There are a number of reasons why the cost and prices charged for distributing power would be much higher for a privatized Toronto Hydro than would be true under continued city ownership.
One is the higher overall rate of profit Toronto Hydro would be allowed to earn under private ownership. The Ontario Energy Board (OEB) has established the initial profitability of Toronto Hydro by determining its debt-equity ratio and the return on each source of funds. This method for determining profitability is called rate-base rate-of-return regulation. If it continued, Toronto Hydro under private or public ownership would come before the OEB periodically and ask for more favourable treatment in arriving at the rate base, the capital structure and allowed rate of return. You can be sure that a privatized Toronto Hydro would devote more resources, be more aggressive, and be more successful in obtaining higher rates from the OEB. The city would not consider it sensible to employ the high priced lawyers and consultants that private firms employ. Its pursuit of higher returns would be moderated by the knowledge that rates to its owners (voters) would be raised. This is the core public accountability issue that differentiates public and private ownership.
More troublesome is the fact that the OEB intends to follow the lead of a number of states in the U.S. and adopt Performance Based Regulation (PBR). It is widely advocated by private utilities, for reasons that don’t benefit small consumers. Under PBR, there is no regulation of the overall profitability of the utility. Instead, the prices that the utility charges are reduced annually by a predetermined fixed percentage that reflects the improved efficiency it is expected to achieve with average performance. That is fine, but the prices it charges are also raised annually as a consequence of events beyond the company’s control, events such as inflation and acts of god.(19) Hence, ignoring the cost increases due to events beyond the control of the utility, its customers profit under PBR by the scheduled annual reduction in rates. To the degree that the company is successful in improving performance beyond the predetermined rate, the company and the consumer frequently share the gain.
PBR is supposed to motivate great effort and superior performance by making it profitable to the utility. PBR is superior to rate-base rate-of-return regulation, it is argued, because the latter is a cost plus system that provides no incentive for efficiency. However, profits can be increased more easily under PBR by finding events beyond management control that increase costs, and by inflating the increase in costs due to these events.
Unfortunately, the distinction between events beyond management control and those within its control, and the cost consequences of either, are difficult to determine. Hence, we can be sure that a privatized Toronto Hydro will take advantage of every opportunity to increase the costs it is allowed to recover through increased rates to its customers. A privatized Toronto Hydro brings to this task greater resources and a greater profit motive than a city-owned Toronto Hydro, and it will meet with much greater success. A city-owned Toronto Hydro is more favourably disposed to spend money to improve performance than to raise rates.
Rate design is a second way in which a privatized Toronto Hydro can profit from raising rates to consumers. Toronto Hydro does not charge all customers one price per kWh. The charge for electricity includes a demand or access charge and a use charge; both of these charges vary among classes of customers and they vary depending on the level of demand or use and other considerations. The rate design could be more or less favourable to residential and small commercial users relative to industrial and large commercial users. In the U.S., where a large fraction of retail distribution is by municipally owned utility corporations, it has been found that their rate design is more favourable to small residential and commercial users than the rate design of private utilities. A privatized Toronto Hydro is likely to change the rate design over time to favour industrial and other large users of power, and that would raise rates to residential and small business consumers.
Foreign ownership is a third way in which a privatized Toronto Hydro would charge higher prices for electricity than a city owned Toronto Hydro. We can be sure that privatization would result in ownership by a large conglomerate sooner or later. In fact, the combination of NAFTA, which prohibits discrimination against foreign investors, and the city’s desire to get the best possible price in the sale make it likely that the sale would be directly to a foreign conglomerate, which would be far more difficult to regulate than a Canadian conglomerate.
As a subsidiary of a large corporation, foreign or Canadian, Toronto Hydro would be charged for services provided by its owners. The OEB would find it extremely difficult to determine whether these transfer prices are fair, and efforts in that direction incur the wrath of the large foreign corporations and their governments. The parent might even integrate the operation of Toronto Hydro with its unregulated energy-producing subsidiaries. The OEB would then have the impossible problem of determining the fairness of the transfer pricing of energy as well as services. Electricity prices are to be determined in an auction spot market by the newly created Independent Market Operator in combination with the buyers and sellers free to make the actual prices different by also trading in a futures market. The people who understand how these complex interdependent markets operate in tandem are few in number and they will find it very attractive to work for the conglomerates. In the case of a privatized Toronto Hydro, the conglomerate would own the unregulated seller of energy as well as the regulated energy buyer. The potential for abuse is enormous.(20)
- It is a judgement call whether, for example, the breakdown of a piece of equipment is in the normal course of business or an extraordinary event. The cost of repairing the equipment then involves an accounting allocation of costs.
- For more on what has proven to be the unfortunate consequence of deregulating the investor-owned utilities in the U.S., see Eugene P. Coyle, Price Discrimination, Electronic Redlining and Price Fixing in Deregulated Electric Power, American Public Power Association, Washington D.C., January 2000.