3 significant data, but there are data problems when you 4 have millions of customers and their side messes up 5 with it. 6 I have thought about it and the 7 problem is you seem to be stuck with these very complex 8 reconciliation processes about the price changes under 9 different time horizons than the meter reading happens 10 and what that means is you end up tracking an awful lot 11 of who paid what price when and trying to match up part 12 months or whatever your billing cycle is. Maybe it's 13 quarterly or part quarters. 14 So I don't think it's a rocket 15 science exercise. What I think it is is a very 16 complicated accounting settlement and system design 17 exercise. I don't know who your IT providers are for 18 the utilities, but they will greatly thank you for 19 getting into this issue. 20 The amount of money they took out of 21 our client in California was extraordinary. 22 MR. WHITE: If you had to literally 23 comply with the SSS as currently in the Board staff 24 paper, is it achievable? 25 MR. ADAMSON: I am not enough of a 26 systems -- I wouldn't try to profess any sort of 27 expertise on the design and implementation of these 28 billing systems. 825 ADAMSON/CONWAY 1 I think we could draw on a board the 2 number of arrows that would be involved. We could just 3 think about: Does this involve one arrow in this or 4 multiple arrows? 5 To do it, to absolutely capture the 6 fact of when the actual hours were, exactly, when one 7 had been metered, versus when the calculations had been 8 done, would seem to me to be extraordinarily complex. 9 Could that be done by software 10 systems? The people writing software systems always 11 tell me that anything can be done, just like the guys 12 who just finished working on my house always tell me 13 that -- the contractors always tell me, "Yes, we can do 14 that. No problem." The problem is, it took an 15 inordinate amount of time to get back into our house. 16 Can it be done? I wouldn't want to 17 say whether it could be done or not. 18 If you think about the implications 19 of the number of hourly prices, the number of customers 20 and the number of different times in which all of their 21 meters are actually read, if you take that as a matrix, 22 think about how many elements are there in that matrix. 23 That is a big matrix. 24 MR. WHITE: I think it gets back to 25 your two-knob situation on the wholesale side as well. 26 MR. CONWAY: Actually, I would like 27 to kick in here. The answer is yes, it can be done. 28 They are still working out the details. I am not sure 826 ADAMSON/CONWAY 1 whether the group is working today, but the settlements 2 committee is still working out how these mechanics are 3 going to happen. When they finish it will be done. We 4 have already said so and we will put a service out 5 there that will do that. 6 I must say that when we launched this 7 product there was a bit of sticker shock among the 8 partners because it is not going to come out at a low 9 cost, frankly. Even though we can bring considerable 10 scale to this issue, it is still not going to come at a 11 low cost. 12 So I would say that the 13 administrative cost of the spot price pass-through is 14 quite significant. 15 MR. ADAMSON: As a general rule, in 16 any type of situation -- and this is an observation, 17 having been with a lot of utilities and stuff, going 18 through these kinds of restructuring processes. 19 Changing everything at the same time is real, real 20 hard. It is real, real hard. Institutions are only 21 able to deal with so many changes, in my opinion, at 22 the same time. Commercial changes, systems changes, 23 organizational changes -- they can get a kind of a 24 numbness there. 25 Anything that, in my opinion, allows 26 a utility company to rely on existing billing systems, 27 and if those billing systems require fixed prices to be 28 put in upfront, gosh, that is -- it is at least one 827 ADAMSON/CONWAY 1 thing not on the list. I can't say it makes everything 2 completely painless, but it is at least one less thing 3 you are dealing with. Because these systems are 4 extraordinarily expensive and time consuming to write. 5 I don't own stock in Andersen 6 Consulting, unfortunately. 7 MR. WHITE: If I were to characterize 8 your comparison of the short-term spot market 9 pass-through versus a longer term contract market -- if 10 I were to characterize your preference as producing a 11 more stable, evolving supply-side market in a truly 12 competitive energy supply market, is that a fair 13 characterization of your preference? 14 MR. ADAMSON: I have a preference for 15 a market that allows good price discovery. That is 16 quite important for lots of people, for lots of reasons 17 they have already talked enough about. 18 I believe that a system that helps 19 those contract markets to evolve helps that price 20 discovery -- that forward price discovery. That is one 21 of the items that is of -- one of my sort of key 22 objectives which I tried to encapsulate into this 23 thing. 24 MR. WHITE: Thank you very much. 25 MR. CONWAY: I was going to kick in 26 there as well. I would characterize the proposal as 27 having a better chance of introducing workable 28 competition. 828 ADAMSON/CONWAY 1 Secondly, I would say that it has a 2 better chance of -- and perhaps this is what you meant 3 by stable -- having a successful introduction where the 4 rubber hits the road, which is with the mom and pop out 5 on the street, who probably will not like what they 6 see, in my opinion. 7 MR. WHITE: Because you insisted in 8 coming in on this, I would like to go back to your 9 comment on the non-interval metered customers, that 10 they can be precisely matched during a settlement 11 system without an accrual and reconciliation pot to 12 work with, or with an accrual and revenue 13 reconciliation pot to work with? 14 MR. CONWAY: Are you addressing that 15 to me? 16 MR. WHITE: Yes. 17 MR. CONWAY: I don't think I made any 18 comment like that. At least, I don't recall. 19 MR. WHITE: That was my question, and 20 you said, "Yes, we could." 21 MR. CONWAY: I said, yes, we would 22 deliver the system that is required to meet the 23 requirements of the Retail Settlements Code. 24 MR. WHITE: I understood from your 25 comment that one existed and that it could be utilized 26 to deal with the fact that non-interval metered 27 customers within a given LDC had their meters read at 28 different times and that this could be, let's say, 829 ADAMSON/CONWAY 1 perfectly matched without a reconciliation pool against 2 the variable spot market. 3 MR. CONWAY: Like I said, it depends 4 on how the settlements code is written. I am not 5 really sure that it will require a reconciliation. 6 There is sort of an infinite sink for 7 accuracy problems, and I think it is called 8 "unaccounted for energy", which is a carry-over 9 mechanism into future years. 10 So, yes, there are systems that are 11 close to the final design available, and when the 12 design gets finalized I am sure they will be adjusted 13 to do whatever it is that is required. 14 MR. ADAMSON: I think the question 15 is: Are these systems there or are they kind of 16 conceptually there and under development? 17 MR. CONWAY: There are several 18 systems under development. I believe there are a 19 couple of other markets that use systems kind of like 20 this for various purposes and they just have to be 21 tweaked, maybe substantially. I am not sure. I guess 22 we are still waiting to see what the code looks like. 23 MR. WHITE: I would suggest 24 that -- and part of the reason my question was phrased 25 the way it was was that the way the current SSS is 26 worded it may not be physically possible to comply with 27 a precise pass-through of spot market price. 28 MR. CONWAY: I mean, that is almost 830 ADAMSON/CONWAY 1 true by definition. 2 MR. WHITE: Thank you. 3 MS LEA: Thank you, Mr. White. 4 Mr. Jennings. 5 MR. JENNINGS: I have about five 6 questions, all I think clarification. 7 Mr. Adamson, in your discussion with 8 Mr. Ronayne this morning -- I want to make sure I 9 understood what you were saying -- you were talking 10 about the level playing field and whether a matter 11 should be shown or not -- I'm sorry, the retail area 12 and whether a matter should be shown or not. 13 The distinction was made earlier in 14 this proceeding between levelling the playing field and 15 arming or harnessing or restricting the players. Did I 16 hear you correctly in saying that your earlier look at 17 the draft staff-proposed code looked like it was 18 restricting the players rather than levelling the field 19 as far as retailers are concerned? 20 MR. ADAMSON: Can you point me to a 21 reference? 22 MR. JENNINGS: No. I was just trying 23 to understand what you were saying with Mr. Ronayne 24 earlier, when you were talking about the -- 25 MR. ADAMSON: Oh, right, when I was 26 talking with Mr. Ronayne, yes. 27 What I was kind of alluding to was in 28 the generation wholesale market. I think I was 831 ADAMSON/CONWAY 1 agreeing with Mr. Ronayne's position that it is 2 competition that is what is important. 3 We don't want to be in the situation 4 of creating unneeded competitors or subsidizing the 5 creation of unneeded competitors just because we think, 6 "Gosh, we have to have more competitors. Let's go out 7 and have the province go out and found some and 8 publicly finance them." I think that is completely 9 ludicrous. 10 What we don't want is to restrict any 11 potential competitors who should be allowed to enter 12 these markets, which is very different than subsidizing 13 them. We are talking about artificial restrictions on 14 people who would choose to enter, for their own 15 commercial purposes, into a market. 16 I think Mr. Ronayne's hero, Alfred 17 Khan, would agree -- in fact, I think he agrees in the 18 paper that Fiona attached to her paper -- that freedom 19 of entry to the market is a very powerful disciplining 20 force in any market. 21 One thing we do want to ensure that 22 we do is not create any artificial and unneeded 23 restrictions that prevent competitors from competing. 24 We don't necessarily want to go out and create 25 competitors. That's what I was alluding to. I think 26 that was Mr. Ronayne's concern, that we were going to 27 be in a situation where we didn't have enough 28 competitors, and had to go out and subsidize them so 832 ADAMSON/CONWAY 1 that they would be there. That was far from my intent. 2 But we do want very strong freedom of 3 entry, to the degree possible, into these markets -- 4 and that includes the retail market on that -- because 5 over the long term that is the defining price 6 discipline mechanism in almost every industry. It has 7 nothing to do with electricity specifically. 8 I was just trying to make that 9 distinction, because I thought Mr. Ronayne was going 10 down a path of sort of portraying what I was saying as 11 being that we had to go and make people do this. We 12 don't have to go and make people, but what we do need 13 to do is -- one thing we do, as a minimum protection 14 need to do, is ensure that people who do want to come 15 in can come in. 16 MR. JENNINGS: When you were talking 17 about, also on generation, the decontrol situation with 18 Ontario Hydro, I would like to test two things with 19 you -- sorry, with Ontario Power Generation Inc. 20 The Market Power Mitigation Plan 21 deals not with 3.8 cents cap on their whole generation; 22 it is a sieve, in that they have to give back anything 23 they make over that 3.8 on 90 per cent of their load, 24 and the other 10 per cent of their load is 25 unconstrained. 26 The other issue involved in that is 27 that the load that is defined there is not their actual 28 load but some previous estimate of what their load 833 ADAMSON/CONWAY 1 might be. So the potential, with a lot of air 2 conditioning this year, for instance, would be for a 3 much larger than 10 per cent, their actual load to be 4 outside. 5 Does that have a significant impact 6 on the overall volatility of the spot market and the 7 electricity price? 8 MR. ADAMSON: Again, I have only 9 reviewed a -- I don't know how many pages it was -- 10 summary of the MPMA. I have not made a substantial 11 study of it. It is well outside the scope of anything 12 I was asked to do. 13 I was making my comments in reference 14 to the issues I thought about implementation of 15 standard supply service, which is the purpose of this 16 technical conference, not a discussion of 17 competitiveness of the market as a whole. 18 I don't want to be drawn into making 19 too many broad statements. 20 As I did say yesterday, and I 21 continue to say, the design of the mechanism, to me, is 22 an issue of concern about how the wholesale market will 23 work. And that is of immediate interest to me in the 24 context of this technical conference, about how the 25 standard supply service function will be implemented in 26 the province. 27 I have only read a summary of the 28 MPMA. I have not seen how these "Q"s are calculated. 834 ADAMSON/CONWAY 1 They are kind of described -- I think it was described 2 in the summary I saw -- and I am relying on memory here 3 from a document I have only read once or twice -- that 4 there was some kind of calculated "Q"s. 5 So I have not seen enough detail of 6 the calculations to say whether those are appropriate 7 or not. I was only trying to raise as an issue, in the 8 context of standard supply, that consideration of what 9 incentives are created by the way the MPMA is designed 10 does need to be carefully considered. 11 If you want any more thoughts than 12 that, I'm afraid I will have to be able to spend more 13 time on it. I would have to be able to spend more time 14 on it to give it to you. 15 MR. JENNINGS: On a different topic, 16 your discussion briefly this morning about self-dealing 17 if there was an affiliated generator, did I understand 18 your concern about that correctly; that there might be 19 an artificial inflation and an artificial over-recovery 20 on the part of the parties at the expense of their 21 customers? 22 MR. ADAMSON: Let's just take a 23 hypothetical example. 24 I, for example, am a standard supply 25 service provider. You are a generator. You are 26 thinking, you know, the market price, "Gosh, I would 27 really like to do better than that market price", 28 whichever market, contract or spot. And you say, 835 ADAMSON/CONWAY 1 "Well, why don't you deal with me. Pass it on to your 2 standard supply service customers. It's a pretty good 3 deal for you." 4 Since it's a good deal for you, it 5 almost assuredly pushes you up in the yardstick 6 competition measure. But you think that the 7 disincentive you would face from that might be less 8 than the amount you might be making extra on the 9 generation contract, and you might be willing to share 10 that with me. 11 So that would be a clear example 12 under any type of procurement mechanism on behalf of 13 customers that we might consider as problematic. 14 The restrictions that tend to have 15 been put on those types of things in other markets, 16 that I am aware of, are relatively simple restrictions 17 on how much you could buy from generators in which you 18 had any financial interest, requirements that those be 19 done on an arm's-length basis or potentially not at 20 all. 21 But you see the mechanism I am 22 worried about. I think that the controls that stop 23 that type of behaviour are going to be very obvious, 24 indeed. Remember the standard supply service provider 25 has to say, "Here's my contract portfolio that I am 26 doing this on." 27 And one very simple question is: Do 28 you have a financial interest in any of the people from 836 ADAMSON/CONWAY 1 whom you have bought the power for the standard supply 2 service customers? If they say yes, well, you know, we 3 will red flag that. 4 MR. JENNINGS: The clarification I 5 was seeking, and I think I got, was that the concern 6 about that is that through collusion they will 7 over-recover and make too much money at the expense of 8 their customers. 9 MR. ADAMSON: Yes. 10 MR. JENNINGS: I want to also talk 11 about another item that came up this morning, and that 12 was the thought of two offerings. I think you said 13 that it would be desirable, in your mind, to have not 14 only the rate that is provided under section 29 15 customer protection rate standard service, whatever we 16 want to call it, but a spot as well. 17 The Market Design Committee, in the 18 report that Dr. Dewees was referring to, in its next 19 recommendation, after recommending their smoothed spot 20 pass, which we have had some questions about, says 21 that: 22 "We recommend that all local 23 distribution companies should 24 also be required to offer all 25 customers the option of buying 26 energy at the wholesale market 27 hourly spot price, including a 28 regulated recovery of 837 ADAMSON/CONWAY 1 administrative costs. The local 2 distribution company may 3 contract this regulated function 4 out to other appropriate 5 parties." (As read) 6 Does that sound consistent -- 7 MR. ADAMSON: This is to say that 8 everybody has to be offered an interval meter rate. 9 MR. JENNINGS: Available. 10 MR. ADAMSON: Right. Yes. I am 11 going back to various comments -- you know, if you hand 12 it over to somebody who does interval metering and does 13 the settlement for interval metering, if that 14 capability exists, why not? People have that right 15 anyway, because you can always go to a competitive 16 retailer who would probably, if you had the interval 17 meter, offer you the hourly rate plus an administrative 18 charge. 19 I don't think that is necessarily 20 a -- that's a protection that I suspect is available 21 most of the way. Whether they should offer the 22 averaged rate that was espoused by Professor Dewees and 23 the MDC, as I think I mentioned in a response to Mr. 24 Ronayne's question, that may be a very nice option. 25 And options to customers have a value. 26 The policy trade-off, to me, is -- I 27 am happy with that as the only option, because I do 28 believe that most customers prefer a fixed rate and 838 ADAMSON/CONWAY 1 will suffer a welfare loss from being forced to take a 2 risk. 3 For those who don't and who like the 4 idea of the hourly price, the averaged hourly price, 5 there is a question, not necessarily a simply question 6 but a practical question, of how do you incorporate 7 multiple -- is it easy to offer this option or not? Is 8 it expensive? Does it require very complicated systems 9 from Mr. Conway or not? 10 There is an option there. The things 11 needn't be -- the circle needn't be exclusive among 12 these two approaches. How well they -- and the hourly 13 interval metering option is probably out there anyway. 14 Are you going to offer the hourly rate, the averaged 15 process as well, I think is a matter of kind of 16 practical cost and assessment of benefits. 17 MR. JENNINGS: Okay. 18 MR. ADAMSON: The hourly interval one 19 is just out there anyway. If anyone has the 20 infrastructure to do it, they are probably going to be 21 willing to offer you the hourly spot price. 22 MR. JENNINGS: But I may have some 23 difficulty, without the necessary wherewithal being 24 available through the LDC, to -- 25 MR. ADAMSON: There may still be a 26 transactional cost; I agree. 27 MR. JENNINGS: Yes. Going back to a 28 couple of issues from yesterday -- again, I just want 839 ADAMSON/CONWAY 1 to clarify two quick things, and I won't be long. 2 MS LEA: Sorry, I wasn't going to -- 3 MR. JENNINGS: No. I was looking at 4 the clock. 5 We were talking about the -- you were 6 talking about the cost and the nature of the portfolio 7 you would need to meet SSC. I think what was said was 8 so long as the profiles were relatively similar and 9 there was a certain amount of homogeneity, I think in 10 people's minds a single portfolio would probably be 11 adequate. I think in people's minds we were looking at 12 residential customers as a group. But the Act requires 13 that all customers have access to the protections under 14 section 29. 15 So if in fact you had a large 16 industrial customer that chose to take advantage of 17 that, would that have a significantly different impact 18 on the strategy for providing SSC and perhaps the costs 19 involved, particularly, let's say, looking at 29(3) 20 where if some supplier failed and they have to take 21 them back on instantaneous notice? 22 MR. ADAMSON: I mean what you are 23 worried about -- by mixing customer classes with 24 different conception patterns, of course, what you are 25 always worried about is allocative efficiency of 26 prices. Anyone from the regulator's perspective is, no 27 doubt, familiar with the long literature on the 28 desirability of cost-reflective, hopefully, somehow, 840 ADAMSON/CONWAY 1 marginally cost-reflective pricing of electricity. 2 Now, the reason one might consider 3 multiple rates is because, as you suggested, the 4 consumption patterns might just be so different and so, 5 in a perfect world, we would have -- in a perfect and 6 costless world, we would try to match people's cost 7 profiles to the rates we offered them. That, however, 8 costs a lot of money. So, for simplicity sake, we 9 might say, "Well, gosh, it's much easier to have -- 10 it's much easier to attract and to bill and everything, 11 you know, a much smaller number of rates, maybe even 12 just one rate." 13 The reason I say this certainly 14 hasn't made my scheme any worse, in terms of the 15 allocative efficiency is, well, think about the 16 alternatives, think about if you are only offering 17 people this average spot price rate. You have already 18 destroyed whatever allocative efficiency signal there 19 was, in these hourly prices, by offering this average 20 number, to a very significant degree. 21 If we thought that there should be 22 peak and off-peak prices because of the economics of 23 the situation, well, offering an average price, 24 especially an ex-post set average price, has already 25 destroyed that price information. So it has already 26 destroyed the allocative efficiency of the pricing 27 regime. So we are certainly no worse. 28 In fact, you know, the allocative 841 ADAMSON/CONWAY 1 efficiency, I think, of a price signal set after the 2 fact is, indeed, probably weak, indeed. So we are 3 certainly no worse. You always, as a matter of rate 4 making, as a matter of pricing, want to try to reflect 5 differences in costs between serving different types of 6 customers. The trade-off in offering the fixed rates, 7 again, I would suggest, is basically one of 8 practicalities. Is it worth it? Is it -- you know. 9 Is the increased system cost, the increased billing 10 cost and whatnot worth the efficiency loss that you, as 11 the regulator, might presume, from having, you know, 12 people lumped together who ought not be lumped 13 together? But I think that is a judgment that a -- I 14 think that is the kind of judgment one could come to 15 relatively quickly. It is not outside the standard 16 bands of electricity rate-setting practice, in most 17 jurisdictions, about how many classes do we have, what 18 are the different consumption problems. 19 MR. JENNINGS: What I was trying to 20 get at, in part, was what are the different conditions 21 that we are trying to provide for. 22 We have tended to think about the 23 people who just don't want to leave. Small customers. 24 But in 29, there is also the requirement for, in 25 theory, accepting a very large customer who wants to, 26 or needs to, come back. And having a portfolio that 27 can accommodate that, I would think, has a 28 significantly different cost, and there may be 842 ADAMSON/CONWAY 1 justification for pricing differently, for those 2 circumstances. 3 MR. CONWAY: I would agree with that. 4 MR. ADAMSON: Do you have any 5 customers with demand side metering -- demand metering? 6 MR. CONWAY: Yes. 7 MR. ADAMSON: KVA metering? 8 MR. CONWAY: Over 15 kilowatts. 9 MR. ADAMSON: Right. How do you 10 incorporate that into an average? How do you 11 incorporate an average weighted product with demand 12 side metering? The one nice thing about doing a fixed 13 rate in advance, where I can start with the cost of 14 what it is costing me to serve peak demand by looking 15 at the contracts I'm buying to serve peak demand, is 16 that it allows me, under normal principles of marginal 17 cost-base pricing -- which we are all familiar with -- 18 it allows me to incorporate the potential for KVA 19 metering into the rates which -- again, I would suggest 20 you look at any standard textbook on utility 21 rate-setting -- is almost always a preferable option 22 when the costs of serving customers are very strongly 23 driven by peak demands. 24 MR. JENNINGS: Under those 25 circumstances, if spot were available, doesn't that 26 provide large industrial customers an amazingly good 27 back-up option if they always have access to it? 28 MR. ADAMSON: Yes. I mean you get 843 ADAMSON/CONWAY 1 the interval meter and you can get the -- you know, you 2 can get as good a price signal as you want. And so, 3 for the industrial customer the hardware required and 4 whatnot to do that is worthwhile. 5 MR. CONWAY: Well, clearly, the 6 customer who is highly on peak would -- may prefer to 7 go onto what he thought was an average price. In which 8 case, that, I think, supports your argument that he 9 wants to separate it back out again. 10 MR. ADAMSON: Yes. Offering average 11 prices on all classes of service, particularly -- you 12 know, that's why, again, you might want to have -- if 13 these people are KVA metered now, you may still want 14 him on a KVA metered ray because, you know, otherwise 15 you end up -- you end up cross-subsidizing the guy who 16 runs the shopping mall with the huge air conditioning 17 load that happens to be coincident with peak demand, if 18 you let him jump onto an average rate with me, who 19 doesn't run any air conditioner, well, come -- you 20 know, I'm cross-subsidizing the guy. 21 MR. JENNINGS: The same thing would 22 be true on a seasonal basis. 23 MR. ADAMSON: Yes. You have to be -- 24 the introduction of all these competitive principles 25 changes very little of the economics of setting rates. 26 MR. JENNINGS: One last point. 27 You were asked, yesterday, about 28 Mr. Todd's paper, page 22, whether you agreed with a 844 ADAMSON/CONWAY 1 paragraph that basically said that the monthly billing 2 and the fact that some customer-care factors are 3 relatively would somewhat mask the volatility of the 4 electricity, on page 22. 5 Just to be clear, in a couple of 6 paragraphs below that, there is a reference to 7 electricity vis-a-vis gasoline and natural gas and, in 8 this province -- I don't know how true it is 9 elsewhere -- we have a parliamentary committee looking 10 at the volatility of gasoline at the pumps and a 11 special office set up, now, to look at that volatility. 12 Mr. Todd's paragraph that wasn't 13 mentioned, I just wondered if you agree with it, as 14 well: 15 "Despite the various factors 16 that may lessen the volatility 17 of consumer prices of 18 electricity relative to the spot 19 market, monthly and seasonal 20 volatility is likely to be large 21 enough that the degree of 22 volatility seen by customers 23 will exceed the volatility seen 24 by customers in other energy 25 markets, such as gasoline and 26 natural gas." (As read) 27 Do you also agree with him, on that? 28 MR. CONWAY: Yes, I do. 845 ADAMSON/CONWAY 1 MR. ADAMSON: Yes. The actual 2 patterns are somewhat different, but I agree that over 3 time one would expect the volatility to be rather 4 higher. 5 I don't disagree, but I don't 6 completely agree with Mr. Todd's next sentence -- which 7 is an important one, and I will just read that out so 8 that you have it: 9 "It can be expected that 10 risk-averse customers will seek 11 supply arrangements that will 12 give them price 13 certainty." (As read) 14 Now, we have made it -- or I listed 15 it as one of my economic principles, that the majority 16 of customers are risk averse. However, I also 17 highlighted, with that picture with the little hump in 18 the middle, that there are some significant costs to 19 doing anything about this problem. There is the hump 20 that you have to get over before you do anything about 21 it. 22 I suggest that some of them who 23 really are possibly very risk averse might be inclined 24 to move immediately into the competitive retail market 25 with someone who might offer them a fixed price 26 contract. That, indeed, would, you know, allow them to 27 escape the level of risk that the spot price 28 pass-through discussed previously might impose on them. 846 ADAMSON/CONWAY 1 However, I also argue that there are 2 a significant -- an excess of customers in Ontario -- 3 in most places -- who are risk averse who, you know, 4 probably would wish this wasn't happening to them, but 5 who might not get over that hump to just switch away 6 into a competitive retailer who offers me the fixed 7 rate, just because it takes a lot of time to understand 8 this, and it is very hard for us in this industry to 9 forget that most people don't understand this a whit. 10 You know. They are still amazed that you can have 11 competition in electricity because gas -- I don't want 12 anybody else running wires to my house. Everyone I 13 talk to, in Massachusetts says that, you know. My 14 electric company can't do one thing right, in 15 Massachusetts, where we live. Where I happen to live 16 is a particularly -- is not known for great customer 17 service. I really don't want anyone -- I don't want 18 them -- it will be like the cable TV guys: you have to 19 wait for them to show up. 20 People do have these costs in getting 21 away from that. So why stick it with them, in the 22 first place? It's extraordinary. 23 MS LEA: Thank you, Mr. Jennings. 24 Mr. Henderson. 25 Mr. Henderson, as you didn't make an 26 appearance on the first day, I wonder if you could 27 state now who you are acting for, please? 28 MR. HENDERSON: Yes, I will. 847 ADAMSON/CONWAY 1 I am Graham Henderson with Ontario 2 Hydro Services Company. 3 Good afternoon, gentlemen. 4 I have five or six questions related 5 to from a distributor's perspective in carrying out the 6 legislated obligation of standard supply. In 7 particular, I would like to frame it in the context of 8 a distributor that is choosing to fulfil that 9 obligation either through an affiliate or through a 10 third party. 11 My first question is, Mr. Adamson: 12 How would you characterize the degree of risk that the 13 distributor is taking on with the spot price model 14 compared to the fixed price model? 15 MR. ADAMSON: The first word I guess 16 I would use is "avoidable". I think we are going to 17 hear more debate about this after lunch from those of 18 us with more detailed knowledge of its legal workings, 19 but I am pretty sure the Act gives very strong 20 assurances that distributors are able to fulfil these 21 obligations through a third party. 22 So I guess the first comment I would 23 make to someone who said, "I am a distributor and I 24 don't want a lot of risk", is, "Well, don't bear any. 25 You seem to be well within your powers to assign that 26 to someone else." 27 That certainly caps the overall risk 28 exposure, I think, right there. 848 ADAMSON/CONWAY 1 The second one is I don't think the 2 magnitude of the incentives required for the 3 procurement function -- I think people respond 4 relatively sharply to economic incentives. We are not 5 talking about betting the house here and whether I fall 6 below or above the black line, horizontal black line I 7 had earlier. We do want the signal to be strong enough 8 to send the right price signals, but we are not talking 9 about a Nick Gleason betting the bank-type scenario 10 under any stretch of the imagination. 11 So I would characterize it as the 12 levels of risk are limited by nature in a form of 13 infinite mechanisms. They have to be consistent with 14 level of risk that the standard supply service provider 15 can take on. But, most importantly, they are avoidable 16 through the provisions of the Act, from my reading of 17 it, by this standard supply service requirement being 18 obligation being discharged by another. 19 MR. HENDERSON: Barry, what is your 20 comment on the same question? 21 MR. CONWAY: I agree totally. 22 MR. HENDERSON: In terms of 23 discharging the obligation to the third party, then, it 24 is your view that if the distributor chose to go that 25 route the distributor has, in essence, then, is it fair 26 to say, passed on the obligation to that third party 27 and, therefore, through that mechanism they are 28 avoiding the risk or benefit of the yardstick 849 ADAMSON/CONWAY 1 mechanism? 2 MR. ADAMSON: One thing I didn't 3 remember -- and maybe it will become a bit clearer 4 after lunch -- is that the precise nature of how one 5 discharges this obligation I don't remember being 6 described in great detail. 7 I took from the tone of the reading 8 of the thing -- but again, I may well be corrected by 9 those who are probably flipping through the pages as we 10 speak -- that the implication seemed to be that it 11 should be able to be handed off on an arms-length basis 12 and without substantial recourse unless, you know, it 13 turns out the distributor handed it off to somebody who 14 simply couldn't do it. You can't hand it off to me if 15 I don't have an office here and obviously don't have 16 any mechanism for doing it. I would think that would 17 probably be interpreted by the Board as a sign of not 18 discharging one's obligation. 19 But having handed it over to a 20 qualified third party, the tone of the thing would seem 21 to me to indicate that that is discharging one's 22 obligation. 23 Now, perhaps we will get a more 24 precise legal opinion on that. 25 MR. HENDERSON: In passing that on, 26 then, as you described, if a distributor was prudent in 27 assigning the obligation, or the fulfilment of the 28 obligation to a third party, is it your opinion the 850 ADAMSON/CONWAY 1 distributor, then, their primary risk in doing that is 2 a regulatory risk in terms of the view of the regulator 3 regarding whether the distributor acted in a prudent 4 manner? 5 MR. ADAMSON: Thinking very broadly 6 in economic terms about it, I imagine it would come 7 down to that. 8 Again, I am not the lawyer who should 9 express an opinion about the precise intentions of the 10 Act and the precise mechanics of how the provisions on 11 standard supply service obligations need to be 12 conducted by those for whom I believe the Act clearly 13 allocates them to. 14 So, you know, I think that is 15 probably best left to someone who can give you a 16 clearer indication of that interaction between the 17 obligated distribution entity, the regulator and the 18 discharging party. 19 MR. HENDERSON: Barry, I'm interested 20 in your view on that also. 21 MR. CONWAY: It's my understanding 22 you can't pass on the obligation so you would have to 23 protect yourself contractually. You would probably do 24 so by insisting on having no volume in price risk and 25 protecting yourself from supplier default with some 26 kind of prudential requirement. 27 There is probably always some 28 residual business risk, but you would try to minimize 851 ADAMSON/CONWAY 1 that with your contract. 2 MR. HENDERSON: In terms of the 3 distributor -- Barry I'm interested in your answer to 4 this question first, and then Seabron's. 5 In terms of the distributor taking 6 the full requirements approach, I think that is what 7 you are describing in terms of no volume or price risk. 8 MR. CONWAY: Yes. 9 MR. HENDERSON: In your view, and 10 based on your knowledge, is that what is the relative 11 cost of that approach compared to other risk management 12 approaches or strategies? 13 MR. CONWAY: By "relative cost" I'm 14 not exactly sure what you mean. 15 The option is always to do it 16 yourself, in which case you would build your costs into 17 the rates. I would assume there would be some sort of 18 allowance for procurement costs. 19 However, you would have to bear the 20 exposure that you might run to run the portfolio. The 21 cost depends, in that case, in terms of how well you do 22 that. 23 But if you want to bear no risk in 24 that regard, you would outsource it. 25 MR. HENDERSON: Even in 26 outsourcing -- I guess my question is more related to 27 in completely outsourcing and trying to take as little 28 risk as possible from the distributor's perspective. 852 ADAMSON/CONWAY 1 Does that mean the outsourcing of that risk management 2 would result in a premium cost as compared to a 3 strategy where the distributor was willing to take some 4 of the risk? 5 MR. CONWAY: If you have a full 6 requirements contract you will have a certain cost 7 quoted, and there may be a range depending on the 8 competition you run. 9 If you decide to run your own 10 portfolio and take on a little bit more risk, you may 11 be able to minimize the cost of power that would come 12 out of that portfolio. But you would be putting some 13 of your capital at risk at that point and you would 14 expect some kind of return for that. I doubt, from the 15 way you posed this question, that you would want to do 16 that. 17 I would expect that if you were 18 running your own portfolio, in that circumstance you 19 would have a fairly tightly hedged portfolio so that 20 your exposure would be minimized. But the extension of 21 that is just to outsource it, in which case you are 22 basically buying power at a fixed cost with no price 23 volatility at all. 24 MR. HENDERSON: Seabron? 25 MR. ADAMSON: I'm just going to say, 26 I understand the question of residual risk but perhaps 27 we might put this in a wider context. 28 What is the residual risk of a 853 ADAMSON/CONWAY 1 regulated entity, regulated distribution entity in this 2 case, in outsourcing any necessary function? It seems 3 to me utilities outsource quite a number of functions, 4 often. I know utilities that have outsourced various 5 billing functions, meter reading functions, call centre 6 functions, all types of things which are necessary for 7 doing what they are supposed to do in the final 8 analysis, which is get electricity to customers. 9 It seems to me there is probably not 10 a great analogy -- I'm sorry, not a great distinction 11 between what is intended in the Act as regards 12 potentially to this obligation and outsourcing all 13 sorts of other necessary obligations of which I think 14 regulated enterprises do quite a lot of. So that is a 15 good benchmark to think about. 16 To the extent that you think there is 17 a residual commercial risk, you deal with that in the 18 terms of the contract with the supplier, just as you 19 would deal with an outsourcing contract with an IBM 20 subsidiary that was handling various billing services 21 functions for you perhaps. 22 It is certainly an issue, but it 23 doesn't strike me as a regulatory issue limited to this 24 problem. There may well be some evidence of how that 25 has been dealt with in some of these other examples. 26 MR. HENDERSON: I think my last 27 question, as I think I am standing between us and lunch 28 at this point -- 854 ADAMSON/CONWAY 1 MS LEA: No, you are not. 2 MR. HENDERSON: Oh, I am not. Good. 3 That makes me feel better. 4 I think my last question is related 5 to a distributor that chooses to take as little risk as 6 possible in doing this, however that results in them 7 fulfilling the obligation, if it's completely 8 outsourcing with the requirement service. I am 9 interested in both of your opinions. 10 Is that, in your opinion, likely to 11 result in that distributor during the yardstick 12 comparison exercise with other distributors who may be 13 willing to take more risk ending up with a higher cost 14 and, therefore, being more likely to be penalized or in 15 danger, in risk of being penalized through the 16 yardstick comparison? 17 MR. ADAMSON: Facing a negative 18 economic incentive. 19 MR. HENDERSON: Very well, facing a 20 negative economic incentive. 21 So my question is: In your opinion, 22 is that a risk for the distributor if they choose the 23 approach of taking zero risk on the price and volume 24 side? 25 MR. CONWAY: I would say it depends 26 on the contract. If I was doing contracting in that 27 circumstance, I would pass it back to the supplier. 28 MR. ADAMSON: Yes. My vision of how 855 ADAMSON/CONWAY 1 this would work and the relationship of what I was 2 thinking about with the terms of the Act was that if 3 your entity contracted with this other party -- let's 4 just cite for an example this person doing the standard 5 supply service provision. Clearly, you want that 6 incentive to be going in the right place, too, and if 7 they are doing the procurement, they should face the 8 economic incentives, not you. 9 So I think your residual regulatory 10 risk in this would be these guys didn't do their job at 11 all or did it in such an extraordinarily bad way that 12 whoever you contracted with you are open to some form 13 of prudency review about did you discharge your 14 obligation in an incorrect way. I would say that's 15 normally handled under contract law through normal 16 forms of liquidated damages provisions or whatever. 17 So that clearly, to me, seems like 18 that's specific to the contract that you developed with 19 the provider, but it certainly, to me, economically 20 makes more sense that if that third party provider over 21 here is doing this for you, he faces economic 22 incentives because he is the one doing the procurement. 23 What you have done is to say, "I have put this in a box 24 and you and I have a contract about what happens to 25 this box." The only thing you are open to is does the 26 OEB say, "You shouldn't have put it in that box." 27 MR. CONWAY: Perhaps we should 28 continue this conversation over lunch. I am sure I can 856 ADAMSON/CONWAY 1 find a solution to your problem. 2 MR. HENDERSON: I am not surprised. 3 That's all my questions. Thank you. 4 MS LEA: Thank you very much, 5 Mr. Henderson. 6 Ms O'Riley has a question. 7 MS O'RILEY: I had better keep this 8 really short. 9 I was just going to ask if you could 10 clarify some of the discussion around contracts for 11 generation and, specifically, I was wondering if there 12 have been merchant plants that have been financed in 13 other jurisdictions without a long-term contract for a 14 large volume of the output. 15 MR. ADAMSON: Yes, there has. There 16 has been new generation and, very substantially, a lot 17 of what there has been has been effectively 18 divestitures, like in a lot of the U.S. states, in 19 Australia, in some of the Latin American countries, 20 notably Colombia, Argentina. We could come up with a 21 laundry list of them. There are lots of merchant 22 generation activities going on around the world in a 23 lot of different markets. 24 To give you an example, the 25 transaction I recently worked on -- and this is kind of 26 publicly known because you can look it up in the Wall 27 Street Journal -- was the financing of the former 28 thermal assets in New York State Electric & Gas. It 857 ADAMSON/CONWAY 1 was almost predominantly merchant. They had 2 relatively -- they did have a very short sell-back 3 contract to the utility doing the selling, which is 4 sometimes common in these things. 5 It's not that there are not people in 6 the financial community unwilling to assume risk, 7 merchant generation risk. Particularly over very long 8 terms, there is always very substantial merchant risk. 9 The question is anything I can do to help lock down any 10 of those revenues contractually helps me a great deal 11 in the financing. There is no doubt that, by 12 definition, a merchant plant is going to have some 13 merchant risk, revenue risk, predominantly quantity 14 risk. It's a question of degree. 15 There have been projects financed 16 which are almost completely merchant. It's not 17 impossible. There have been ones that have mixtures of 18 some contract cover and some without contract cover. I 19 guess my assertion is that anyone buying or building a 20 merchant plant can forecast revenue stability better to 21 the extent that they are able to hedge those risks 22 contractually or take price signals from forward 23 contract markets. 24 To the extent that those risk-hedging 25 options and forward price signals are available not 26 only to the developer but very critically to the 27 capital market, whether that's the banks that 28 participate in a syndicated loan, whether that is to 858 ADAMSON/CONWAY 1 the rating agencies that rate that issuance, to the 2 extent you are able to rely on those market price 3 signals gives a very strong signal to the capital 4 markets on the longer-term economics of the plant you 5 are looking at. 6 So merchant generation exists. The 7 question is one of relative risk and what relative 8 return on capital one requires for assuming that. The 9 required returns on equity for merchant generation, 10 even for quite solid, highly-competitive facilities, is 11 very high. Even for good relatively base-load plans, 12 it is not uncommon to hear bandied about by people in 13 the financial community real returns on equity in the 14 order of 18 to 22 per cent. 15 For a capital-intensive facility, 16 that is pretty big money and that's a substantially 17 higher cost of equity than one is used to in the 18 regulated world. We also hope that helps allocate risk 19 better over the long term to people building these 20 things. The required returns on equity and even 21 returns on debt can be substantially higher than what 22 one is used to under the kind of franchise-regulated 23 utility model. 24 So anything that helps convince me as 25 the equity participant and helps convince you as the 26 lender, whether you are a commercial bank participating 27 in a syndicated loan, whether you are someone buying a 28 bond which is backed by the revenues from my debt, it 859 ADAMSON/CONWAY 1 just helps lower the cost of capital. So it's not 2 impossible. It's almost always possible to get 3 somebody to invest at some target rate of return, but 4 those can be, in real terms, very, very high. It's a 5 matter of degree. 6 MS LEA: Thank you. 7 Any other questioners that I might 8 have missed? I see none. 9 Thank you very much, gentlemen, for 10 the assistance you have given to parties and the Board 11 through your presentation and the answers to your 12 questions. 13 Thank you, Mr. Power. 14 MR. POWER: Thank you. 15 MS LEA: One hour for lunch, please, 16 returning at 20 to 2:00. 17 --- Upon recessing at 12:40 p.m. 18 --- Upon resuming at 1:40 p.m. 19 MS O'RILEY: Good afternoon. 20 Mr. Power. 21 MR. POWER: Thank you very much. 22 Just for everybody who is in the room, there was a 23 prefiled witness statement for John Jenkins and Gunars 24 Ceksters, and of course the report which we have seen 25 earlier by Fiona Woolf. 26 To my side over here there are 27 overhead presentation materials by Gunars Ceksters and 28 Fiona Woolf. Unfortunately, I forgot Mr. Jenkins'. I 860 ADAMSON/CONWAY 1 will make those available Monday morning, copies of the 2 slides that he will be presenting here today, although 3 they don't vary significantly from the witness 4 statement he had made. 5 In terms of the three people that we 6 have before us today, Fiona Woolf, of course, has had a 7 wide range of experience in advising governments and 8 regulators on almost all parts of the competitive 9 electricity markets. You can see from her CV and 10 attached materials that she has been at this game in 11 nearly every major electricity restructuring for 12 15 years. 13 She has also been the project 14 director on many of the restructurings, which is more 15 than simply giving advice but actually leading the 16 teams. 17 John Jenkins is the Manager of 18 Business Development at ATCO Power Limited. He has had 19 24 years of business development in both natural gas 20 and power project development, and he is the project 21 manager for the Lakeview generating project. 22 Gunars Ceksters is the Executive 23 Director at Hydro Mississauga who is responsible for 24 systems planning and operations. He is also 25 responsible for Hydro Mississauga's participation in 26 the Lakeview project and other generation projects, and 27 is also responsible for Hydro Mississauga's involvement 28 in the G6 initiative consortium, which is six utilities 861 ADAMSON/CONWAY 1 which are analyzing and looking at amalgamating their 2 retail operations for a provincial retail company. 3 With that introduction, perhaps I can 4 turn it over to the panel. 5 PRESENTATION 6 MS WOOLF: Thank you. 7 I am Fiona Woolf from Cameron 8 McKenna. If I could have the first slide, please. 9 I have called this "Implementing the 10 White Paper through the Standard Supply Service Code". 11 The reason I have done that is fairly obvious. When I 12 look at the code I asked myself, as I am sure we all 13 did: What is this trying to achieve? I then looked at 14 the licence, which is the basis through which it is 15 given force, and I looked at condition 14(2) and I 16 said: What is this trying to achieve? That took me 17 back to the legislation, which obviously was trying to 18 achieve a number of things which are set out in section 19 1 of the act. Also, of course, it then took me back 20 to: What is that trying to achieve to the White Paper? 21 Indeed, as I noticed Don Dewees said 22 in his presentation, we were guided by the White Paper 23 of November 1997. Part of our mandate was to follow 24 the White Paper as our terms of reference. We looked 25 there, among other things, for goals. 26 From the point of view of the goals, 27 let's look to see what the White Paper said in relation 28 to the issues that we have been discussing this week. 862 WOOLF/JENKINS/CEKSTERS, presentations 1 Let me say that the emphasis that is 2 on these slides, of course, was added by me. 3 Retailers, brokers and large volume 4 customers, including local utilities, would buy from 5 the spot market or arrange bilateral contracts with 6 generators as they would in a wholesale model. 7 They, meaning customers, would have 8 the choice of staying with their current utility, 9 having an electricity broker arrange supply on their 10 behalf, as in the gas and telephone industries, or even 11 buying directly themselves. 12 Directly on this issue, distribution 13 utilities would continue to supply electrical energy, 14 either directly or under contract with a private firm, 15 so customers would not be required to make any changes 16 if they did not wish to. Customers would always have 17 access to electricity at market-based prices through 18 their current supplier. 19 I was a little bit confused with Don 20 Dewees' statement when he said, "Without doing more, 21 everybody has the benefit of wholesale competition 22 simply by staying on standard supply service. None of 23 the other schemes seems to offer that benefit." It 24 seems to me that the Seabron Adamson proposal, as I 25 have called it, does exactly what the White Paper 26 indicates. It gives customers access to electricity at 27 market-based prices. 28 So in a sense, just as a statement of 863 WOOLF/JENKINS/CEKSTERS, presentations 1 the obvious, the White Paper represents policy 2 objectives in a codified form. It reflects some two 3 years of debate and consultation. What is unusual in 4 my experience where White Papers normally upset 5 everybody -- and they are doing well if they upset 6 everybody equally -- this White Paper commanded a 7 remarkable degree of support and acceptance in Ontario. 8 So I think we can take it that it has established 9 government policy objectives and also there is a lot of 10 accepted wisdom of stakeholders reflected in it. 11 Believe me, these are very important 12 issues because, as much as people love to debate the 13 wholesale market and as much as people love to debate 14 market power and OPGI's position and all that sort of 15 thing, it is in the retail sector that the rubber hits 16 the road. The success of this restructuring will 17 depend upon how well the standard supply service works 18 and how well retail competition works. 19 I have based my paper and this 20 presentation on the assumption that there has been no 21 change in the policy objectives stated in the White 22 Paper. Why have I taken that assumption? Because I 23 believe that Bill 35 very faithfully reflects 24 government policy, and particularly I think that 25 section 79 of the OEB Act remains government policy. I 26 think that the government is that sort of a government 27 where it would have told us if it wasn't still its 28 policy objective when it has actually enacted that 864 WOOLF/JENKINS/CEKSTERS, presentations 1 objective in legislation. 2 What am I talking about in terms of 3 section 79? Let's look at it in the way it has been 4 cast in condition 14(2) of the transitional 5 distribution licence, which is the document that gives 6 legal basis for the SSS code, as I will call it for 7 shorthand. 8 It says that the licensee may fulfil 9 its obligation to supply directly, through an 10 affiliate, through another person with whom the 11 licensee or an affiliate has a contract, or through a 12 combination of the three methods. In a world where 13 distributors are being asked to unbundle, 14 commercialize, merge, achieve economies and 15 efficiencies it is fairly obvious that flexibility had 16 to be given to them to adopt the most appropriate 17 strategy. 18 Why deviate from this? Let's go down 19 the hierarchy. I started with the White Paper. We 20 have been through the legislation, into licensing and 21 we are now into the code. I should say the "codes". 22 The key restrictions are the ARC 23 2.5.7, affectionately known as "the ARC", which 24 restricts transfer to an affiliate SSS provider; SSSC 25 2.2.4 and 5, which restrict third parties to SSS 26 provision only within the distributor's service 27 territory; and SSS 2.2.2 and 2.5, which restrict the 28 use distributors can make of market sources to offer 865 WOOLF/JENKINS/CEKSTERS, presentations 1 SSS customers market-based prices. 2 I do regard the ARC 2.5.7 as being 3 inextricably linked to the Standard Supply Service 4 Code. I think that if you read it at face value it 5 simply makes it impossible to implement condition 14(2) 6 of the transitional distribution licence as drafted. 7 You could not transfer the customers over to a retail 8 affiliate to have the SSS provided. 9 It also means that the retail 10 affiliates must, of course, start from completely 11 nothing. They can't use any customer lists. So they 12 are going to be small, and given that margins are thin 13 in the retail business, it is going to restrict the 14 exercise of choice under the TDL for implementation of 15 the Standard Supply Service Code. 16 I think it is very similar in the way 17 that it operates to the restrictions on standard supply 18 service providers marketing or retailing electricity 19 and gas in the service area of the distribution 20 utility, because both of them restrict market entry. 21 And also from the point of the 22 Seabron Adamson proposal, if it was left untouched, 23 then it would mean that the retail affiliate best 24 placed to manage procurement under Seabron's proposal 25 would be precluded from doing so. 26 I think it is also useful to note 27 that the code that it was taken from, the California 28 code, is nothing like as restrictive as this particular 866 WOOLF/JENKINS/CEKSTERS, presentations 1 provision. 2 Could I have the next slide, please. 3 As I indicated, the Standard Supply 4 Service Code creates restrictions on the choice that is 5 given to distribution utilities under Condition 14(2) 6 of the TDL. As pictures speak louder than words, at a 7 glance you can see that what is created is three 8 companies rather than the two that are envisaged in the 9 legislation. 10 Particularly, the problem for the 11 third party provider is that it can't exploit economies 12 of scope and scale in the LDC's service territory. 13 There is no scope or incentive to make money by 14 efficient power procurement because of the 15 restrictions. 16 In fact, although the staff 17 background paper talks of allowing third parties to buy 18 outside the spot market because 222 of the Code only 19 relates to distributors, why would a third party do 20 that? 21 Why would anybody be mad enough to 22 buy a fixed price and then sell at spot? The price 23 that a third party can sell at is fixed by the Code. 24 They can only sell at the spot price, which is 25 volatile. Nobody would be mad enough to buy fixed and 26 sell at a volatile spot price. 27 If they could buy it at a cost that 28 was lower than the spot price, why would they sell it 867 WOOLF/JENKINS/CEKSTERS, presentations 1 in a standard supply service business with all the 2 restrictions on marketing in the LDC's service 3 territory? Why wouldn't they just sell it back into 4 the spot market? 5 I am really mystified as to why the 6 third party would be interested in getting into this 7 business. 8 By the same token, I don't think an 9 LDC would want to burden its retail affiliates with 10 this business -- or should I call it an obligation, 11 because that in effect is what it is, it is a public 12 service obligation. 13 The affiliate has the same marketing 14 and retailing restrictions as the third party because 15 of the definition of third party in the Code, which 16 includes affiliates. 17 So how on earth did all this trouble 18 arise? Well, I think it probably arose -- and it was 19 probably inadvertent -- because of the need to deal 20 with specific problem areas. I call them "mischiefs" 21 in my paper. People think that is very 19th Century 22 English, so I call them "problem areas" now. 23 Could I have the next slide, please. 24 So what are the problem areas that 25 people have been legitimately, in my view, seeking to 26 address? And indeed the Codes do address these issues. 27 Well, the obvious one is the 28 distributor's potential conflict of interest, as I call 868 WOOLF/JENKINS/CEKSTERS, presentations 1 it; the potential for cross-subsidies between the 2 distributors and affiliates, a preferential service of 3 the affiliate's customers. Indeed, these problem areas 4 Don Dewees mentioned twice in his presentation. 5 Then, of course, there is the 6 protection of customer information. That is just not a 7 regulatory or a market concern. That is also a very 8 legitimate personal privacy issue here, customer 9 privacy issue here, which I will come back to at the 10 end of the presentation. 11 Then there is the obvious issue of 12 regulating the price of the standard supply service for 13 the people who are in effect captured customers, maybe 14 by choice or inertia. But, nevertheless, the price for 15 them needs to be regulated. 16 Then there is the final problem area, 17 which I think has been obsessing everybody, which is a 18 potential for what might be perceived as an unfair 19 market advantage or abuse of market power. 20 The point here is that we must not 21 confuse controlling access to essential facilities such 22 as distribution-wise with controlling or restricting 23 market entry. Indeed, it seemed to me that Don Dewees 24 managed to show easy it is to confuse these issues, and 25 indeed I think Alfred Khan has written on this subject 26 on many occasions as well. It is easy to fall into the 27 confusion. 28 He said in his presentation -- it 869 WOOLF/JENKINS/CEKSTERS, presentations 1 says the third party provider may not retail in the 2 service area. That goes beyond what the MDC said 3 explicitly, but it is consistent with our concern, the 4 MDC's concern, that opportunities for cross-subsidy and 5 preferential treatment be minimized. 6 There, in a single sentence, he leaps 7 from something that controls market entry into 8 something that deals with the first point, which is 9 controlling access to essential facilities. 10 So if a professor of economics can be 11 confused, then I think maybe everybody else can be 12 forgiven for being confused as well. But for the 13 purposes of this afternoon, it is important that we not 14 be confused. 15 There is another risk which has been 16 talked about, which is protecting distributors from 17 risk. I won't go over the eloquent answers of Seabron 18 Adamson this morning, but I had to do it through 19 contract. Where I come from, I think a distributor 20 would shrug his shoulder and say: Well, I am perfectly 21 able to manage risk. I am in a good position to do 22 that and I regularly do it. And I don't really regard 23 myself as being at a disadvantage. 24 I think if we could move on, I would 25 like to concentrate now on the issue of the potential 26 market advantage. I think, as Seabron has indicated, 27 governments and regulators avoid imposing restrictions 28 on market entry unless they are absolutely necessary. 870 WOOLF/JENKINS/CEKSTERS, presentations 1 And this would be the last sort of restriction that 2 they would put in place. 3 As Alfred Khan likes to say, there is 4 a heavy burden of proof that there will be a problem 5 before any regulator starts putting any measure in 6 place that interferes with market forces. 7 Frankly, I don't see how in Ontario 8 you can begin to discharge that burden of proof. The 9 market participants in the retail market haven't even 10 identified themselves. Let's contrasts that with the 11 wholesale market, where obviously we do have some 12 inkling that OPGI would like to participate in the 13 wholesale market. So we do know that at least there 14 will be one participant in there. 15 I think also that the view that this 16 perceived competitive advantage that the LDC retail 17 affiliates might have if they could use the LDC's 18 customer list is unlikely to be unfair in all analysis. 19 There is nothing unfair about exploiting economies of 20 scope and scale. Everybody does it. 21 I was thinking this morning, when I 22 went into Starbucks to get a cup of coffee, that 23 Starbucks were exploiting an economy of scope and scale 24 by offering me a muffin at the same time. 25 Using customer lists and names and 26 reputations is very much open to anybody else with a 27 customer list in Ontario -- notably, of course, the gas 28 companies. 871 WOOLF/JENKINS/CEKSTERS, presentations 1 We are finding in the U.K. that it is 2 essentially the supermarket chains who are very 3 interested in selling electricity and using their 4 customer lists, their credit card facilities, their 5 premises, as economies of scale for entering into the 6 market at low cost. 7 There is another sort of economy of 8 scope and scale which can be utilized, which might 9 surprise you, which is the economy of trading off 10 between the portfolio of contracts for standard supply 11 service and for retail service. I am sure that is 12 exactly what the England/Wales RECs do with their 13 contract cover. 14 Let's just have a look at the next 15 slide on restrictions on entry into the market. 16 Seabron said that the threat of 17 market entry is one of the most powerful 18 pro-competitive forces that there is. It is a highly 19 beneficial source of competition. 20 I was reading last night the famous 21 article in 1989 by Stephen Littlechild, who has just 22 been appointed the electricity regulator in England. 23 He had assumed an obligation that is very similar to 24 the duty on the Board here in Ontario. 25 "Promoting competition involves 26 facilitating the entry of new 27 competitors, including the entry 28 of existing competitors into new 872 WOOLF/JENKINS/CEKSTERS, presentations 1 parts of the market." (As read) 2 We did debate what the difference 3 between promoting and facilitating competition was. We 4 debated endlessly the meaning of the two verbs and came 5 to the conclusion, in practice, that there wasn't much 6 difference between the two. I was on the receiving end 7 of this because the national company that I represented 8 had a duty to facilitate, and the regulator had a duty 9 to promote. We came to the conclusion that in making 10 practical decisions, it pretty much wound up as the 11 same sort of thing. 12 Entry, of course, is normally based 13 on the utilization of existing resources of achieving 14 economy in scope and scale. This enables entry at much 15 lower than any incremental cost, and that of course can 16 result in lower prices and cost to the consumer. 17 And handicapping does not create 18 competition. It is not the level playing field that 19 the staff background paper promised. 20 Of course, I suppose there is a 21 trade-off between facilitating entry and the effect on 22 developing competition when it is up and running. But 23 let's get it up and running first, rather than 24 prejudging what it will eventually look like. 25 Everybody is somewhat pessimistic in 26 Ontario about the extent of retail competition, if Don 27 Dewees was anything to go by. 28 So it seems to me that at the outset, 873 WOOLF/JENKINS/CEKSTERS, presentations 1 what is important is to get it going. 2 Of course, the short point, as you 3 will doubtlessly realize, and as day follows night, is 4 that if you restrict the retail affiliate from 5 utilizing the customer lists and the resources of the 6 distribution utility, and you restrict third parties 7 and retail affiliates from marketing and retailing gas 8 or electricity in the service area, then you are going 9 to find that there are no economies of scope and scale 10 that they are going to be able to utilize. 11 Indeed, I doubt whether you will find 12 them in the market at all. 13 So, in short, I suppose if you are 14 back to level playing fields and teams -- what with 15 references to ball games from last night, anything to 16 go by -- there is a difference between equal access and 17 equal teams, and there is nothing that says that you 18 have to protect the less efficient teams or indeed 19 subsidize the less efficient teams, as Seabron has 20 mentioned, to get things going. 21 What worries me is that you will wind 22 up with, at most, a couple of competitors in a service 23 area. Where I come from, I am afraid that duopolies do 24 not create competition. We think actually that they 25 just create twice the opportunity for the exercise of 26 monopoly power. 27 Could I have the next slide. 28 The other White Paper objective was 874 WOOLF/JENKINS/CEKSTERS, presentations 1 of course the rationalization of the distribution 2 sector. As an international consultant, I can say that 3 the only place that has more distribution utilities 4 than Ontario is South Africa. Therefore, there was 5 obviously a desire in the mind of the government, well 6 expressed in the White Paper, to provide a framework to 7 motivate rationalization and motivated, obviously by an 8 express and indeed an obvious desire to achieve 9 efficiencies and economies of scope and scale. 10 Of course, as I have indicated, the 11 restrictions that are imposed by the Codes could 12 involve diseconomies rather than economies -- you know, 13 the three where two would do -- if of course you could 14 persuade a third party to get into the business anyway. 15 It is an unattractive business case 16 for both competitive retailing and standard supply 17 service provisions for other LDCs looking to merge, or 18 for third party investors contemplating M&A activity. 19 Of course, what motivates merge of the acquisitions? 20 Obviously, the answer is the opportunities to achieve 21 economies of scope and scale. 22 If I could carry on with the next 23 one. 24 I think it is unlikely to attract 25 outside investors to come in and acquire the assets of 26 the distribution utilities. I think it is unlikely to 27 encourage investment even in the business or even in 28 the infrastructure required to provide this public 875 WOOLF/JENKINS/CEKSTERS, presentations 1 service obligation, because the Code doesn't actually 2 provide any assurance that there will even be a return 3 on the investment in the infrastructure servicing the 4 provision of this service. 5 We have heard a lot about the 6 disincentive to invest in generation because of lack of 7 buyers to enter into contracts with -- and you will 8 hear more from John Jenkins about this this 9 afternoon -- and the high cost of entry because of the 10 liquidity in the contract market. So I am happy not to 11 dwell on that and to move forward with that. 12 But I can say that the uncertainty 13 surrounding the SSSC is causing delay to potentially 14 beneficial projects. And by beneficial, I mean those 15 that might create jobs or might be benign to the 16 environment, as well. 17 If I could move to the end -- you 18 will be glad to know -- to the proposal, essentially I 19 think all it would take as an alternative to these 20 restrictions and indeed the slightly strange 21 restriction on the use of information in the 16(6) of 22 the transitional distribution licence -- and let me say 23 that actually all the confidentiality provisions of the 24 ARC and the SSSC and the licence are somewhat 25 differently cast. And they seem to be crying out for 26 rationalization. 27 I think all it would take to 28 implement something that makes sense, as an alternative 876 WOOLF/JENKINS/CEKSTERS, presentations 1 to these restrictions, is to identify the information 2 that we are talking about that needs protection and to 3 essentially give control of all this to the customer to 4 whom it belongs. 5 In the wholesale market, we now deal 6 with confidentiality provisions very specifically, and 7 we identify the information that needs to be kept 8 confidential. That makes it much easier to implement 9 systems and commission software, to make sure that this 10 is effective. And it can be monitored and made to 11 work. 12 The sort of information that I think 13 is sensitive is load profiles, connection information, 14 payment histories, and the inevitable names, addresses 15 and telephone numbers. 16 I have to say that of course names, 17 addresses and telephone numbers are so readily 18 available, you can buy them on CD-ROM, you can hire 19 telemarketing agencies who seem to have the most 20 wonderful lists with value-added socioeconomic data 21 that know even what the length of your driveway is, 22 that you begin to wonder whether this is information 23 that should be kept confidential. It is another reason 24 why I think that not allowing retail affiliates to 25 utilize it does not create an unfair market advantage, 26 because, frankly, you can buy it from anywhere these 27 days. 28 But, nevertheless, I think if you as 877 WOOLF/JENKINS/CEKSTERS, presentations 1 the average customer, if I was to go around the room 2 and say, "Would you like your name, address and 3 telephone number to be disclosed", you would probably 4 say no. 5 So let's be specific about the 6 information. 7 Then I think the offer is made -- not 8 that it is entirely necessary, in my view, but it is 9 there -- that the customer lists should be made 10 available to all licensed retailers prior to market 11 opening. But prior to that release customers could 12 stipulate that the information not be provided. Then 13 after that the information would be updated and 14 available to all licensed retailers on an ongoing basis 15 where approved by a customer. 16 So all of that I think in terms of 17 what it would take to put an alternative in place that 18 would overcome all the problems that I have articulated 19 this afternoon, and particularly the restrictions on 20 market entry, could be done very quickly indeed. 21 In fact, I think in order to 22 implement the Seabron Adamson proposal, essentially you 23 could write the thing up in the distribution rate 24 handbook. It's a scheme that looks to me a lot like 25 the way in which the PBR works, and indeed it doesn't 26 involve changing billing and settlement systems, and 27 I'm sure that those who are grappling with retail 28 settlements would be glad to hear that, one of the more 878 WOOLF/JENKINS/CEKSTERS, presentations 1 difficult issues, obviously, in implementing retail 2 competition, as we all well know. 3 Indeed there is already a hook 4 in 2.5 of the Standard Supply Service Code. There is a 5 reference to the Distribution Rate Handbook in there. 6 As it is in an early stage of development -- it has 7 just gone out for review but doesn't have anything in 8 it relating to the standard supply services -- there 9 is obviously plenty of room for a chapter to be put 10 into it. 11 But I don't think -- just to move to 12 my last slide -- that we are talking about anything 13 other than really sort of relatively minor amendments, 14 minor surgery, even sort of medication, if you like, 15 which could deliver all the policy objectives 16 articulated in the White Paper, Bill 35 and the 17 licences. 18 Thank you very much. 19 Shall I pass to John Jenkins? 20 PRESENTATION 21 MR. JENKINS: Thank you, Fiona. 22 As we said earlier, my name is John 23 Jenkins and I am with ATCO Power Limited. We are a 24 company headquartered in Calgary and we are looking to 25 make one or more significant investments in the 26 Province of Ontario, and have been looking for quite a 27 period of time, leading to where we are today. 28 Just a little background so those of 879 WOOLF/JENKINS/CEKSTERS, presentations 1 you who don't know the ATCO companies -- and I won't 2 give you a long commercial, I will just let you know 3 that we are involved in both the natural gas and the 4 electricity businesses. Our gas companies operate 5 primarily in Alberta and we gather, distribute and 6 retail natural gas and other related services. 7 We also have electric utility in 8 Alberta, Alberta Power -- formerly Alberta Power, not 9 called ATCO Electric -- and that is a traditional 10 utility, although investor-owned considerably different 11 in its operation and approach than provincially-owned 12 utilities such as the former Ontario Hydro, but we have 13 a pretty good understanding of those two businesses as 14 they have developed historically. 15 In particular, ATCO Power is an 16 unregulated company. We are an independent power 17 developer. We have projects in Canada, Great Britain 18 and Australia. 19 Each of the markets in which we 20 operate as ATCO Power is undergoing, and has undergone 21 in some cases, a fundamental electric market 22 transition. The markets are unique, they have their 23 own unique characteristics, but in some cases there are 24 similarities. 25 Ultimately, each market will arrive 26 at a solution that reflects the specific requirements 27 of that market, and our experience really is that there 28 is no single model that can be applied to every single 880 WOOLF/JENKINS/CEKSTERS, presentations 1 jurisdiction, given our experience in both the number 2 of provinces in Canada and internationally. 3 The Standard Supply Code as presented 4 in draft form on the 29th of January of this year was 5 carefully reviewed by a number of people, experienced 6 people within our group. I have to say that my 7 participation here today is perhaps a little unusual, 8 but certainly motivated by what we saw as a concern, a 9 great concern moving forward in Ontario here, that 10 while the overall recommendations were workable the 11 spot price pass-through to standard supply customers 12 did not hold with our understanding of the overall 13 objectives related to electricity regulation in 14 Ontario. 15 The objectives include -- and I will 16 just deal with a couple -- in our view, facilitating 17 increased competition in the electric generation and 18 retail sectors, and the protection of consumers with 19 respect to the price, reliability and quality of 20 electrical service. 21 The outline to the presentation, I 22 will try to hold it brief, I know it is getting late in 23 the day. 24 This is really from a generator's 25 perspective. I am going to try to relate to you our 26 view of this market and some of the things that we see 27 and comment on some of the things that I have seen and 28 heard here in the past few days and some discussions I 881 WOOLF/JENKINS/CEKSTERS, presentations 1 have had in the past, because while we get involved in 2 a session like this and we talk, even at the Market 3 Design Committee, perhaps even at the White Paper 4 level, there are a lot of theoretical approaches and 5 economic models that some learned people in the room 6 here can talk about, but really when it comes down to 7 it someone ultimately has to make an investment. They 8 have to put money on the table. 9 In the case of the generating side of 10 the business it is very large money and mistakes or 11 risks can be catastrophic, even to a company of our 12 size. 13 So it is from that perspective that I 14 will talk -- at least I will try to. 15 What I will do today, quickly, is 16 look at a couple of the differences that we see between 17 the gas and the electric markets. There are some 18 parallels, and sometimes in discussion with people I 19 see that we get on a similar path and gas and 20 electricity are sometimes viewed as much the same in 21 the ability to deregulate them or their operation in 22 the market, some of the physical characteristics. 23 There has been reference to some of the differences, 24 but I will just highlight those quickly. 25 Fundamental to competition from our 26 perspective is in the impact of retail market design in 27 general on generation investment in Ontario. 28 Now, I am one particular generator 882 WOOLF/JENKINS/CEKSTERS, presentations 1 independent investor. There are many. It is a highly 2 competitive business. Certainly what I am speaking of 3 here today is from our perspective, I don't purport to 4 speak for any of my illustrious competitors, but I am 5 fairly aware that they share many of the same views 6 that I have, although if you want to clarify that some 7 are probably in this room, but certainly I am speaking 8 from ATCO's perspective. 9 As well, I will take a brief look, I 10 will take a very brief look at the impact of the 11 current draft code on one specific project that we have 12 announced, which is the Lakeview new generation 13 project. 14 Believe me, we are not used to having 15 a project discussed in an open forum like this, but I 16 hope what you see from my being here is the importance 17 that we place on this issue. 18 Natural gas and electricity, as we 19 have seen and heard, are both tradeable commodities in 20 much the same way as crude oil, soy beans are now 21 traded on world markets. 22 Something to remember is that the 23 commoditization of these energy sources does not 24 detract from our reliance on them in our day-to-day 25 lives, particularly electricity that in many cases is 26 considered an essential service. Spot price 27 terminology is now familiar in both the gas and the 28 electric businesses, but the nature of the two 883 WOOLF/JENKINS/CEKSTERS, presentations 1 commodities is such that the markets operate quite 2 differently, leading to different outcomes from the 3 same set of market dynamics applied to gas or the 4 electricity market. 5 As a result, it is our view that the 6 electricity market, in particular, is not conducive to 7 spot price pass-through for the majority of customers, 8 those customers being those, in particular, who don't 9 have interval metering. I won't go into that. It has 10 been discussed at length. There are certainly the 11 smaller customers and the anticipation is that the 12 costs involved -- it will be many years before those 13 customers or interval meters are introduced to that 14 level. 15 Some of the differences that you 16 see -- in many applications, for example, electricity 17 has no substitutes. Other fuels, natural gas being one 18 of them -- in an industrial setting, for example, a 19 user has the opportunity to substitute either natural 20 gas or fuel oil. Even at the household level there can 21 be a substitution, but the substitution gets to be 22 electricity. That's the default in that particular 23 situation. 24 In addition, operational 25 considerations are more critical for electricity than 26 natural gas. Failure to operate within tight 27 tolerances can impact the stability of the electric 28 system and result in customer outages and, in some 884 WOOLF/JENKINS/CEKSTERS, presentations 1 cases, equipment damage. It is very expensive. 2 Customers who are able to curtail electric demand on a 3 real-time basis are limited. 4 Some industrial customers -- clearly, 5 we deal with many of them -- do manage their loads on a 6 real-time basis at this time. Most do not. For some 7 customers, deficient levels of supply reliability 8 create problems, as I indicated earlier. In gas, it's 9 not quite the same. Full interruption of gas can be 10 difficult, but gas is rarely interrupted on a full 11 basis. Usually, there is enough to keep the pilot 12 lights going and all the rest. So gas has the ability 13 to sag, whereas electricity's ability to sag exists, 14 but it is limited. 15 Electricity supply and demand is 16 instantaneous -- and I have heard this a couple of 17 times over the last couple of days -- while natural 18 gas, if you understand the differences, has a full 19 pipeline fill, there is compression, there is storage. 20 It is much more elastic to swings in either supply or 21 demand. 22 This, I think, above all others, 23 explains the volatility of electric prices relative to 24 gas. Clearly, natural gas can be stored while 25 electricity cannot. Water behind a dam is storage, but 26 it requires large reservoirs. It may or may not be 27 available. With electricity, the lack of storage 28 capability increases that price volatility again, as I 885 WOOLF/JENKINS/CEKSTERS, presentations 1 said. Any time demand approaches the immediate supply 2 capability, rapid price escalation can and usually does 3 occur. 4 Another difference that many people 5 don't recognize is that gas storage tends to occur very 6 close to the demand source, while electricity, in the 7 form of dams of water, is usually far from the demand. 8 This tends to reduce the volatility of gas prices again 9 relative to electric prices in other forms. You hear a 10 lot of discussion about volatility of gas prices, but 11 on a comparative basis to electricity, that is quite 12 minor. 13 Gas, as we know, is priced on a daily 14 basis while electricity can be priced on a 15 minute-to-minute basis. In all jurisdictions we are 16 moving to hourly, 15-minute, 10-minute pricing time 17 frames and that again reflects that instantaneous 18 relationship relative to electricity. 19 Again it's back to, except for the 20 very sophisticated electricity consumers, the typical 21 customer has no visibility of the market price and is 22 not able to react real time to price risk. As we have 23 heard at length, seeing something a week or a month 24 later does not help that reaction. 25 One last difference in natural gas 26 that I think is interesting -- and I have heard 27 references to it here the last couple of days, but 28 there is some similarity that we see. Deregulation in 886 WOOLF/JENKINS/CEKSTERS, presentations 1 the gas market has really taken -- it has been ongoing 2 for the last 15 years. The undertaking on electricity 3 is a tremendous effort and I think it's a credit to all 4 of the people in this room and with the Market Design 5 Committee and elsewhere who have moved forward so 6 quickly with the deregulation here in Ontario. It's a 7 huge effort and there will be things missed. 8 It's important to recognize that 9 those things will be missed and they have to be caught 10 and made right along the way. Oftentimes it is that 11 experience that teaches you the correct way as opposed 12 to the theory that can be applied in the beginning. 13 Back to the gas for a minute. The 14 concept of default supply for gas really does exist 15 here in Ontario and elsewhere. You hear the reference 16 to system gas, which is to some degree the default for 17 spot price. I guess, to a degree, if you are a 18 consumer, you may view it that way, but that particular 19 default supply on gas has been based traditionally on 20 the WACOG, which brings us back to our portfolio of 21 contracts that make it up, being a series of short and 22 long-term contracts that have put it together. 23 We have a situation in Alberta, which 24 is the opposite to that these days, where our gas 25 company supplies gas to most of the households and 26 businesses across the province. We are on a true spot 27 price pass-through after the fact and the couple of 28 times when the price of gas has been out of line 887 WOOLF/JENKINS/CEKSTERS, presentations 1 with -- or, I should say, the true-up mechanism has 2 caused a hit to the bill at a period of time, there has 3 been a tremendous amount of flak in the media and from 4 the public directed at our company, which in this case 5 is a utility who is simply passing along the gas at the 6 spot price. Believe me, the consumers don't understand 7 it, they don't like it, and it's a parallel that I 8 think has useful merit and may be worth investigating. 9 Back to generation investment and the 10 impact of the retail market design on that generation 11 investment. The impact of spot price pass-through has 12 a significant impact on the development of a 13 competitive market in Ontario, particularly as it 14 relates to new investment in generating plants in the 15 province. 16 Market power was one of the most 17 difficult issues addressed by the Market Design 18 Committee. The plan to mitigate the market power of 19 the former Ontario Hydro is complex and far-reaching. 20 Fundamental to this mitigation is the creation of a 21 competitive market for electricity; that is, the 22 generation of electricity. A lot of our discussion 23 here revolves around the retail side. 24 We had some discussion from 25 Mr. Adamson relative to the generation side, but 26 clearly the signals that we took from the White Paper 27 were that the desire of the government in the province 28 was to expand competition at the generation level and 888 WOOLF/JENKINS/CEKSTERS, presentations 1 at least to open the market to new entrants so that we 2 could read the signals and come into the market when 3 the time was right. 4 What we need, in addition to the 5 reshuffling of the deck on the existing OPG generation 6 plants, which is part of the market power plan, we do 7 need the addition of new generating plants into the 8 province; in particular, gas-fired technology. There 9 are many reasons for that and I will touch on some 10 later. 11 The mechanisms to assure energy 12 supply reliability must be consistent with the desire 13 for a more open and competitive electric marketplace 14 capable of sending sufficient and appropriate market 15 signals to generators and consumers alike. I keep 16 falling back to the comparison of the gas market, but 17 staying with that comparison just for a moment, market 18 power at the generation level really hasn't been an 19 issue. When I say "generation", I mean the supply 20 level of natural gas. It has not been an issue. 21 The generators in the gas business 22 are the oil and gas companies across North America. 23 There are thousands of them. They don't have market 24 power. Most of them have direct access to the Ontario 25 market through the ever-expanding natural gas pipeline 26 system. 27 It is also important to understand 28 that transporting natural gas over large distances is 889 WOOLF/JENKINS/CEKSTERS, presentations 1 more efficient than moving electricity. As 2 transmission lines are loaded, electrical losses 3 increase dramatically. As pipelines are loaded, 4 efficiency is increased and profits go up for the 5 pipeline company. 6 Gas deregulation has never had to 7 consider the supply part of the equation since 8 competition has been alive and well at the production 9 end of that business for many years. 10 The difference in the supply side of 11 the electricity market requires that generation be 12 developed close to the load centres. This is best 13 exemplified by a cogeneration facility inside the fence 14 of an industrial facility or by a generating plant in 15 close proximity to a large load centre. 16 A number of points need to be 17 considered in reviewing the impact of market design on 18 generation investment. 19 A wide range of generators is 20 necessary as the first step in the development of the 21 competitive electricity market. This includes new 22 entrants who construct state of the art plants to 23 ensure a reliable supply into the future. 24 We see that through the ECMA, with 25 their objectives to reduce OPG generation down to 35 26 per cent in 10 years. But with market growth and with 27 retirement of plant, new entrants are required and new 28 plant is required in Ontario. 890 WOOLF/JENKINS/CEKSTERS, presentations 1 In developing a market such as 2 Ontario, where re-regulation is in its early 3 stages -- and I mean very early stages -- generators 4 need secure markets for the output of generating plants 5 to obtain financing. We touched on this a little bit. 6 There have been a number of comments 7 about that. Mr. Adamson, I think, referred to some 8 this morning, and I think Mr. Power questioned 9 Professor Dewees with regard to project financing. 10 There was also a question about 11 merchant plants just before lunch and perhaps reference 12 to the ability to finance merchant plants in other 13 jurisdictions around the world. There is always the 14 ability to finance a plant, as Mr. Adamson said, 15 provided that the risk and return for both the lender 16 and for the owner are significantly high. 17 The issue there is that in a market 18 such as Ontario the pricing that would be required to 19 support a merchant plant would be significant. You 20 have a higher cost of capital when you are borrowing 21 and the return on investment for the investor needs to 22 be higher in order to construct the plant. It would 23 obviously raise -- the output of the electricity from 24 that plant would result in a plant that would be 25 uneconomic, given the market that we see developing 26 over the next several years. 27 That is not to say that a merchant 28 plant will never be capable of being financed in the 891 WOOLF/JENKINS/CEKSTERS, presentations 1 Ontario market. I am sure it will. It is the timing. 2 The timing is such that the lead time for building a 3 plant is so significant that at this point in time, 4 plants that are looking at being developed, the 5 earliest they can come on stream is about two to three 6 years after the market opening in 2002-03. So 7 following that "some" experience in the market, if you 8 look at that three to four-year lead time, that is the 9 kind of time frame beyond that 2002-03 date that a 10 merchant plant may have some capability -- and I am not 11 even saying it would be possible -- some capability of 12 coming on stream because there would be experience in 13 the market. The spot price -- pricing over the course 14 of a number of years in the market would be developed. 15 Another point that I found 16 interesting was the reference to standard supply 17 customers that obviously make up a significant part of 18 the Ontario demand, at least on day one. I think the 19 reference was around 75 per cent. That will be the 20 starting point, I think is the way to look at it. 21 The difficulty with that -- and 22 Professor Dewees was fairly cavalier in his reference 23 that, "Well, that doesn't really matter. There is 24 still 25 per cent of the market left." Clearly, when 25 you are looking at investing $400-plus million in 26 plant, whether you are our company or any other, if you 27 have a very small portion of the market to look at to 28 service your investment it is going to make it much 892 WOOLF/JENKINS/CEKSTERS, presentations 1 more difficult, and perhaps costly, to bring on that 2 project. 3 That is not to say that the other 4 25 per cent of the market is being ignored by our 5 company or by my competitors, but it is to say that in 6 order to develop a competitive market and in order to 7 allow new generation to come into the market, 100 per 8 cent of the market has to be available to bring 9 investment on on the terms that not only satisfy the 10 investors but also can be brought on at a price level 11 that will satisfy the market. 12 In markets with surplus or sufficient 13 supply, the spot market provides energy at the 14 short-run cost and consumers get both energy and supply 15 reliability by paying the marginal cost. The supplier 16 reliability is treated in this case as a free resource 17 because consumers can avoid paying for reliability by 18 paying the spot price based on the marginal cost. 19 As demand catches up with supply the 20 price becomes more volatile. Because price and 21 reliability are not linear with respect to the supply, 22 the price impacts can be fast and dramatic, as I said 23 earlier. 24 Over time, the market must return 25 both the marginal costs and the capital costs of the 26 plant or the business will fail. The issue here is 27 very simple. The time frame that we look at developing 28 plants in is anywhere from 20 to 30 years. Over that 893 WOOLF/JENKINS/CEKSTERS, presentations 1 period of time the market, either through a bilateral 2 contract or, in the case of a merchant plant, on a spot 3 basis, must -- the price must be sufficient to pay not 4 only the operating costs but clearly the capital. I 5 don't think that is a big surprise to anyone. 6 As we have discussed, new plants need 7 the certainty of bilateral contracts -- and that is new 8 plants in Ontario here -- for their output to obtain 9 financing. In addition, these bilateral contracts 10 serve to give price signals to the long-term market. 11 Some of that was referenced and I think it is important 12 to understand that. I don't purport to be a futures 13 market expert, but I think that is a very important 14 aspect. It says that without a balance of short and 15 long-term prices in the market the competitive dynamic 16 and liquid foreign market will fail to develop in the 17 electricity market in Ontario. I think Mr. Adamson 18 addressed that as well. 19 Briefly, I would like to have a look 20 at the Lakeview project. There has been some reference 21 to it and I think I would be remiss if I didn't tell 22 you a little bit, specifically, about what we are 23 talking about. The only reason I put it forward is, as 24 I said earlier, Lakeview is a real project. It is a 25 project that we have been working on for close to two 26 years. We have a consortium of partners who are 27 willing and able to do it. It is a $400 million, 28 550 megawatt plant, being developed by a consortium led 894 WOOLF/JENKINS/CEKSTERS, presentations 1 by our company, ATCO Power. Our other partners are 2 Hydro Mississauga, Toronto Hydro and OPG. 3 The project has been in the planning 4 stage, as I said, for well over a year and it is sound 5 technically, economically and we think environmentally, 6 although we haven't yet passed our environmental 7 permitting stage. It is one of those major hurdles 8 that you have to go through when you are developing a 9 project of this magnitude. I am sure that Mr. Gibbons 10 will have some comments with regard to that. 11 The draft proposal for the standard 12 supply service customers being serviced at spot price 13 would dramatically impact this project and, at the very 14 least, in its original form, would delay it and would 15 change the project significantly enough that it may 16 make it impossible for some of our partners to 17 participate. 18 Like any new power plant we need 19 customers to support the operation of the plant in 20 order to obtain financing. I went through that. 21 The impact of the spot price 22 pass-through would be to remove the ability of one or 23 both of our partners, Hydro Mississauga and Toronto 24 Hydro, to take power from the project. It is pretty 25 simple. 26 A number of points are worth 27 considering, I think. 28 One of the fundamental tenets of the 895 WOOLF/JENKINS/CEKSTERS, presentations 1 White Paper, and supported by the Market Design 2 Committee, was the ability of the MEUs to enter into 3 bilateral contracts for their supply of electricity. 4 The current draft code impairs their ability to do so, 5 for the majority of their customer base. 6 The Lakeview Project is dependent on 7 two municipalities to take 50 per cent each of the 8 output of the plant. The financing of the project is 9 based on certainty of the sale of the output of the 10 plant. There is just not enough pricing history in the 11 market here to support a merchant kind of a plant. If 12 there was, this would not be as big an issue as it is. 13 But, clearly, that is the case. 14 I think the other thing that we have 15 talked about -- and I won't dwell on this; perhaps it's 16 a commercial, but I don't intend it that way -- but I 17 think we have some corporate responsibility; perhaps, 18 we are just lucky to be in the gas generation business. 19 But we feel that this project will bring significant 20 environmental benefits to Ontario through reductions in 21 emissions from coal-fired plants somewhere in the -- 22 within range of where we are sitting here today, that 23 includes into the U.S., if you look at the supply/ 24 demand and the way clients get dispatched across a 25 total supply area. 26 In addition to the jobs and 27 investment, delay or cancellation will clearly negate 28 these benefits. 896 WOOLF/JENKINS/CEKSTERS, presentations 1 In summary, spot price pass-through 2 places price risk on the smallest customers, who are 3 least able to react to it. The standard supply service 4 draft code will impair the development of competitive 5 electricity markets by reducing access through 6 bilateral contracts to a large portion of the market in 7 Ontario. Investment in generation and the resulting 8 air quality improvement will be delayed -- and, again, 9 I defer to Mr. Gibbons and others, on that count -- and 10 just to caution, that gas and electricity commodity 11 markets are different and, in many cases, require 12 different solutions. 13 Thank you. 14 MR. POWER: Thank you, Mr. Jenkins. 15 Mr. Ceksters. 16 PRESENTATION 17 MR. CEKSTERS: Thank you. 18 As Executive Director of Operations 19 at Hydro Mississauga, I have been involved with many 20 other staff at the hydro, preparing our company for the 21 coming changes to the electrical marketplace. 22 I would like to first start by giving 23 a bit of background on Hydro Mississauga. 24 We are the second largest municipal 25 utility in Ontario. We have approximately 150,000 26 customers, 300 employees and we consider ourselves to 27 be an industry leader in the approach to changing the 28 market. 897 WOOLF/JENKINS/CEKSTERS, presentations 1 As far back as 1989, we issued a 2 report called the Phoenix Report on the possible 3 consolidation of utilities throughout the province 4 which, in our estimation, could save up to $500 million 5 and reduce the number of utilities to less than 10. 6 Since the mid-nineties, we have been 7 promoting the need to attack the wholesale cost of 8 power, which represents 91 per cent of every dollar 9 that we -- 91 cents of every dollar that we take in. 10 Over that period, we have become very 11 efficient and cost-effective. We have the lowest rates 12 in the GTA. We consider ourselves to have very high 13 reliability levels and, actually, our safety record is 14 one of the best in the province. At the end of this 15 month, we will be celebrating 1.5 million hours of safe 16 work without a lost-time injury. 17 We have been very supportive of 18 Bill 35. Karl Wahl participated on the Market Design 19 Committee. Many of our staff worked on OEB and MDC 20 subcommittees in helping them develop the 21 implementation of the Act. 22 Hydro Mississauga considers itself to 23 really be following the policy objectives of the 24 government. We have introduced efficiency to the 25 distribution of electricity. We are using best 26 practices. We are keeping jobs in Ontario. We are 27 creating expertise within the province that can be 28 exploited, at a future date. 898 WOOLF/JENKINS/CEKSTERS, presentations 1 Our analysis of the White Paper led 2 to two specific examples of action -- and these have 3 been mentioned before; I would like to go through them 4 again. 5 First, is participation in the G6. 6 G6 is a group comprised of Hydro Mississauga, London 7 Hydro, Oshawa PUC, Sarnia Hydro, St. Catharines Hydro 8 and Whitby Hydro. 9 This is a group of like-minded 10 utilities that are exploring the viability of a unified 11 retail entity in the new competitive marketplace. We 12 represent 10 per cent of the Ontario electrical load 13 and approximately 400,000 customers. We have been 14 working together since the spring of 1998 to analyze 15 and prepare for the change in the electric market. Our 16 business plan looked at amalgamating marketing on a 17 unified basis, including common branding, sharing our 18 resources, removing redundancies, even aggregation of 19 load, for the purchase of power. 20 Our report concluded that the new 21 market will present significant challenges for MEUs. 22 Particularly, we feel that a critical mass of between 23 500,000 and one million customers is required to 24 survive in the retail business. 25 We are hoping to attract other 26 utilities within the province to the G6 group. At the 27 present time, the G6 has issued a request for 28 expressions of interest for power procurement to 899 WOOLF/JENKINS/CEKSTERS, presentations 1 approximately 26 potential suppliers. The intent is to 2 finalize an arrangement by the end of this year. 3 Our focus on commercial potential has 4 been stalled, substantially stalled, as a result of the 5 ARC and the SSC complications. Since January, our 6 group has had to refocus and put its attention to the 7 regulatory issues. 8 Repeating something that Fiona had 9 talked about, we feel the G6 utilities address the 10 government policy objectives. In the government's 11 White Paper, an early unphased move to full retail 12 access was proposed. Retailers, brokers and 13 large-volume customers, including local utilities, 14 would buy from the spot market or arrange bilateral 15 contractors with generators, as they would in the 16 wholesale model. 17 As well, the G6 utilities would 18 provide efficiency to the distribution of electricity 19 within the province, keep the jobs in Ontario and 20 create expertise that we could exploit at a future 21 date. 22 I would like to now talk about 23 Lakeview, Lakeview New Generation, which is really a 24 practical example of the application of a government's 25 White Paper and the Energy Competition Act. 26 As John mentioned, it is a consortium 27 led by ATCO Power, out of Alberta. It includes Ontario 28 Power Generation, Toronto Hydro and Hydro Mississauga. 900 WOOLF/JENKINS/CEKSTERS, presentations 1 We have been working together for well over a year to 2 do a feasibility study on the project. 3 This project will convert two of 4 eight coal-fired at the existing Lakeview plant to a 5 new set of generators comprising 550 megawatts of 6 natural gas-fired combined cycle power. 7 At the present time, key investment 8 decisions involving the commitment of substantial 9 capital dollars by the equity partners now need to be 10 made for the project to proceed. 11 Modifications are needed to the 12 codes, in order for the project to proceed in its 13 current form. 14 Lakeview New Generation addresses the 15 government's policy objectives: it will create 16 investment in Ontario generation facilities; it 17 promotes the competition on the generation side of the 18 business; it creates jobs; and, it is environmentally 19 positive, as it converts coal-fired plants to natural 20 gas. 21 But there are issues related to the 22 codes. The first of these being access to customers. 23 Without assurance of some access to 24 customers, retail activity will be too risky to invest 25 in. A lack of a level playing fields to allow 26 competitors with existing customer bases creates an 27 issue. The gas companies have had 15 years of 28 experience in the competitive marketplace, they have 901 WOOLF/JENKINS/CEKSTERS, presentations 1 their existing customer lists -- as do companies such 2 as Amway and Sears, who have stated they will be in the 3 energy marketplace in Ontario. 4 MEUs and groups like G6, that are 5 interested in competitive retailing, should be allowed 6 to keep their customers and transfer them to their 7 retail affiliate. Let the market decide. Let the 8 competitors come and do their best and use their 9 expertise and experience to take the customers away and 10 let the market take care of it. 11 Another issue related to the Code is 12 the issue of spot price. From a distributor 13 perspective, the risk, as mentioned many times 14 throughout the day, of market volatility is placed 15 entirely on the customer. Fixed-income and other 16 vulnerable customers are put at risk. 17 As an example, we replaced our 18 billing system at Hydro Mississauga recently and we 19 just replaced the system; the bill was the same. 20 As soon as the customer saw that the 21 bills looked different, the call centre was overwhelmed 22 with calls. Even though we had bill stuffers stating 23 exactly what the new bill would do and say, and no 24 changes had been made to the bill, the call centre has 25 been inundated with calls from customers asking for 26 clarification. 27 I would welcome all of you to come to 28 our call centre if and when spot price pass-through is 902 WOOLF/JENKINS/CEKSTERS, presentations 1 brought forward. 2 In our minds, fixed price balances 3 the risk between the generator, the distributor and the 4 customer. The cost to comply with the existing draft 5 codes will be significant. The separation of the 6 utilities into multiple affiliates, in our minds, will 7 do away with the efficiencies we particularly have 8 achieved at Hydro Mississauga. The redundant systems 9 that have to be put n place, the overheads to have 10 other affiliates in place, will be quite large. 11 The cost of a billing system to 12 handle a full retail settlement, which has still to be 13 developed, will be quite large. 14 The cost of billing delays inherent 15 in the spot price pass-through mechanism are apparent. 16 From a generator perspective, the 17 issue related to spot price deals with the fact that a 18 fixed price is required or bilateral contracts over 19 time are necessary to sell power. John mentioned this. 20 Without long-term contracts, 21 investors in financial institutions will not risk 22 financing in the present economic conditions of Ontario 23 in terms of how the energy market is to work. Without 24 financing, a project such as Lakeview regeneration will 25 not proceed. 26 Without liquid intermediate markets, 27 power prices will go up to the customer. Our analysis 28 indicates that if Lakeview regeneration can't be 903 WOOLF/JENKINS/CEKSTERS, presentations 1 competitive, no new generation project can be. It has 2 the infrastructure, it has the load, it has the 3 investor, and the investor is ready and able to invest 4 in this project. 5 Hydro Mississauga is supportive of 6 the government initiative to introduce competition. We 7 feel that with some modifications, the Standard Supply 8 Service Code and the Affiliate Relationship Code will 9 reflect the intent of the legislation and the stated 10 policy objectives of the government, as outlined in the 11 White Paper and the Energy Competition Act. 12 Thank you. 13 MR. POWER: Thank you very much. 14 MS O'RILEY: Mr. Gibbons? 15 MR. GIBBONS: No questions. 16 MS O'RILEY: Mr. Adams? 17 MR. ADAMS: Just a couple of 18 questions for you, Ms Woolf. 19 Looking through the first page of 20 your prefiled material, there is a list of the group of 21 stakeholders supporting your presentation. 22 I don't notice Enron on the list. 23 Did Enron support the presentation? 24 MS WOOLF: No. 25 MR. ADAMS: Other than their 26 relationship with ENERconnect. 27 MS WOOLF: They are not a supporter 28 of the paper. 904 WOOLF/JENKINS/CEKSTERS 1 MR. ADAMS: Thank you. 2 Can you, for the record, describe 3 your relationship with the firm Power Budd. 4 MS WOOLF: My firm, Cameron McKenna, 5 has an association with Power Budd. It's as simple as 6 that. 7 MR. ADAMS: What is the form of that 8 association? 9 MS WOOLF: There is an agreement 10 between the two firms that they will work together. 11 It's as simple as that. 12 Let me say that there are highly 13 restrictive bar association rules in Ontario which have 14 to be respected. So it is not the case that Cameron 15 McKenna has a presence here through Power Budd. It is 16 a separate firm with an arm's length association. 17 MR. ADAMS: Thank you. No further 18 questions. 19 MS O'RILEY: Mr. Stephenson. 20 MR. STEPHENSON: Thank you. 21 I think most of this is for Ms Woolf, 22 but by all means if somebody else has something to say, 23 feel free to do so. 24 One of the key recommendations I took 25 from your paper was that your conclusions, your 26 ultimate recommendations -- which I think are at pages 27 31 and 32 of your paper -- were an integrated package, 28 and you caution that if you pulled it apart it's like 905 WOOLF/JENKINS/CEKSTERS 1 pulling a thread out of a cloth. 2 MS WOOLF: Like out of a tapestry. 3 MR. STEPHENSON: The concern I have 4 is this, that the Affiliate Relationships Code, and in 5 particular 2.5.7, is manifestly not on the table in 6 this proceeding 7 MS WOOLF: Yes, I understand that. 8 MR. STEPHENSON: Let's just assume 9 that that provision remains unchanged, as I think we 10 must essentially for the purposes of this proceeding. 11 What are we then left with? 12 Your thread has been pulled. How do 13 you keep the sweater together? 14 MS WOOLF: Well, I think particularly 15 from the point of view of implementing the Seabron 16 Adamson proposal, it presents a very severe difficulty, 17 because essentially, as I said in my presentation, it 18 would not be possible for the retail affiliate to 19 essentially manage the risk in the manner that Seabron 20 proposes. 21 All I can say in response to it is 22 that you can see that this is very much a string that 23 would unravel the tapestry. Apart from anything else, 24 I don't actually see how you can begin to implement 25 Condition 14(2) of the Transitional Distribution 26 Licence, for starters, by utilizing a retail affiliate 27 anyway. 28 It simply says you can't transfer 906 WOOLF/JENKINS/CEKSTERS 1 customers over. You would have to do that to get the 2 Standard Supply Service Code implemented through there. 3 I think we are just reinforcing the 4 point I made; that it doesn't actually hang together. 5 MR. STEPHENSON: Just coming back to 6 Mr. Adamson for a moment -- and I recognize that you 7 are not him and you can't speak for him. But as I had 8 understood it, his proposal regarding essentially the 9 yardstick mechanism and the portfolio, and so forth, I 10 didn't see anything intrinsic in that proposal which 11 was such that it couldn't be carried out by the LDC 12 directly. It doesn't require this activity be taken on 13 by any form of LDC affiliate; it could be done by the 14 LDC. 15 So I didn't see that as having any 16 impact on the Affiliate Relationships Code. Am I wrong 17 about that? 18 MS WOOLF: I think that it goes back 19 to another point that was discussed this morning: what 20 if the distributor doesn't actually want to do that 21 and, being risk-averse, wants to involve either a third 22 party or a retail affiliate to do it? 23 All I can say, to go back to the 24 original point, is that there is a choice that is given 25 under Condition 14(2). The ARC prohibits that. 26 MR. STEPHENSON: Are you familiar at 27 all with natural gas regulation in Ontario? 28 MS WOOLF: No, I am not. 907 WOOLF/JENKINS/CEKSTERS 1 MR. STEPHENSON: For the purposes of 2 this question, let me just advise that, so far as I am 3 aware at least, the Board has I think indicated a 4 preference, generally speaking -- and certainly a 5 number of stakeholders have indicated a preference, 6 generally speaking -- for what they refer to as 7 regulatory symmetry between gas and electricity; that 8 more or less the same sorts of rules apply. 9 I take it that you are aware of that 10 concept in general terms, even if not so in Ontario. 11 Is that fair? 12 MS WOOLF: It's an issue that has 13 arisen in many jurisdictions. In my experience, it is 14 actually extremely difficult to achieve it until you 15 get to a stage where both industries are up and running 16 and equally competitive. 17 That is the reason that in England 18 and Wales they have had separate regulators and 19 separate regulatory regimes until now, when they regard 20 competition as being sufficiently robust to be able to 21 regulate them on a symmetrical basis. 22 Even in other Canadian jurisdictions, 23 I think you will find, for example, that Alberta has 24 found it really quite difficult to achieve symmetry in 25 the regulatory regime between electricity and gas. 26 MR. STEPHENSON: One of the issues 27 that I am sure that the Board will be concerned 28 about -- and I want to give you the opportunity to deal 908 WOOLF/JENKINS/CEKSTERS 1 with this issue -- is in the gas industry the Board has 2 approved an Affiliate Relationships Code already. It 3 contains essentially very, very similar provisions, and 4 2.5 of that Code is identical more or less -- I think 5 it may be exactly identical -- and 2.6 dealing with 6 confidentiality is, I believe, identical to the 7 proposed Electricity Affiliate Relationships Code. 8 I think it may be in fact verbatim, 9 but if it is not I don't think there are any material 10 differences. 11 The question I have for you is: If 12 the Board has decided as a matter of policy that those 13 kinds of restrictions are appropriate for dealing with 14 gas LDCs and their affiliates, why would it be prepared 15 to consider a different regime for the relationship 16 between electricity LDCs and their affiliates? 17 MS WOOLF: Because it is under a 18 different statutory duty in relation to electricity. 19 Under section 1 of the Electricity Act, there is an 20 obligation to promote competition -- I'm sorry, to 21 facilitate competition. 22 At the moment, the electric power 23 market is not competitive. The Board has almost a dual 24 role, one of modern economic regulator, and also, 25 secondly, as the implementer of government. That is 26 why in section 1.1 of the OEB Act you will see that it 27 must be guided by these overall objectives. 28 Therefore, putting in place a 909 WOOLF/JENKINS/CEKSTERS 1 restriction on market entry before the market has even 2 begun operations, when there is no proof that there 3 will be any likelihood of an unfair market advantage, 4 they are imposing the heavy burden that Alfred Khan 5 talks about in terms of justifying imposing 6 restrictions. 7 So there is a tremendous difference 8 between the state of competition in the electric power 9 market as we are on Friday afternoon now and the state 10 of competition in the gas industry in Ontario. 11 MR. STEPHENSON: Can you assist us: 12 What basis do you have for your conclusion that -- or I 13 don't know if it is a conclusion or a presumption, that 14 in the absence of the LDCs being permitted to engage in 15 retailing in the fashion that you propose, we won't 16 have sufficient competition in electricity retailing in 17 Ontario. 18 MS WOOLF: Well, I think for the 19 reasons I mentioned in the paper and the presentation, 20 I think that you will find that only those people who 21 are sitting on substantial potential for economies of 22 scope and scale are going to get into this. 23 So you will find that you have one 24 gas company in each of the service areas who has the 25 potential for the sort of economies of scope and scale 26 that will get them in at incremental costs -- because 27 remember that the margins in retailing are very slim -- 28 maybe one other. But even so, maybe that people will 910 WOOLF/JENKINS/CEKSTERS 1 be comfortable, as we have seen in other jurisdictions, 2 from buying their electricity from a gas company. They 3 may sort of scratch their heads and say, "Why should I 4 buy it from Sears? This is kind of an add thing 5 to do." 6 So I think you really need to 7 understand the retail business is a business where you 8 really have to work on economies of scope and scale to 9 overcome the margin problem. 10 MR. STEPHENSON: This is the problem 11 that I saw, and I hope you can assist me with it. On 12 the one hand the proposition is that in the face of the 13 kinds of restrictions that you are concerned about LDCs 14 will be faced with a competitive disadvantage to the 15 extent that they, practically speaking, won't be able 16 to get in. 17 The question I guess I have is: That 18 presupposes the competitive disadvantage against 19 somebody else. There are a lot of examples that 20 various people have given, and you talked about grocery 21 chains getting in the sale of this, and Sears and Amway 22 and gas companies, and so forth. 23 So when you talk about the 24 competitive disadvantage, it seems to me that you are 25 talking about that there is this group of other people 26 out there that have some readiness, willingness and 27 advantage to carry out this function, which in some 28 sense presupposes that there are in fact a number of 911 WOOLF/JENKINS/CEKSTERS 1 viable and interested competitors, and why doesn't that 2 deal with -- 3 MS WOOLF: Well, I think it goes back 4 again to the fact that they may, for a whole variety of 5 reasons, not decide that the electricity market is the 6 one that they want to get into because the economies of 7 scope and scale for them are not that attractive. 8 MR. STEPHENSON: Well, wouldn't 9 that -- 10 MS WOOLF: Put it this way: You only 11 have to look around the world to see how difficult the 12 retailing business is anyway. 13 MR. STEPHENSON: So if they decide to 14 bail out, I mean wouldn't that leave the door wide open 15 for the LDCs to do it? 16 MS WOOLF: But they can't. 17 MR. STEPHENSON: Sure they can. 18 MS WOOLF: The restrictions that are 19 imposed prevent them from doing -- you can't use the 20 LDC itself for retailing, okay. 21 MR. STEPHENSON: No, but -- 22 MS WOOLF: You can't use a retail 23 affiliate, because ultimately it can't compete from 24 being such a small base. 25 MR. STEPHENSON: The problem I'm 26 having is that if it can't compete, it can't compete 27 against someone else, and that presupposes, I think, 28 the existence of somebody that is out there doing this 912 WOOLF/JENKINS/CEKSTERS 1 on an efficient basis. If that is what is going on, 2 then where is the problem? 3 MS WOOLF: What we are essentially 4 talking about is the ability of you to use your 5 customer lists to essentially do something which is 6 going to be providing a service on price. It's as 7 simple as that. Electricity is going to go flow 8 through customers' meters whatever happens. It is a 9 question of who is paid the money for that service. It 10 is a money game, retailing. 11 It may or may not be attractive -- 12 MR. CEKSTERS: Both Amway and Sears 13 have said they are going to be in the electric market. 14 They are starting with their existing customer base. 15 MR. STEPHENSON: Doesn't that -- 16 MR. CEKSTERS: That is all we are 17 suggesting, is that we start with our existing customer 18 base. 19 MR. STEPHENSON: Doesn't that reflect 20 what a vibrant market this is going to be? 21 MR. CEKSTERS: Exactly. Let the 22 market decide. I agree with you entirely, 23 Mr. Stephenson. 24 MR. STEPHENSON: So the issue about 25 the LDCs not playing a role in this market, if they 26 choose not to, doesn't that mean that we have a vibrant 27 market whether there or not? 28 MS WOOLF: That is where I said that 913 WOOLF/JENKINS/CEKSTERS 1 you would wind up with, I think, most -- if you are 2 lucky, two players in a particular market. 3 MR. STEPHENSON: Sears and Amway. 4 MS WOOLF: Sears and a gas company. 5 MR. STEPHENSON: Let me turn to 6 gas -- 7 MS WOOLF: As I said, where I come 8 from we don't regard duopolies as being competition. 9 MR. STEPHENSON: Let me come to the 10 gas company for a minute. I think everybody 11 understands that gas LDCs cannot sell electricity in 12 Ontario. Is that your understanding? 13 MS WOOLF: No. 14 MR. STEPHENSON: Affiliates of gas 15 LDCs can sell electricity in Ontario. I may be 16 operating under the wrong presumption here, but gas 17 LDCs currently can't sell electricity. 18 Mr. Hewson is shaking his head. I 19 could be wrong. 20 MS WOOLF: Is there anything to stop 21 them setting up an affiliate to do so? 22 MR. HEWSON: Oh, they can set up an 23 affiliate to do so, but they cannot do it directly. 24 MR. STEPHENSON: A gas LDC proper 25 cannot sell electricity in Ontario. 26 MR. HEWSON: They can't transfer any 27 information about their customers. 28 MR. STEPHENSON: Exactly. 914 WOOLF/JENKINS/CEKSTERS 1 A gas LDC's affiliate which can sell 2 electricity is under precisely the same restrictions in 3 terms of its access to the gas LDC's customer lists as 4 an electricity LDC's affiliate is vis-a-vis the 5 electricity LDC. There is symmetry in that respect. 6 Would you prefer there not to be the 7 symmetry, in the sense that the electricity LDC's 8 affiliate has access to electricity LDC customer 9 information when a gas LDC affiliate doesn't have equal 10 access to the gas LDC's customer information? 11 Well, I think that you will find that 12 symmetry question is probably a bit of a red herring in 13 this. The question is that, really, everybody has 14 access one way or another to a customer list, in my 15 view, and restricting the use of a customer list I 16 think is nonsense. 17 MR. STEPHENSON: I think even 18 Dr. Dewees agreed with me that the issue about customer 19 lists comes down to this. It's an equal access issue 20 and that, from his perspective, from market design and 21 competitive purposes, he was indifferent as between the 22 two propositions that no one gets it and everyone gets 23 it. I take it under your proposal you are in the 24 everyone gets it camp. 25 MS WOOLF: Indeed. That is part of 26 the proposal, that before the market opening, everybody 27 would get it. 28 But let me finish with the gas 915 WOOLF/JENKINS/CEKSTERS 1 companies. The gas companies are restricted and they 2 have their handicapping, too. We have equal sympathy 3 with the handicaps, as we would, wouldn't we? So that 4 increases my concern about not having retail 5 competition because if you are handicapping the gas 6 LDCs as well, then you are going to wind up with just 7 Sears Roebuck in the retailing business. 8 MR. STEPHENSON: But doesn't it 9 reflect a policy choice which has already been made in 10 this province? The question is that if that policy 11 choice -- after what due consideration has been made, 12 shouldn't we have a very, very good reason, indeed, to 13 have a different policy choice made here? 14 MS WOOLF: The policy choice that is 15 on the table for the electricity industry is 16 articulated in the White Paper and the implementation 17 of that policy decision is being restricted by the 18 provisions of the Codes. It's as simple as that. 19 MR. STEPHENSON: Just on the issue of 20 customer information -- it's a small point, I think, 21 but it's one that's worth getting to -- I understood 22 your customer information proposal to be essentially 23 the negative option kind of situation that a customer 24 has to engage in a positive act to prevent his or her 25 customer information being released. 26 MS WOOLF: I am a little confused by 27 the question. You are talking about negative options 28 and positive actions. 916 WOOLF/JENKINS/CEKSTERS 1 MR. STEPHENSON: Yes, sorry, this has 2 been -- 3 MS WOOLF: I am aware that there is a 4 sensitivity from the gas background of -- oh, no, 5 sorry, it was in cable, I think, about the use of 6 negative options -- 7 MR. STEPHENSON: Negative options in 8 the sense that if you do nothing, something will happen 9 to you. 10 MS WOOLF: Yes, I see. Right. Okay. 11 MR. STEPHENSON: The thing being here 12 the transfer of your information. It's essentially a 13 negative option structure. 14 MS WOOLF: I think the way in which 15 the form would be designed would probably not 16 necessarily involve -- the proposal doesn't go into the 17 detail of how the form would be designed -- designing 18 it on the basis that your information will be released 19 automatically if you don't say -- I guess it is 20 probably going to get on people's nerves one way and 21 another. 22 MR. STEPHENSON: I guess the concern 23 I have here is that I think everybody agrees there are 24 legitimate privacy concerns around this information, 25 but I think we all also realize that for the apocryphal 26 Mrs. Jones there is -- the fact of the matter is that 27 there is an enormous body of customers out there that 28 simply don't respond and do nothing. Indeed, all of 917 WOOLF/JENKINS/CEKSTERS 1 this whole SSS debate is premised essentially upon the 2 presumption by all of us in the room that there is a 3 very substantial body of customers out there that, 4 frankly, do nothing and that inertia will, de facto, 5 govern a substantial portion of the market. 6 Isn't the effect of a negative option 7 here that you are going to, de facto, wind up with a 8 whole bunch of customer information being released 9 about a bunch of customers who probably just didn't 10 read their bill-stuffer very well? 11 MS WOOLF: I don't think that the 12 negative option route of dealing with the consent is 13 necessarily to be read into this proposal. 14 MR. STEPHENSON: Sorry, I thought 15 that was what your (b) on page 32 indicated. 16 MS WOOLF: It's a question of how you 17 design the form. 18 MR. STEPHENSON: So would you be 19 equally -- you don't have a strong view. You could 20 well structure it that no customer information is 21 released to anybody unless you tick off the box? 22 MS WOOLF: Exactly. 23 MR. STEPHENSON: The way that you see 24 an LDC affiliate participating competitively in the 25 retail market, I take it, is by virtue of leveraging 26 off the LDC's infrastructure in the sense of they can, 27 at incremental cost to the LDC's infrastructure, 28 operate as a competitive retailer. Do I have that 918 WOOLF/JENKINS/CEKSTERS 1 right? That is their price advantage. 2 MS WOOLF: The objection to the ARC 3 is they can't use their customer lists, if that's what 4 you mean by infrastructure. 5 MR. STEPHENSON: I must say I thought 6 you were a little more explicit than that at page 13 of 7 your paper. I don't think this is related to customer 8 lists, per se. I took it more broadly. 9 MS WOOLF: The restrictions that are 10 at play are the ARC 2.5.7, which relates to your 11 customer lists, obviously. The other restrictions are 12 in the Codes, the pricing mechanism and the restriction 13 on third parties and retailers marketing in the LDC 14 service area. So that's essentially what we are 15 talking about. 16 MR. STEPHENSON: Maybe, yes, you 17 could just clarify this for me. I think it's in the 18 last sentence of the first paragraph on page 13 of your 19 paper you say: 20 "More importantly, allowing a 21 retail affiliate to utilize a 22 distributor's customer base and 23 infrastructure to sell retail 24 services would enable the retail 25 affiliate to enter the market at 26 lower, incremental costs which 27 would result in lower prices to 28 the consumer and more effective 919 WOOLF/JENKINS/CEKSTERS 1 competition." (As read) 2 When you used the term 3 "infrastructure" there, I had assumed you meant 4 something more than the customer lists. Am I wrong 5 about that? 6 MS WOOLF: Probably not. It would 7 be, obviously, helpful to the LDC if it could utilize 8 the sort of existing infrastructure, if I use the term 9 loosely, that is within the LDC and the ARC, I think, 10 essentially, very carefully crafts a simple and very 11 clearly drafted set of rules designed to avoid 12 cross-subsidization and to achieve some degree of 13 separation between distributors and the affiliates. So 14 in some small areas they can share and in other areas 15 they can't, and that is all dealt with in the ARC. 16 If that word implies that they can 17 use all the infrastructure that an LDC has, then 18 obviously I am creating a misleading impression in your 19 mind because the ARC, obviously, deals with the 20 separation between the two in the conventional way. 21 MS O'RILEY: I am sorry, 22 Mr. Stephenson. I have to interrupt for a moment. I 23 understand that Mr. Ceksters and Mr. Jenkins are not 24 available to be with us on Monday morning. I would 25 just like to find out if anyone has questions directly 26 for them and then I will let you go back to your 27 questioning. I'm sorry. 28 Does anyone have any questions for 920 WOOLF/JENKINS/CEKSTERS 1 Mr. Jenkins or Mr. Ceksters? 2 MR. PERDUE: Mr. Jenkins, you are in 3 the business of building generation plants, 4 cogeneration plants and what you are looking for, 5 presumably, is a market that would be firm that you 6 could use to ease your financing costs. Have I 7 summarized it more or less? 8 MR. JENKINS: I may not put it 9 exactly as you put it, but I think reasonably, yes. 10 PERDUE: So you don't really care, 11 for example, if the firm contract came from the utility 12 itself rather than from the affiliate, would you? 13 Would that make any difference to you? 14 MR. JENKINS: Not directly, no. The 15 concern there is that the contract that is signed as 16 the out-take agreement is also a financial contract and 17 whatever entity we sign with obviously needs the 18 substance to support its financial commitments made 19 within that contract. 20 MR. PERDUE: I appreciate that, but 21 if the LDC was in a position where, for example, the 22 Board refused the right to move the customers, for 23 example, and the LDC had to keep the customers and it 24 said, "We are going to have a lot of these customers. 25 We are going to need a supply. We can provide them 26 through that supply, that's fine", you would accept 27 that? 28 MR. JENKINS: That's correct. 921 WOOLF/JENKINS/CEKSTERS 1 MR. PERDUE: This is a very efficient 2 plant you are building there, isn't it? 3 MR. JENKINS: We hope so. 4 MR. PERDUE: Yes. You never 5 mentioned the 3.8 cents at all. I gather that is not a 6 problem for you, is it? 7 MR. JENKINS: That is a commercial 8 issue and we have a lot of economic runs on the plant 9 that we can work it one way or the other. But I don't 10 think I want to delve into the pricing issue because it 11 is commercial. 12 MR. PERDUE: That's okay. It is just 13 that I was aware that it was a very efficient plant. I 14 am surprised you couldn't just sell into the spot 15 market. 16 MR. JENKINS: Again I go back to the 17 discussion about financing a plant selling into the 18 spot market, which essentially is a merchant plant on 19 that basis. 20 MR. PERDUE: Yes. And they are not 21 uncommon in the United States? 22 MR. JENKINS: There is a lot more 23 talk about merchant plants than there are merchant 24 plants that are actually on the ground and up and 25 running. Certainly merchant plants are being brought 26 in. Merchant plants are -- some are up and running. 27 But, again, in an immature market like Ontario the 28 timing is not right to move forward with a merchant 922 WOOLF/JENKINS/CEKSTERS 1 plant in terms of the financing capabilities. 2 MR. PERDUE: What percentage of the 3 550 megawatts would you require to have under firm 4 sales before you would consider being able to 5 economically build the plant? 6 MR. JENKINS: I think that is a good 7 question and it would depend, again, on the market in 8 which we were building it. 9 I couldn't answer that for you here 10 in Ontario, again because the market itself is not 11 developed. I can tell you that in other jurisdictions 12 we have plants that have a component of merchant in 13 them. In fact, in Alberta we have a couple of small 14 plants -- and I underline "small" because that 15 obviously makes a difference -- that are 100 per cent 16 merchant. Some are about 40 per cent merchant. 17 So we have three plants currently in 18 Alberta that fall into that range, but I honestly 19 couldn't speculate for you here in Ontario. I wish I 20 could, because if I could do that I may not be standing 21 up here today. 22 MR. PERDUE: So you are trying to get 23 the percentage, obviously, as high as you can. 24 MR. JENKINS: That's right. 25 MR. PERDUE: What about the supply? 26 If it takes you three years to build your plant, who is 27 going to provide the supply during the first three 28 years while your plant is under construction? 923 WOOLF/JENKINS/CEKSTERS 1 MR. JENKINS: Again that is an issue 2 that we are in the process of working out. 3 When you are moving into a market 4 like this, timing is an issue on many fronts, and that 5 is also an issue that has been brought forward and one 6 that we are working with. But if you ask me that 7 question about timing, certainly the timing of the 8 42 months of the 3.8 cent revenue cap for Ontario 9 Hydro, or OPG, has an impact as well, so we could go on 10 forever about those timing issues. 11 Suffice it to say that it is a 12 commercial issue that we have to address in our risk 13 profile of looking at the plant. 14 MR. PERDUE: How firm do the 15 contracts have to be before you and your bankers would 16 consider it an economically feasible project? 17 In other words, SSS customers may not 18 be signed up customers. They may not have a contract. 19 Would that disturb you? 20 MR. JENKINS: It depends on the 21 backing that would be provided by the customer who we 22 would be selling to, who in this case would be the 23 municipals, Toronto and Mississauga. Our arrangement 24 is with them. The back-up behind that is going to be 25 their responsibility. 26 MR. PERDUE: Would there be 27 displacement provisions in the contract? 28 MR. JENKINS: Displacement from what 924 WOOLF/JENKINS/CEKSTERS 1 perspective? 2 MR. PERDUE: Oh, I'm sorry. That is 3 a common type thing in gas contracts -- gas supply 4 portfolio contracts. Most of them have a displacement 5 provision for a customer who wishes to go direct 6 access. 7 MR. JENKINS: No. There would not be 8 displacement in our direct arrangement, as I understand 9 what you have said. 10 MR. PERDUE: So it would be up, then, 11 to the utility or the affiliate, whomever you signed 12 the contract with, to in fact sell that power on the 13 secondary market if those customers under SSS decided 14 to go to a private retailer. Have I got it correct? 15 MR. JENKINS: That is the way it is 16 contemplated today. But, again, what you are doing is, 17 you are walking down a number of commercial 18 alternatives that are available. But certainly from 19 the perspective we have taken so far, the output of the 20 plant is intended to be committed to two customers. 21 MS WOOLF: If I can help here, I 22 think that the -- 23 MR. PERDUE: I'm sorry, I don't think 24 I am allowed to ask you a question, but please -- 25 --- Laughter 26 MS WOOLF: I think the mechanics are 27 such that the person obligated to serve SSS customers 28 is the LDC or, as I have been articulating, through a 925 WOOLF/JENKINS/CEKSTERS 1 third party or retailer, and it is with the SSS 2 provider that you would be looking to contract. 3 I think that Seabron Adamson may have 4 touched on this, but the risk of flight of customers 5 from SSS to retail is something that can be managed. 6 MR. PERDUE: I didn't realize there 7 was a middle man, then, between yourself, Mr. Jenkins, 8 and the SSS supplier, whomever that might be. There is 9 another -- 10 MS WOOLF: No, no, no, sorry. He is 11 contracting with the SSS supplier, not the SSS 12 customer, which is I think where your questions were 13 going. 14 MR. PERDUE: The SSS customer was 15 Mrs. Jones I thought. 16 MS WOOLF: Yes. 17 MR. PERDUE: I understand. He is not 18 contracting with Mrs. Jones -- 19 MS WOOLF: Okay. Sorry. 20 MR. PERDUE: -- you are contracting 21 with the affiliate or the LDC, whomever is supplying 22 Mrs. Jones. 23 MR. JENKINS: That's right, and that 24 hasn't been determined yet -- 25 MR. PERDUE: No, I understand that. 26 MR. JENKINS: -- because they are 27 still setting up their structures. 28 MR. PERDUE: What I am saying is, if 926 WOOLF/JENKINS/CEKSTERS 1 you don't have displacement provisions so that if, for 2 example, a lot of Mrs. Joneses decided to go to a 3 retailer, then presumably the corporation with whom you 4 have a contract, that is, either the LDC or the 5 affiliate, or a third party, the person supplying the 6 SSS, would be responsible for getting rid of that extra 7 load. Is that correct? I mean, it is not your 8 responsibility, it would be theirs. 9 MR. JENKINS: That would be correct. 10 Keep this in mind. The approach that 11 we are taking follows, coincidentally, because we 12 certainly haven't had a prior discussion with 13 Mr. Adamson -- the approach we are taking is a 14 portfolio approach. So the supply coming from, say, 15 the plant that is under discussion here is only one 16 portion of a larger load. So that displacement 17 provision is a broader issue than one specific contract 18 or supplier -- 19 MR. PERDUE: And the spot price 20 wasn't displaceable. Obviously, if you are buying from 21 the IMO on the spot you would be able to displace that 22 on a daily basis. 23 MR. JENKINS: That's correct. 24 MR. PERDUE: But still, ultimately, 25 it gets down to the point where you want a firm 26 contract for the sale of so many megawatts, so much 27 power, to the body which is going to supply the 28 standard service offering, whomever that might be. And 927 WOOLF/JENKINS/CEKSTERS 1 it would be a firm contract. There would be no method 2 of -- there would be no escape clause, for example. If 3 the customers leave they would be responsible for 4 selling that power to someone else, presumably, and 5 then have to make up the money to you. 6 MR. JENKINS: That's right. 7 MS WOOLF: But, of course, I think 8 Seabron would say that that customer went somewhere 9 else within the province, didn't disappear off the face 10 of the earth, and therefore there would always be a 11 market for the SSS provider to sell -- 12 MR. PERDUE: Oh, yes, but I am 13 supposing that if that customer went to a retailer and 14 the retailer has an arrangement with some generator of 15 a similar -- maybe TransCanada Power or 16 whatever -- they may therefore look to TransCanada 17 Power to supply Mrs. Jones. 18 MS WOOLF: I think his view would be 19 that there would be so much contract covering the 20 market and that the contract cover would probably move 21 around with the customers, if you will. 22 MR. PERDUE: Yes. And I don't mean 23 to just be simply talking about Mrs. Jones as one 24 customer, I am talking about a large number of 25 customers that would -- 26 MS WOOLF: Yes, well, that -- 27 MR. PERDUE: Nonetheless, I think, 28 Mr. Jenkins, you would agree with me that there would 928 WOOLF/JENKINS/CEKSTERS 1 be a firm contract with the LDC or the supplier of the 2 SSS? 3 MR. JENKINS: I agree with that. 4 MR. PERDUE: Mr. Jenkins, those are 5 the only questions I have for you, sir. I thank you 6 very much. 7 I have a couple of questions for 8 yourself, Mr. Ceksters, if I could, please. 9 The fundamental objection to the 10 utility itself supplying the SSS -- you have a 11 fundamental objection to that, and I wonder if you 12 could just tell me what it is. 13 I know that you are allowed to do it 14 by an affiliate or a third party. I am not asking 15 that. I am asking why the utility itself decided not 16 to do it. 17 MR. CEKSTERS: Well, the fundamental 18 objection that Hydro Mississauga has to the SSS as it's 19 presently written is that it is spot priced, not fixed. 20 MR. PERDUE: What objection is that 21 to the regulated wires company? Why do they care? 22 MR. CEKSTERS: Well, as an example, 23 we could decide -- it hasn't been decided yet, but we 24 may decide to move that function over to an affiliate. 25 MR. PERDUE: Well, I appreciate that. 26 I am asking you: Other than for the prospect of making 27 money in your affiliate and therefore increasing 28 shareholder value, the actual utility itself could 929 WOOLF/JENKINS/CEKSTERS 1 perform this function perfectly well on a spot service. 2 Could it not? 3 And it would neither make nor lose 4 any money. 5 MR. CEKSTERS: It could. But the 6 market the way it is shown in the draft code, in our 7 minds, will not work properly. It won't create the 8 generation competition, the things in the White Paper 9 that the government would like to achieve. 10 MR. PERDUE: What you are saying, 11 then, is that what you would like to do is move it over 12 for the reasons that you want to create competition. 13 Is that one of your reasons for moving it over? 14 MR. CEKSTERS: Allow competition to 15 work in the marketplace, yes. 16 MR. PERDUE: You want to create 17 competition or allow -- 18 MR. CEKSTERS: By whatever means it 19 happens, yes, have competition in the marketplace. 20 MR. PERDUE: All right. What you are 21 suggesting, therefore, sir, is that there is no 22 competition in the marketplace. 23 MR. CEKSTERS: Well, the competition 24 is very much reduced with the spot price pass-through, 25 yes. 26 MR. PERDUE: And it is reduced why? 27 MR. CEKSTERS: The dominant player 28 will be the primary supplier. 930 WOOLF/JENKINS/CEKSTERS 1 MR. PERDUE: That's Ontario Hydro, 2 you mean. 3 MR. CEKSTERS: Correct. 4 MR. PERDUE: But the spot price 5 itself does not prevent a retailer from having a 6 bilateral contract to supply any customers that 7 retailer may have. 8 And you could do the same thing. Am 9 I correct? 10 MR. CEKSTERS: You could, yes. 11 MR. PERDUE: Therefore, why would 12 that prevent competition from arising? Are you 13 concerned that competition in fact will not arise in 14 Mississauga? 15 MR. CEKSTERS: In the way that the 16 draft code is put together, yes, we are concerned. And 17 it is evident by our participation in Lakeview, as an 18 example. 19 Right now, we are like deer frozen in 20 the headlights. We can't move forward with the codes 21 as they are presently drafted. We cannot. 22 MR. PERDUE: So it isn't a question 23 of attempting to increase shareholder value; it's a 24 question of bringing competition to the marketplace? 25 MR. CEKSTERS: Both. 26 MR. PERDUE: Both. I didn't see 27 shareholder value mentioned. I just wondered if that 28 was considered at all. It wasn't clear. 931 WOOLF/JENKINS/CEKSTERS 1 You are saying that that is a 2 concern. 3 MR. CEKSTERS: It is a consideration. 4 It has to be now, with the changes to the marketplace. 5 MR. PERDUE: If there is shown to be 6 enough competition in the market, will that deter your 7 entry at all? 8 MR. CEKSTERS: No. 9 MR. PERDUE: What you want to do is 10 supply the SSS through an affiliate, and at the same 11 time that affiliate would also provide retail 12 non-regulated offerings. 13 MR. CEKSTERS: Correct. 14 MR. PERDUE: And would there be a 15 code of conduct in that affiliate? 16 MR. CEKSTERS: I would presume so. 17 MR. PERDUE: There is no such code of 18 conduct currently contemplated, is there? 19 MR. CEKSTERS: I have not seen it. 20 MR. PERDUE: So you would anticipate 21 a code of conduct there where half the retail affiliate 22 was in fact regulated? 23 MS WOOLF: I think the code of 24 conduct actually is already in place in both the ARC 25 and the SSSC. 26 MR. PERDUE: Again, I am not allowed 27 to ask you questions, ma'am. 28 But I think the code of conduct is 932 WOOLF/JENKINS/CEKSTERS 1 between the regulated LDC and the affiliate, not 2 between the regulated part of the affiliate and the 3 unregulated part of the affiliate. 4 MS WOOLF: Well, I think that the -- 5 if I may answer the question? 6 I think that the SSS -- 7 MR. PERDUE: I will ask these 8 questions of you when I get my turn, if that's 9 acceptable. I just wanted to ask the questions, and I 10 felt that an officer of Mississauga Hydro may be the 11 right person to do that. 12 But if you would rather I wait, I'll 13 give you -- 14 What do you say, Ms O'Riley? 15 MS O'RILEY: I think I should defend 16 myself here. 17 I'm sorry, I didn't ask 18 Mr. Stephenson to bow down from his questioning. I 19 just meant that if there were questions for Mr. Jenkins 20 and Mr. Ceksters, we are aware that we only had them 21 for the rest of the day. 22 So I apologize for the confusion. 23 You are allowed to ask questions, but it was -- 24 MR. PERDUE: Just a second. 25 MS O'RILEY: But there is a real time 26 constraint on the time for those two gentlemen, just so 27 we are aware of that. 28 MR. PERDUE: I don't mind asking my 933 WOOLF/JENKINS/CEKSTERS 1 questions -- instead of asking them of yourself, 2 Mr. Ceksters, I will ask the same questions of 3 Ms Woolf. I don't mind. I just want to ask the 4 questions. 5 MR. POWER: Mr. Perdue, they are here 6 to help you and the Board as best they can. 7 MR. PERDUE: There we are! 8 MR. POWER: You have the advantage of 9 three very bright minds up there. I think you should 10 enjoy it to the best you can. 11 MR. PERDUE: I have imposed on 12 Mr. Stephenson. Why don't we just leave it. 13 Ms Woolf, I will carry on the 14 conversation -- this is not a cross-examination, of 15 course -- when my turn comes up, if that is acceptable. 16 Ms O'Riley, thank you very much. 17 MR. RONAYNE: I am Mark Ronayne, from 18 the Competition Bureau. I just want to try to square a 19 circle here. Maybe I am getting confused about 20 something. 21 Is the problem for you or for the 22 distribution utility that there are going to be too 23 many competitors in the marketplace, making it 24 difficult? 25 How does that square with what we 26 have been hearing from Seabron Adamson and others that, 27 really, consumers are going to be very immobile off of 28 whatever they start off with in the marketplace? 934 WOOLF/JENKINS/CEKSTERS 1 MR. CEKSTERS: Well, the way that we 2 see the Code, you have just taken 260 competitors out 3 of the market, the way it is drafted. 4 MR. RONAYNE: So if you can't set up 5 an independent affiliate to sell in the retail market, 6 then that's prohibited? 7 I didn't understand that to be the 8 Code. 9 MR. CEKSTERS: No, it's not 10 prohibited. But you have to set up a second one if you 11 want to have a third party take care of your SSS 12 obligations, which will create inherent cost 13 impediments. 14 It's a low margin business. 15 Electricity retail will be very low margin. So you 16 want to have anything that will make it efficient. We 17 run our businesses to make it efficient by training 18 people to be able to do multiple jobs. 19 If you have to have multiple 20 affiliates, I have to go and take those people and get 21 two or three others to do the same thing. That is 22 inefficient. That will kill competition. 23 MR. RONAYNE: Did I hear a projection 24 about how many people are going to be on Standard 25 Supply Service Code of something like 75 per cent from 26 somebody? 27 MR. JENKINS: No. What I was saying 28 was that earlier in the proceedings the customers who 935 WOOLF/JENKINS/CEKSTERS 1 would be eligible, I suppose, by some measure -- in 2 other words, those served by the MEUs today -- range to 3 be about 75 per cent of the customers in the province. 4 What I said was that that would be 5 the start point. On day one, every one of those 6 customers, I would assume, will be on default supply. 7 The intention of the competitive market is that, over 8 time, you will migrate to whatever their choice gets to 9 be. 10 So it was really just building on 11 what we had heard earlier in the proceeding, and saying 12 that that is the start point. If you recall, it was 13 used to address another point, and that is that this 14 issue is eliminating, from our perspective as a 15 generator, 75 per cent of the market from us, so that 16 we end up -- 17 MR. RONAYNE: If I can ask: There is 18 a presumption there that everybody starts off on 19 Standard Supply Service Code, so that there won't be 20 any marketing -- actually, before the market opens. 21 MR. JENKINS: The intention was 22 simply a broad brush presumption. There will be some 23 marketing in advance, I am sure. We are looking at 24 trying to start this market in the year 2000. By my 25 calendar, that's not very far away. There is a lot of 26 customer education. 27 I think Mr. Adamson and others have 28 talked about the experience in California where the 936 WOOLF/JENKINS/CEKSTERS 1 migration of customers initially was very -- and 2 perhaps Fiona could add to that. 3 The initial migration, in my 4 understanding, is rather slow regardless of the 5 education. People will sit and wait. It was as simple 6 as that. It wasn't intended to draw any specific 7 measures as to who was going to do what and when. It 8 was a broad approach. 9 MR. RONAYNE: I guess the plan, then, 10 is that those immobile customers you would have, then, 11 also combined in an affiliate, which would also be 12 involved in unregulated retail market activities? 13 MR. JENKINS: Who are you addressing 14 that to? 15 MR. RONAYNE: Well, I guess either -- 16 anybody on the panel. 17 Is that the idea, that if you 18 combine -- let's say you start off with 75 per cent of 19 the customers. They are going to be -- those are the 20 ones that are on standard supply service. If you 21 combine that standard supply service in one company 22 with the unregulated retail activity of the LDC, then 23 they are going to start off with all those 75 per cent 24 from day one? 25 MR. CEKSTERS: Yes. 26 MR. RONAYNE: Will anybody else -- 27 well, no, nobody else can start off with that many 28 customers. Okay. 937 WOOLF/JENKINS/CEKSTERS 1 Those are my questions. Thank you. 2 MS O'RILEY: Mr. White? 3 MR. WHITE: I am Roger White. ECMI. 4 I am working with a number of municipal electric 5 utilities. 6 Some of the economies that you were 7 talking about being able to achieve from the retailing 8 affiliate that might have SSS obligations or 9 opportunities in a reconfigured system, where would 10 those economies come from? 11 MR. CEKSTERS: Well, the economies 12 come from using one person to do one function rather 13 than have two affiliates, two people, to do the same 14 function that would be necessary, as an example. 15 MR. WHITE: Would billing hardware or 16 information technology equipment be able to serve two 17 masters? 18 MR. CEKSTERS: It could. It could be 19 outsourced. 20 I'm talking more of the human 21 resources. 22 MR. WHITE: I continued to search for 23 someone who has thought about whether or not the SSS, 24 the way it is currently crafted, can be implemented for 25 non-interval metered customers with different meter 26 reading dates within a given utility. 27 Have you any comment on that? And 28 the answer "no" is acceptable. 938 WOOLF/JENKINS/CEKSTERS 1 MR. CEKSTERS: I'll go with that 2 answer. 3 --- Laughter 4 MR. WHITE: No further questions. 5 Thank you. 6 MS O'RILEY: Mr. Stephenson? 7 MR. STEPHENSON: Thank you. 8 Let me come back to Ms Woolf, 9 first -- and I think this may apply to the other 10 panellists. 11 I just wanted to clarify, coming back 12 to this issue about use of LDC infrastructure at 13 incremental cost by the affiliate, and I think you have 14 clarified that you certainly recognize that other 15 aspects of the ARC deal with the issue of transfer of 16 services and pricing of services and so forth. 17 MS WOOLF: Sure. 18 MR. STEPHENSON: I take it that, on 19 my reading of the paper, you are not particularly 20 concerned about those issues, or at least not 21 sufficiently so that you are recommending that they be 22 changed? 23 MS WOOLF: That is right. The group 24 is prepared to live with the other provisions in the 25 interests of homing in on what is really important to 26 them. 27 MR. STEPHENSON: Okay. 28 I know that the Board will be very 939 WOOLF/JENKINS/CEKSTERS 1 concerned about any issue about cross-subsidization, or 2 the appearance of cross-subsidization. That is one of 3 the things that they are always very sensitive about. 4 Without getting into the detail of 5 the transfer pricing mechanisms that are contemplated, 6 I had understood that, more or less, these were going 7 to be fully allocated costs that were going to be 8 charged for services rendered by the LDC for the 9 affiliate and not on some incremental basis. Am I 10 wrong about that, as a general rule, in terms of 11 transfer pricing? 12 MS WOOLF: I think the Code deals 13 with it on an arm's-length cost basis, yes. 14 MR. STEPHENSON: If I could just turn 15 to Mr. Ceksters, for a moment. 16 In terms of the efficiencies that you 17 are seeking to gain that are crucial for you, I assume 18 that -- in terms of human resources and things like 19 that, I'm assuming that you view that you can gain 20 those efficiencies on the basis of transfer pricing of 21 those resources on an arm's-length basis, some sort of 22 fully allocated cost, as opposed to simply incremental 23 cost of an hour's labour of individual employees? 24 MR. CEKSTERS: I was referring more 25 to the set-up of the affiliates. With separate 26 affiliates, you have separate resource requirements. 27 With one affiliate, we could have one set of resource 28 requirements. 940 WOOLF/JENKINS/CEKSTERS 1 MR. STEPHENSON: I understand that 2 point. I guess the point of the question I have is 3 that, insofar as you are able to share resources, do 4 you feel you can achieve those efficiencies if you have 5 to pay for the shared resources at something 6 approaching the fully allocated cost of those resources 7 on an arm's-length basis? 8 MR. CEKSTERS: Yes. 9 MR. STEPHENSON: Okay. Now, 10 Ms Woolf, at page 14 of your paper, you make the 11 reference -- towards the last full paragraph, in the 12 last sentence of the last full paragraph, you say that: 13 "The SSSC and the ARC appeared 14 to be protecting inefficient 15 competitors by inhibiting market 16 entry by incumbent utilities on 17 the basis of incremental costs 18 which will increase efficient 19 competition at lower prices for 20 the consumer." (As read) 21 Again, there is the incremental cost. 22 I take it you mean that as modified by the ARC itself? 23 MS WOOLF: I'm sorry? I didn't 24 understand the question. 25 MR. STEPHENSON: Well, you say that, 26 you know, you feel that restrictions on the ability of 27 the LDC to compete on the basis of incremental cost is 28 a bad thing. 941 WOOLF/JENKINS/CEKSTERS 1 MS WOOLF: Yes. 2 MR. STEPHENSON: But I take it you 3 accept the restrictions in the ARC, in terms of 4 transfer pricing. So that is not what you are talking 5 about? 6 MS WOOLF: Yes. That is between 7 affiliates. 8 MR. STEPHENSON: Now, you make the 9 reference to it protecting inefficient competitors. 10 Who are you talking about here? Who 11 are the inefficient competitors that are being 12 protected? 13 MS WOOLF: If you bias the level 14 playing field against the incumbent utilities, it is a 15 bit like giving some sort of subsidy to everybody else 16 to participate, if you like, so, in a sense, they 17 are -- in, I suppose, economic terms, Seabron would say 18 they are less efficient. I am just repeating the point 19 he made this morning which is that it is not 20 appropriate -- indeed, it would be laughable -- to 21 subsidize people to compete. 22 MR. STEPHENSON: What kinds of 23 entities are we talking about? Who are these 24 inefficient competitors? What sort of entities are we 25 referring to? Are they other LDCs? Are they 26 electricity marketers? Is it Enron we are talking 27 about? Is it Sears? 28 MS WOOLF: We are talking about any 942 WOOLF/JENKINS/CEKSTERS 1 other competitor who is advantaged, if you will, by the 2 disadvantage that is placed on the LDCs. 3 If they already have their own 4 advantages and their own efficiencies, because they can 5 utilize their own existing resources and, therefore, in 6 a sense, they are already economically efficient so 7 that the perceived market advantage which you are 8 trying to take away from the LDCs, by not allowing them 9 to use their customer lists, is something where you are 10 trying to give that market advantage to somebody else 11 because you are taking it away from them. 12 So that is essentially what Khan is 13 getting at when he says that you should not try to 14 protect people who are more efficient, in other words, 15 who can enter at incremental cost, by handicapping them 16 from using that. So it doesn't necessarily imply that 17 the other competitors are economically inefficient, 18 it's just that if you are taking something away from 19 somebody, by implication you are giving it to somebody 20 else. 21 I'm sorry if it was not apparent from 22 the words in the paper. 23 MR. STEPHENSON: You are not saying 24 that these people are inefficient per se, that they are 25 otherwise inefficient. 26 MS WOOLF: Yes. 27 MR. STEPHENSON: So we could read it 28 equally well just by taking the word "inefficient" out. 943 WOOLF/JENKINS/CEKSTERS 1 You are protecting competitors. 2 MS WOOLF: Other competitors. 3 MR. STEPHENSON: Okay. 4 One of the things that I believe 5 Professor Dewees mentioned was that an LDC's retail 6 affiliate, even under the proposed Code, will have an 7 enormous asset and an enormous competitive advantage, 8 in all likelihood, in the marketplace, and that asset 9 is its affiliation with the known and trusted LDC, that 10 notwithstanding the lack of promotion that an LDC may 11 not be permitted to do, nevertheless it would be known 12 that an affiliate is in fact related in some way to the 13 known and trusted LDC, and that will give them, amongst 14 unsophisticated consumers, at a minimum, a very 15 substantial competitive tool. I'm not going to say 16 "advantage", but a competitive tool. 17 Would you agree with Professor Dewees 18 about that? These affiliates aren't going to be 19 orphans. They will have, in fact, very substantial 20 goodwill in the market. 21 MS WOOLF: Firstly, I think the ARC 22 seeks to deal with that, as most affiliate relationship 23 codes do, by making a clear separation between them. 24 Indeed, there is a restriction, I think, on using the 25 name in the ARC. 26 But the short point in reply to that 27 is, actually everybody else is using the reputation of 28 their parent company. Sears Roebuck has a reputation 944 WOOLF/JENKINS/CEKSTERS 1 for quality. Enron has a reputation for quality. So 2 does the LDC have a reputation for quality. Believe 3 me, they all are in Ontario by comparison to many 4 countries I have worked in. 5 So that's why I think you will find 6 that not only I but Alfred Khan would argue that a 7 restriction on uses of names and reputations in itself 8 is actually not an unfair advantage simply because you 9 happen to be an LDC when everybody else has that 10 reputation that they will be using, and you are not 11 asking Sears Roebuck not to use it. 12 MR. STEPHENSON: One of the 13 criticisms about the use of the spot price as the SSS, 14 as the sole option, is that it forces customers to 15 choose between two things that they both want. They 16 want two things and it forces them to choose between 17 the two. 18 They can choose, on the one hand, to 19 receive power from a known and trusted supplier, namely 20 their LDC, or, on the other hand, they can choose to 21 get power at a fixed price, which is what they prefer. 22 But they can't have both. 23 Are you aware of that criticism? A 24 number of the proposals have pointed it out, that that 25 is a problem with the spot market as SSS. 26 MS WOOLF: I'm sorry. I'm not sure 27 what your question is. 28 MR. STEPHENSON: The criticism is 945 WOOLF/JENKINS/CEKSTERS 1 that customers shouldn't be forced to be put to this 2 choice, I guess, between choosing their known supplier 3 and fixed price. 4 MS WOOLF: Obviously, the White Paper 5 says very clearly that customers should not be forced 6 to make a choice. The criticism of the spot price 7 pass-through mechanism is the obvious one, that it puts 8 the risk of volatility on them by passing it through. 9 They are not going to like that. 10 MR. STEPHENSON: Well, let me just -- 11 MS WOOLF: Having said that, of 12 course, if you take Seabron Adamson's point further, on 13 the one hand it appears that it is actually an 14 attractive option that they are, in a sense, being 15 given a rotten price and are therefore being forced to 16 make a choice. 17 I would argue that regulators have 18 been extremely unsuccessful in forcing inert customers 19 to choose, even in Pennsylvania where they bribed them 20 to do it -- those are my words and not the words of the 21 PUC in Pennsylvania -- but that, on the other hand, the 22 customer is a loser anyway because, if you remember in 23 his presentation, there is a hump, a transaction cost 24 and information hump that they have to get over. 25 So they are losing out both ways. 26 MR. STEPHENSON: I guess where I was 27 going was this is that if in fact we go to a spot 28 market priced SSS and you have a situation where an LDC 946 WOOLF/JENKINS/CEKSTERS 1 sets up an affiliate and it is able to offer fixed 2 price, as all competitive retailers would be able to 3 offer fixed price, wouldn't that give the LDC's 4 competitive retail affiliate enormous advantage in the 5 retail market because it permits the very next best 6 thing, I guess, to what they would ideally want? 7 It gives them both the fixed price, 8 on the one hand, and while it doesn't give them power 9 from the known and trusted LDC it gets it at least from 10 the LDC's affiliate, which they would, somehow in their 11 own mind, subconsciously or consciously, relate back to 12 the LDC. 13 Wouldn't that scenario create, in 14 fact, an enormous competitive advantage for LDC 15 affiliates in the competitive retail market? 16 MS WOOLF: By "customer" are you 17 talking about the standard supply service customer or 18 are you talking about the retail customer? Because it 19 seems to me that there is something of a confusion 20 actually. 21 MR. STEPHENSON: I'm sorry. No, not 22 at all. Not at all. 23 My premise was that SSS must be on 24 spot, okay, and so we have this situation where, as 25 some people have said, the customer is forced to choose 26 between two things that it wants, either take it 27 getting fixed price or getting power from the LDC. It 28 can't have both. 947 WOOLF/JENKINS/CEKSTERS 1 What I am suggesting to you is that 2 because the LDC would be permitted to set up a 3 competitive retail affiliate which could offer fixed 4 price, that fact would give the LDC competitive retail 5 affiliate an enormous advantage over all other 6 competitive retail affiliates because it comes very 7 close, it is the next best thing to what these 8 customers absolutely want. 9 MS WOOLF: That is going back to the 10 point you raised before about using the name and 11 reputation of the parent company. 12 MR. STEPHENSON: They clearly are 13 permitted to do that. 14 MS WOOLF: That is the next best -- a 15 fixed price from Sears Roebuck is, you know, the next 16 best thing to heaven as well. 17 People will choose on price, and if 18 they get a cheaper price overall from Hydro 19 Mississauga's retail affiliate, or they get a cheaper 20 price from Sears Roebuck, they will think they are in 21 heaven. 22 The problem I have with it, as 23 Seabron did -- and I put in my paper, and it was 24 actually Seabron's thought, to give him his due -- is 25 actually, how on earth will the poor customer actually 26 be able to compare whether what is on offer from Hydro 27 Mississauga's retail affiliate is going to be cheaper 28 on a fixed price when it has to compare a weighted 948 WOOLF/JENKINS/CEKSTERS 1 average spot price pass-through that is appearing in 2 his bill every so often and he thinks that maybe with a 3 bit of luck, you know, all the plants will be back on 4 next month in the wholesale market, if he understands 5 the wholesale market, and that maybe the spot price 6 actually next month could be really low. 7 MR. STEPHENSON: I am taking way too 8 much time. Thank you. 9 MS O'RILEY: I thought we could take 10 a short 10-minute break and come back at quarter after 11 4:00. 12 --- Upon recessing at 4:05 p.m. 13 --- Upon resuming at 4:17 p.m. 14 MS O'RILEY: Mr. Jennings? 15 MR. JENNINGS: I think I can be brief 16 in the interest of hot afternoons. I just want to 17 clarify or touch on a couple of the issues that have 18 come up already. 19 On the issue of symmetry of gas and 20 electricity, I believe, Ms Woolf, you are quite 21 familiar with Bill 35, and it's our view that there are 22 some significant differences between the treatment of 23 gas and the treatment of electricity, which we presume 24 are intentional. Would you see it the same way? Do 25 you have any comments about how the Act sees symmetry? 26 MS WOOLF: They are certainly written 27 very differently. Obviously, the Electricity Act only 28 deals with electricity. The regulatory regime for gas 949 WOOLF/JENKINS/CEKSTERS 1 is written differently even though the Code represents 2 some degree of symmetry in the issue that we are 3 already talked about this morning, and I am obliged to 4 Brian for that. 5 One thing that I am not clear on is 6 actually whether there is a public service obligation 7 on gas companies in quite the way that is cast in 8 section 29 and whether the whole standard service 9 supply regime is the same. 10 MR. JENNINGS: I think that's a good 11 point. There doesn't appear to be anything that's the 12 equivalent of section 29, as it is laid out. 13 Are you aware of the Board decision 14 allowing Union Gas to transfer its water heater 15 customers and all of their records to its retail 16 affiliate? 17 MS WOOLF: No, I am not. 18 MR. JENNINGS: Would you presume that 19 that was a reasonable action? 20 MS WOOLF: I am sure that the Board 21 had excellent reasons for doing it. 22 MR. JENNINGS: Okay. They did and it 23 would seem to set a precedent, albeit it was not all 24 customers, it was a significant group. 25 In your discussion earlier on, on a 26 third point, on the issue of level playing field and 27 the question of whether customers would move, absent a 28 specific policy direction to do so, is it appropriate 950 WOOLF/JENKINS/CEKSTERS 1 for a regulator, in your view, to be trying to 2 encourage customers to move to another supplier? 3 MS WOOLF: Very few regulators have 4 attempted to do it. Those that have attempted to do it 5 have been singularly unsuccessful, even those who have 6 actually paid customers to do it, like Pennsylvania. I 7 think that the answer here goes back to the White 8 Paper. The White Paper says that in fact customers 9 will not be forced to choose, so I don't think that a 10 regulator in Ontario has a mandate to do that. 11 MR. JENNINGS: Thank you. 12 MS O'RILEY: Mr. Brett? 13 Thank you, Mr. Jennings. 14 MR. BRETT: Thank you. 15 I just have one area of questioning 16 for you, Ms Woolf. 17 I would just like to read you a 18 passage from the White Paper. It's contained on 19 page 18, at the bottom. 20 I will read it out slowly for you. 21 It says: 22 "Provincial and local wires 23 companies would be permitted to 24 own a small amount of generation 25 as necessary for technical and 26 efficiency reasons. The Ontario 27 Energy Board would be empowered 28 to approve generation 951 WOOLF/JENKINS/CEKSTERS 1 investments beyond these levels 2 if they are consistent with the 3 fair and efficient operation of 4 the market. Distribution 5 utilities that presently own 6 generation assets would be 7 allowed to keep them." 8 (As read) 9 My clients, the independent 10 generators, are of the view that to promote a level 11 playing field the municipal distributors should be 12 restricted to some degree with respect to how much of 13 their default supply they purchase from generation 14 which they own or will own in the future. Do you have 15 a view on that? Do you concur that there would be some 16 need for safeguards in that respect? 17 MS WOOLF: I think I am fairly 18 agnostic on the subject. I can echo what Seabron 19 Adamson said this morning, that in other jurisdictions 20 there has been a limit placed on the amount of 21 generation that LDCs can -- 22 MR. BRETT: Can own? 23 MS WOOLF: -- own to deal with what 24 Seabron described as a self-dealing. 25 I think that probably at different 26 times in the development of competition, perhaps 27 different levels, if you will, would apply. I think 28 that when you are looking at getting wholesale and 952 WOOLF/JENKINS/CEKSTERS 1 retail markets up and running, the view has been taken 2 elsewhere that in order to avoid, if you like, 3 self-dealing and re-integration of the industry on day 4 one, it's appropriate to impose these restrictions. 5 As competition develops, then perhaps 6 these restrictions are less justified and, indeed, 7 generators in a truly competitive market may well 8 look -- sorry, distributors in a competitive retail 9 market may, with some justification, look to own some 10 generation to hedge their risks. It's a bit of sort of 11 the reverse of the coin of generators looking to 12 acquire distributors with customer lists. To hedge 13 their risks, you begin to see a pattern developing 14 where, if you like, the top and the bottom of the 15 industry have a relationship, but it's the transmission 16 and the distribution wires that are kept separate 17 ultimately. 18 MR. BRETT: Just following up on your 19 point about ownership guidelines, are those in place in 20 jurisdictions that you are aware of, such as, for 21 example -- well, do any specific instances come to 22 mind? 23 MS WOOLF: They vary, I think, 24 initially from zero on day one to 15 per cent I think 25 was the percentage that Seabron Adamson was looking at 26 in England and Wales in the RECs. Twenty-five per cent 27 is a figure that is somewhere out there as well. In 28 other places, of course, competition has been put in 953 WOOLF/JENKINS/CEKSTERS 1 place without forcing a separation at all. 2 MR. BRETT: So it could be an issue 3 where you might have some restrictions initially, but 4 they would be phased out as the market gained strength 5 and the competitive market gained -- 6 MS WOOLF: Yes. Usually, the 7 regulator is given some discretion as to relaxing or, I 8 suppose, tightening, depending on how competition is 9 developing. 10 MR. BRETT: Thanks very much. That 11 is all I have. 12 MS O'RILEY: Mr. Perdue. 13 Thank you, Mr. Brett. 14 MR. PERDUE: If I didn't introduce 15 myself before, my name is Perdue and I act for the gas 16 marketers, who probably will be entering the 17 electricity marketing field as well. They currently 18 serve non-utility gas customers in Ontario. 19 I wonder if you could just imagine 20 for me the scenario if the Code demanded that the 21 regulated LDC, within the regulated bounds of the wires 22 company, provide the SSS. Can you imagine that 23 scenario, that the LDC is providing the SSS? 24 MS WOOLF: You mean it is not given 25 the choice that it is currently given? 26 MR. PERDUE: No, ma'am. It's not 27 given the choice. 28 MS WOOLF: It's a public service 954 WOOLF/JENKINS/CEKSTERS 1 obligation on the LDC. 2 MR. PERDUE: Yes, ma'am. Now, if 3 that is the case and the shareholders of the LDC want 4 to set up an affiliate -- or, excuse me, want to market 5 electricity privately, fixed term contracts, would it 6 seem reasonable to you that they would have to do that 7 through an affiliate, or would you say that it would be 8 reasonable that they could do that through their 9 regulated utility? 10 MS WOOLF: I think, actually, this 11 goes back to the point that you were dealing with 12 earlier. 13 I think that you could do it either 14 way, and I think that the way the Code is set up at the 15 moment has the machinery in place for that. 16 But, sorry, I am obviously not 17 answering the question that you -- 18 MR. PERDUE: I'm not saying you can 19 ignore the codes, I am simply asking as a hypothetical 20 example, where this is the case, would you find it 21 offensive if they were required, for example, to do it 22 through an affiliate, or would you find it acceptable 23 if they could provide that private service through the 24 regulated utility itself? 25 MS WOOLF: My immediate reaction was 26 that you could do it either way. I have seen it done 27 either way. 28 MR. PERDUE: Throughout your paper 955 WOOLF/JENKINS/CEKSTERS 1 you assumed -- and you talked about this -- that the 2 SSS is not profitable. Where did you get the idea that 3 it had to be profitable? 4 MS WOOLF: I think I did not imply 5 that it had to be profitable -- 6 MR. PERDUE: No, you said it wasn't. 7 MS WOOLF: I said it wasn't, yes. If 8 it is a public service obligation, which obviously it 9 is, then normally there would be a full cost recovery 10 at the very minimum, which is not entirely clear on the 11 language of the Code. There would at least be some 12 return on investment on the infrastructure employed in 13 providing that public service, because without that the 14 quality of the service might well deteriorate, which 15 would not obviously be in the government's interest 16 because it is, after all, a public service obligation. 17 MR. PERDUE: I agree with that. So 18 if we go back to the original example, if the SSS is 19 actually supplied through the regulated utility, via 20 the regulated utility, there would be that return on 21 infrastructure, there would be that cost-based rate, 22 there would be recovery of all of those costs. That is 23 the normal rule for rate of return regulation. Am I 24 correct? 25 MS WOOLF: If normal rate of return 26 regulation -- if that was the scenario that you are 27 postulating at the moment. But it is not apparent that 28 it is the scenario that is coming out of 2.5 of the 956 WOOLF/JENKINS/CEKSTERS 1 Code. 2 The overall point is that I wouldn't 3 like you to feel that the notion, somehow or another, 4 is that the MEUs should be allowed to make a profit out 5 of the standard supply service. I think that the point 6 is that they should be given the choice which is 7 offered to them under the distribution licence to 8 utilize an affiliate to do this. 9 MR. PERDUE: I don't have any 10 objection to that, but surely the rules should be the 11 same if they decide to perform the function by an 12 affiliate, or whether or not they decide to leave it 13 within the regulated utility. Why should the rule be 14 different one from the other? It is still a public 15 service, is it not? 16 MS WOOLF: In what way do you think 17 that the cost recovery issue would be any different 18 within a retail affiliate or if it was within the LDC? 19 Because that is the way I read the Code -- 20 MR. PERDUE: It wouldn't be any 21 different. It wouldn't be any different, would it? 22 MS WOOLF: It wouldn't be any 23 different, no. 24 MR. PERDUE: So what we have done is, 25 we have created a second regulated company. The 26 affiliate is now regulated. 27 MS WOOLF: No, it is the service 28 which is regulated. 957 WOOLF/JENKINS/CEKSTERS 1 MR. PERDUE: Well, ma'am, that means 2 that the charges are regulated. 3 MS WOOLF: And absolutely right, so 4 they should be. These customers are, in effect, 5 captive. 6 MR. PERDUE: But in order to 7 regulate -- What did you call it? The service charge? 8 Whatever. You spoke about a small whatever. I have 9 forgotten what you referred to it as, but do you know 10 what I mean by -- 11 MS WOOLF: The administrative charge. 12 MR. PERDUE: Administrative charge. 13 Good enough. 14 MS WOOLF: Administrative fee, I 15 think, is the terminology. 16 MR. PERDUE: How is the Board going 17 to set that on any other basis than it sets any other 18 such rate in a regulated company? It would be 19 cost-based. 20 MS WOOLF: Yes. 21 MR. PERDUE: That would mean that 22 they have to look at the cost, which means they have to 23 regulate the company. 24 MS WOOLF: But they are going to have 25 to do that anyway, the way that they have set up 2.5. 26 MR. PERDUE: Yes, they will. I am 27 just pointing out -- 28 MS WOOLF: That is, I think, the 958 WOOLF/JENKINS/CEKSTERS 1 greatest protection. You don't have to re-write 2.5 in 2 order, in effect, to ring-fence the provision of 3 standard supply service and retail service within the 4 same retail affiliate, because if there were any, if 5 you like, cross-subsidization, which is probably what 6 you are worried about, and legitimately so because this 7 is a regulated business within a retail affiliate, it 8 is in fact because the price to the end consumer is 9 regulated. There is only one price that can be 10 charged, and the Board would regulate that in the 11 normal way that any regulator would because it is a 12 regulated service. 13 As currently drafted, you have the 14 spot price pass-through mechanism, plus an 15 administrative fee. 16 Now, if the Board felt that the 17 administrative fee was too high because, somehow or 18 another, the retail affiliate was gold-plating its 19 entire infrastructure and it was using the 20 administrative fee to fund that, because in a sense it 21 would be a cross-subsidy to the retail side, then the 22 Board would look at that administrative fee, because it 23 has power to regulate it under 2.5, and it would say, 24 "My goodness me, this looks rather high per capita by 25 comparison to all of the other people who are providing 26 SSS", and they could see in a nanosecond, with minimal 27 regulatory burden, that there was some degree of 28 gold-plating cross-subsidy going on here and it would 959 WOOLF/JENKINS/CEKSTERS 1 doubtless get a pertinent letter or a telephone call 2 saying, "What is going on here?" 3 That is why I didn't think you would 4 need to re-write the Code to deal with running SSS and 5 retail activities. 6 MR. PERDUE: I am not suggesting that 7 you have to re-write the Code. I am not suggesting 8 that. I am just suggesting that what you have done is, 9 you have made another regulated company. 10 MS WOOLF: You have a regulated 11 service within a retail affiliate. 12 MR. PERDUE: Call it what you will, 13 ma'am. That is -- 14 MS WOOLF: And when I started 15 answering this question I said that you can do this 16 either way, and around the world people do it either 17 way. 18 MR. PERDUE: All right. 19 MS WOOLF: The creation of a separate 20 corporate entity is, in a sense, almost a cosmetic 21 issue at the end of the day. 22 MR. PERDUE: If the spot price 23 pass-through prevails, presumably there would be no 24 advantage to the affiliate offering SSS, or am I 25 incorrect? 26 MS WOOLF: If the spot price 27 pass-through mechanism prevails, my analysis of it is 28 that that along with the other restrictions will make 960 WOOLF/JENKINS/CEKSTERS 1 not only the whole thing very unattractive to anybody, 2 including the LDC, who is ultimately left with the 3 section 29 obligation and will have to look after it 4 itself, but it will -- 5 MR. PERDUE: Why is it unattractive 6 to them? 7 MS WOOLF: By definition, it is a 8 public service obligation. 9 MR. PERDUE: They don't make any 10 money on it. 11 MS WOOLF: They don't make any money 12 on it. 13 MR. PERDUE: They never do. 14 MS WOOLF: So what is unattractive -- 15 MR. PERDUE: No, but no gas company 16 in Ontario, or in North America, makes money on 17 commodity. Electric companies don't make money on 18 commodity. 19 MS WOOLF: Well, that's a different 20 question. I mean, you are talking about where they are 21 retailing the commodity the margins are thin. Yes. 22 But this is a public service 23 obligation, and the way that I think that Board staff 24 designed the 2.5 is essentially that it is a cost 25 recovery mechanism. 26 MR. PERDUE: I had understood that 27 the SSS would be -- no matter if it's a fixed charge or 28 whatever, that the person selling is not going to make 961 WOOLF/JENKINS/CEKSTERS 1 any money out of it. They are going to make their 2 money elsewhere. They are going to make their money on 3 rate of return on their investment. 4 But I don't think any rate-of-return 5 utility in North America selling a commodity, either 6 gas or electricity, makes money on it, unless they are 7 marketing it separately from the SSO or the SSS. 8 If it's the standard regulated 9 service, the object is not to make money on it. 10 MS WOOLF: Yes. In the electric 11 power industry, they certainly seem to have simply 12 dealt with it on a cost recovery basis, although most 13 jurisdictions do try to put some incentive to make sure 14 that the infrastructure is kept in a state where 15 investment will be encouraged to meet need but without 16 gold-plating. 17 But you can regulate -- 18 MR. PERDUE: That is a different 19 issue, I think, than the actual commodity. 20 MS WOOLF: Yes. 21 MR. PERDUE: But you are correct, it 22 is a separate issue. 23 Customer lists appear to be a big 24 part of your concern. It has come up several times. 25 From the marketer's point of view, I 26 don't think there would be any objection at all if the 27 suggestion is to give the customer lists out to 28 everybody. I don't think anybody would object to that. 962 WOOLF/JENKINS/CEKSTERS 1 I don't think any one of the marketers would use it. 2 MS WOOLF: I tend to agree with you, 3 because I think that they probably have better customer 4 lists themselves. 5 MR. PERDUE: The essence of the 6 disagreement, I think, between us is that in the 7 affiliate, if you are providing both a public service 8 of the regulated SSS and you are also retailing 9 electricity under the same name, out of the same 10 office, that presents, in our opinion, opportunities 11 for cross-subsidization and unfair competition. 12 MS WOOLF: Well, I have just dealt 13 with the issue of cross-subsidization and explained to 14 you how that would be regulated. 15 MR. PERDUE: Yes. I wasn't asking 16 you the question; I was simply stating a position. 17 MS WOOLF: As far as the name issue 18 is concerned, I have also dealt with that this 19 afternoon. 20 MR. PERDUE: The name that you are 21 talking about is the name of the regulated company. 22 There is no restriction on the name under which they 23 provide the SSS if they provide it under an affiliate. 24 In other words, the name of the LDC is Pembroke Hydro. 25 The name of its affiliate is energy from Pembroke. 26 So they provide the SSS and send out 27 a bill saying energy from Pembroke, and then they turn 28 around and say, "Oh, we also have fixed prices here 963 WOOLF/JENKINS/CEKSTERS 1 competitively with other people", and it's also 2 Pembroke Hydro, whatever it is. 3 There is a problem between the name 4 of the regulated utility and the affiliate, but there 5 is also a problem if the affiliate itself is providing 6 both the public service of the SSS and also marketing 7 under the same name. Do you see my problem? 8 MS WOOLF: Frankly, I don't. I think 9 that it goes back to what I was saying before, that 10 everybody has a name and a reputation that they will be 11 using in the marketplace. 12 MR. PERDUE: Okay. I think that's 13 all. 14 Thank you very much, Ms Woolf; I 15 appreciate that. 16 MS WOOLF: Thank you. 17 MS O'RILEY: Mr. White, I think, is 18 next. 19 MR. WHITE: I am Roger White, and I 20 am with ECMI. We represent a number of municipal 21 electric utilities in the province. 22 Are any of these companies that are 23 created by the municipalities under Bill 35 regulated 24 in any way other than the OBCA in Ontario -- the 25 Ontario Business Corporations Act? 26 MS WOOLF: In relation to what sort 27 of activities? 28 MR. WHITE: Let me lead you a little 964 WOOLF/JENKINS/CEKSTERS 1 bit, then maybe we can get there. 2 My reading of the statutes indicates 3 that it is not the companies that are regulated; it is 4 the services that they provide and the prices that they 5 charge for those services. 6 MS WOOLF: Yes. "Regulation 101" is 7 regulators regulate prices and quality of service, yes. 8 MR. WHITE: Are you familiar with any 9 electric utility in Ontario that contracts out 10 services -- we will ignore Ontario Hydro Services 11 Company for the time being -- that actually contracts 12 out services, like maintenance or billing, or things 13 like that to "other non-regulated companies"? 14 MS WOOLF: Well, I imagine they might 15 contract out to have their premises cleaned to 16 non-regulated companies. 17 MR. WHITE: I find that to be the 18 case, and I find that even in many cases they farm out 19 linemen work, capital construction, maintenance, all 20 kinds of services which are part of their duties under 21 a regulated tariff. 22 MS WOOLF: And it's a very efficient 23 way of proceeding. 24 MR. WHITE: These companies that are 25 created, what duties do the boards of directors have to 26 the companies under the Ontario Business Corporation 27 Act? Are you familiar with those types of duties? 28 MS WOOLF: I am not an Ontario 965 WOOLF/JENKINS/CEKSTERS 1 lawyer, and I am not entitled to give legal opinions on 2 Ontario law. I could give you the answer under English 3 law. 4 MR. WHITE: Good. Take me there. 5 MS WOOLF: The duties of directors 6 are primarily to the company. 7 What are the duties of the company? 8 They are obviously to add value to the shareholders. 9 I am not quite sure where your 10 question is leading me. 11 MR. WHITE: That sounds to me a 12 little like there is a duty to make profit maybe, as 13 part of enhancing value? 14 MS WOOLF: I don't think company 15 lawyers normally would answer that technically, and 16 maybe you should ask some other people in the room that 17 question. 18 Put it this way: A lot of directors 19 that you talk to at cocktail parties will talk about 20 enhancing shareholder value. Put it that way. 21 MR. WHITE: I guess what I was trying 22 to get at is, seeing how the wires business which has 23 statutory duties, some of which are regulated, is 24 incorporated under the same statute that the 25 competitive businesses are incorporated under in 26 Ontario, the directors would have had similar 27 obligations. 28 What I am trying to get to is that 966 WOOLF/JENKINS/CEKSTERS 1 enhancing shareholder value and profit is not 2 necessarily a dirty word for a regulated company in 3 Ontario. 4 MS WOOLF: I would entirely agree 5 with that, yes. 6 MR. WHITE: If you were trying to 7 differentiate the gas industry regulation in Ontario 8 and the current situation that we are into in terms of 9 the electricity business -- if you were to try and put 10 on a regulatory hat for a minute and say: If I have 11 significant players in the energy sector in a 12 geographic area and one of those players or a group of 13 those players have been in a competitive market, an 14 evolving competitive market, for ten years, as the 15 legislature is crafting a statute that is going to 16 unbundle the electricity business, do you think they 17 might consider giving the latitude or a different set 18 of basic rules to the electricity industry than the 19 already established other energy sector entity in the 20 province that was regulated? 21 MS WOOLF: You raise an interesting 22 thought in my mind as to whether in fact it would be 23 because of the superior skills and know-how of the gas 24 marketers, and just their experience of retailing, that 25 in a sense there is an argument if you go down the 26 handicapping routes that they should be handicapped 27 rather than the infant retailers, if you like, in the 28 infant retail market in electricity, and that somehow 967 WOOLF/JENKINS/CEKSTERS 1 or another the gas marketers have an unfair advantage. 2 But I have to say that I should get 3 back really to my original analysis of the difference 4 of approach between gas and electricity, is that at an 5 earlier stage in the development of competition then 6 you need a different set of regulatory rules to deal 7 with the facilitation of competition. Typically that 8 is what regulators have done. 9 MR. WHITE: Thank you very much. 10 No further questions. 11 MS WOOLF: You are not going to ask 12 me the question that you have asked everybody else, 13 because I was ready with my answer -- 14 MR. WHITE: I'm afraid I couldn't -- 15 MS WOOLF: -- which is no, I do not 16 have any experience of how to fix your problem on 17 different meter readings. 18 I'm disappointed. 19 --- Laughter 20 MR. WHITE: Thank you. 21 MS O'RILEY: Is there anyone else 22 besides Board staff who have questions for this 23 witness? 24 Part of the presentation that you 25 made and that Mr. Adamson made was about the advantages 26 of a fixed price over a spot price. I believe that was 27 part of the argument that was in your pre-filed 28 evidence. So I just wondered if you could -- 968 WOOLF/JENKINS/CEKSTERS 1 MS WOOLF: I'm sorry. What was the 2 question? 3 MS O'RILEY: I was starting it up. 4 I just wondered what it is that based 5 that view on. Why do you think a fixed price is 6 preferable for consumers to a non-fixed price? 7 MS WOOLF: Well, I think it takes you 8 through all the arguments in my paper and which I have 9 articulated today and all the arguments in Seabron's 10 paper, of which there are many, but the most obvious of 11 which are, from a purely regulatory perspective in your 12 role as a regulator, that it creates -- it expressly 13 doesn't protect consumers in the way that the Act 14 contemplates. It would make consumers very -- put them 15 in a very difficult position in making a choice as to 16 whether to take a supply from a retailer anyway. 17 So I think that it doesn't achieve 18 what some people may think it does of essentially 19 encouraging people to switch in order to provide a 20 number of buyers in the retail market. 21 It has a distorting effect on the 22 development of wholesale competition, and it has not 23 much effect on promoting retail competition. 24 So for all the many reasons -- and 25 many of the arguments are highly interactive, it's a 26 matrix of arguments, if you will, a fixed price option 27 is considered a much better solution from the point of 28 view of delivering the objectives of the licences, 969 WOOLF/JENKINS/CEKSTERS 1 Bill 35, and ultimately back to the White Paper. 2 MS O'RILEY: So when you are thinking 3 about a fixed price, I take it, if you agree with 4 Mr. Adamson's paper, that it is not a uniform fixed 5 price across the province. 6 I'm just wondering what exactly you 7 mean by a "fixed price" or what exactly you would see 8 as being a fixed price, whether it is the equivalent of 9 something that is uniform and fixed; if it is an 10 equivalent to, I guess, in the current context of spot 11 market price that this gets passed through with part of 12 it being procured separately by a utility. I'm just 13 not quite sure I understand the mechanics of it. 14 MS WOOLF: Well, I think the 15 mechanics of it would be if you think about how the 16 price is derived is that the standard supply service 17 provider would go out into the market to produce the 18 market-based price, which I referred in the White 19 Paper. 20 The mechanics of that are quite 21 simple and no different, in a way, to any other 22 wholesale market in any commodity. There is a contract 23 market and a spot market on offer in Ontario, and the 24 skill of the provider is to go out and procure a 25 portfolio of contract. To the extent that he doesn't 26 have sufficient power coming in on those contracts, he 27 would buy out of the spot market, he would use 28 financial contracts to hedge the risk in the contract 970 WOOLF/JENKINS/CEKSTERS 1 market. So ultimately what he would have is a 2 portfolio of different sources of supply and different 3 contracts which deliver him power at a price that is 4 becoming as fixed as it can be, and then he is able, 5 obviously, to pass on that fixed price to the end 6 consumer, which is a lot better and a lot simpler for 7 people to manage. 8 MS O'RILEY: I was interested in the 9 reference to the PBR Handbook, and I agree with you 10 that there is a semi kind of methodology between the 11 approach that is taken in your -- I'm going to call it 12 a joint presentation and in the PBR Handbook. 13 One of the reasons that -- at least 14 in the initial stages of the PBR Handbook, it is also a 15 Board staff draft document -- 16 MS WOOLF: Indeed, I understand. 17 MS O'RILEY: -- says that they are 18 using a price cap mechanism rather than yardstick 19 measures was the difficulty in establishing benchmarks, 20 a lack of, I guess, real good information about the 21 distribution sector and about how it is going to 22 evolve. 23 I'm just wondering whether or not you 24 see a problem in establishing an official benchmark for 25 a regime in terms of generation price going forward? 26 MS WOOLF: It is a little bit unkind 27 of you to ask me questions on Seabron Adamson's paper 28 when he was here for over a day on this. 971 WOOLF/JENKINS/CEKSTERS 1 I can say, though, having read the 2 excellent Distribution Rate Handbook, that the Board 3 has my sympathy in implementing PBR for the first time 4 in Ontario, because it is very hard to get PBR up and 5 running quickly when you have actually never regulated 6 these utilities before, because PBR requires a great 7 deal of information, both on the parts of the regulated 8 utility and on the part of the regulator to make sure 9 that the right choices have been made. 10 So I'm not surprised that you find it 11 difficult in relation to PBR to get any comparatives or 12 yardstick measures going. 13 All I can say is, this is a rather 14 different kettle of fish because it is dealing with an 15 entirely different issue. So I think that whilst your 16 concerns in relation to PBR might be well founded, I 17 think that the work that Seabron said he thought could 18 be done really quite quickly would come up with some 19 yardstick measures which I think would be quite robust. 20 MS O'RILEY: Then we will adjourn 21 until Monday at 9:00 a.m. 22 MR. DADSON: Can I make one 23 administrative point? 24 MS O'RILEY: Sure. 25 MR. DADSON: This is a point that I 26 discussed with you, I guess yesterday, Ms O'Riley. 27 When Don Dewees was speaking, I think 28 on Tuesday or Wednesday of this week, he referred to a 972 WOOLF/JENKINS/CEKSTERS 1 paper which you referred to again filed by Enron during 2 the course of the MDC proceedings regarding the midwest 3 price spikes in the summer of 1998. 4 I would just point out that that 5 paper is on the Web site. My recollection is sort of 6 it does not address the impact of volatility on 7 customers. The topic of the paper is rather what 8 factors account for the price spikes in the summer 9 of 1998. 10 I haven't had time to go back to the 11 office, frankly, and locate the paper to make it 12 available, but I will endeavour to do that over the 13 weekend or on Monday and make copies available for the 14 Board. 15 MR. JENNINGS: If I can, the Web site 16 is the MDC Web site? 17 MR. DADSON: Yes. 18 MR. JENNINGS: It's closed, I 19 believe. 20 MR. DADSON: I will have to find it 21 in my files then. 22 MR. ADAMS: For the purposes of the 23 transcript, can I ask Mr. Power what the status is of 24 his motion? 25 MR. POWER: Yes. That is exactly 26 what I was hoping to address. 27 Unfortunately, due to the timing of 28 the break I didn't get down to finish it off, so what I 973 WOOLF/JENKINS/CEKSTERS 1 will do is have it faxed out Monday morning, at least 2 the Notice, and of course that will give us the weekend 3 to get the materials together. 4 So if that is acceptable to 5 everybody, that would be the timing of it. 6 MR. DADSON: One last thing. 7 Mr. Mia indicates that the MDC Web 8 site has moved to the IMO Web site. 9 MR. JENNINGS: I certainly haven't 10 been able to find most of the background papers at the 11 MDC Web site. It may be there, but I haven't found it 12 yet. 13 MS O'RILEY: I believe that we have 14 it on CD-ROM, so I will endeavour to dig that up. 15 Are there any other administrative 16 matters? 17 Thank you, Ms Woolf. 18 We can adjourn until Monday at 19 9:00 a.m. 20 --- Whereupon the hearing adjourned at 5:00 p.m., 21 to resume on Monday, July 19, 1999 at 9:00 a.m.