Bill 35 mandates that Toronto Hydro be converted into a business corporation, and it allows the city to earn a fair rate of return on its investment in Toronto Hydro starting in 2000. Exactly when in 2000 this will take place has not been stated clearly, and in view of all that must be done to carry out the reregulation of the industry under the banner of “introducing competition,” it will be quite an accomplishment if Toronto Hydro is able to start operating as planned at the start of 2001.(8) If Bill 35 is carried out as planned for Toronto Hydro in 2001, its rates will be determined by the Ontario Energy Board to provide the city a fair return on its capital, and its profit will be subject to a charge by the province that is equal to the combined provincial and federal income and other taxes. Carrying out these provisions of Bill 35 would result in a very large increase in the price Toronto Hydro charges for its distribution services.
The average capital of Toronto Hydro will be about $1,700 million, and it is likely to be represented by a capital structure with 65% debt and 35% equity.(9) The debt would carry an interest rate equal to a low A-rated bond, which at the present time is selling to yield about 6.80%. The return on equity set by the Ontario Energy Board is 9.88%, a rate that is not far different from the rate set for Enbridge Gas, and the provincial charge in lieu of taxes is set at 43.5%. Table II establishes that under these regulations and a capital of $1,700 million, Toronto Hydro would have a profit net of depreciation expense, but before interest and taxes of $179.2 million in 2001.
The price Toronto Hydro charges in 2001 under Bill 35 and city ownership would have to cover operating costs and depreciation as well as the above pre-tax return on capital. As shown in Table I, I estimate operating costs at about $143 million and depreciation at $111 million in 2001. Total revenue requirements would then be $433 million, and dividing that figure by estimated power consumption of 25,847 million kWh results in an average distribution charge of $1.676¢ per kWh. That would represent a 50 per cent rise over the 1.115¢ per kWh charge in 2000. The latter is about the charge that would prevail in 2001 in the absence of Bill 35.
In order to prevent a popular uproar over the electricity price increases that could result from this and other changes being proposed by the government, it persuaded Ontario Hydro to guarantee no change in its wholesale rates for energy for a number of years, and the municipal electric hydro companies are being discouraged from raising their rates by more than 10% in carrying out Bill 35. With the average price per kWh guaranteed by Ontario Power Generation (OPG, the successor to Ontario Hydro) to remain equal to the 6.34¢ charged in 1998, the average price per kWh charged by Toronto Hydro for electric power would rise from 7.46¢ in 2000 to 8.02¢ in 2001.(10) The rise is only 7.5 per cent, even though the distribution price rises by 50 per cent. How much the price will rise after the freeze on OPG and the restraint on Toronto Hydro are lifted remains to be seen.
The people of Toronto would not be worse off by the full amount of the price increase. In fact, some would argue that what people give up in higher prices as consumers of electricity, they gain in profits as owners of Toronto Hydro. That is not true. Of the $179.2 million in profit before interest and taxes earned by Toronto Hydro in 2001, only the $75.1 million in interest and a dividend of $39.2 can be paid out to the city.(11)
Most important, the income tax of $45.3 million in Table II is simply a new provincial tax on the consumption of electricity in Toronto that has been imposed in order to help pay for the fire sale liquidation of Ontario Hydro’s generating assets.(12) Federal legislation makes public corporations engaged in the electric power business free of federal taxation, so that Toronto Hydro has been free of both federal and provincial taxation. The provincial government has now imposed a tax on Toronto Hydro’s income equal to the combined federal and provincial rates. The City of Toronto should investigate what can be done to reverse this tax grab or return to a non-profit operation. If nothing can be done, the change in the status of Toronto Hydro mandated by Bill 35 can be expected to cost the people of Toronto an amount of money in higher prices for electricity that starts at $45.3 million in new taxes in 2001, and will grow with the passage of time. In addition, there will be the “profit tax” on the generation and transmission of electricity by the new provincial corporation, Ontario Power Generation.
However, once generation is privatized, the private and (for the most part) foreign owners will adopt accounting practices that avoid the taxes. The end result is that practically all of the $23.3 billion in stranded debt will either be paid off through higher prices paid by small consumers or added to provincial debt.
- To advise it on how to restructure the electric power industry, the government created a Market Design Committee in January 1998, which in turn employed Charles River Associates, a consulting firm in Cambridge, Massachusetts. Their work culminated in a Final Report on Jan. 29, 1999 that ran well over 1,000 pages in four volumes. The far more detailed regulations needed to create this “competitive unregulated market” are now being worked on. How it all will play out remains to be seen.
- This capital structure and other figures in Table II are taken from the Ontario Energy Board Electricity Distribution Handbook, March 9, 2000, p. 3-8.
- The 8.02¢ is the estimated 6.34¢ for power, plus the 1.68¢ for delivery. The province has fixed the price that OPG can charge for power in order to keep the public quiet, I have been told, while the groundwork is being laid for the privatization and deregulation of power generation. The changes mandated by Bill 35 with respect to generation are enormous and their long-run impact on the cost of electricity will be very costly. See my article, “Don’t Sell Hydro Short,” Policy Options, June 1999, 61-4.
- The estimated retained earnings of $19.6 million would not be enough to finance the excess of the investment budget over the depreciation expense. To cover the difference, the city would have to allow Toronto Hydro’s outside (real) debt to increase by relatively small amounts annually, or put part of its dividend back into Toronto Hydro.
- The Ontario Ministry of Finance has written the generating assets of Ontario Hydro down by $23.3 billion, from about $28.3 billion to $5.0 billion. The associated amount of debt, called stranded debt, is likely to fall on consumers of electricity. The implied value of all the nuclear generation is little more than zero.