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June 28, 2021

Ontario’s electricity sector has struggled with rising system costs for more than a decade. The main solution governments of all stripes have come up with is to shift costs to taxpayers. These subsidies for electricity use now cost taxpayers more than what the province spends on long-term care. It’s time for some proper fixes.

The crux of the problem is the increase in the cost of electricity supply from high-cost contracts signed by the province. At the same time, Ontario has consumed less electricity than forecast by the government when it struck the contracts. With high fixed costs in contracts spread over less demand, the result has been upward pressure on prices, mitigated mainly by your tax dollars.

How can Ontario remedy this? We need to cut costs in the system.

The first way to do so is to create the right price incentives. Consumers should reduce consumption when demand is highest. When we reduce the need for costly peak-period production, we cut system costs. Today’s pricing system does not give consumers the right signals as to when to reduce demand when it costs the most to produce it. How we create the right price signals depends on the type of customer.

Residential customers and small businesses pay regulated energy rates. Most are familiar with the time-of-use system. That system does not reflect system costs very well any more. The province should give them an option of paying a lower price – most of the time outside extreme peak demand hours. Those who take that lower-price option would need to cede some control to the system operator through smart devices to, for example, slightly reduce their air conditioning use or electric-vehicle charging during demand extremes.

Ontario should replace the industrial electricity pricing structure. Its byzantine system encourages companies to shut down their production at various times – not necessarily the highest-cost periods – over the summer to save money. That is not a smart way to save electricity. Instead, we should use a market-based “interruptible rate”; the electricity system operator should determine the rewards for interruptions of supply during extreme peak demand hours.

For medium-sized business customers, most of their bill is charged at an unpredictable price at the end of the month. They pay the same per-kilowatt-hour amount for most of their electricity cost regardless of whether they used power at the peak of demand or in the trough. The province should instead set the full cost of energy prices on an hourly basis, charged at lower rates during off-peak times. That would encourage price-sensitive businesses to push production to early mornings. They would avoid high-use, high-system-price afternoons and evenings. This would save them money, and the system as whole.

The second way to cut costs is to make the companies producing and delivering electricity find savings, too. That starts with regulation of the power procurement process. The previous Ontario government had a hands-on approach to energy procurement. They did not focus on costs, whereas a regulator, free from political considerations, would. Other provinces saw similar cost debacles such as Site C in British Columbia or Muskrat Falls in Newfoundland and Labrador, when regulators were sidelined.

Governments often make choices based on a broad set of criteria in their policy goals. Legislation is the right forum for socio-economic goals. Implementation should then be left to independent agencies. That should leave regulators with the sole priority of seeking low-cost options.

There have been savings in parts of the electricity system. Look at what Hydro One has done since its 2015 part sale. Since privatization, Hydro One has lowered its annual cost for each customer by $90. They did this by reducing back-office costs.

Other local distribution companies can emulate those savings. The province should allow cities to bring in outside investors to find savings. That would also unlock value for municipal taxpayers.

Once we find these savings, the province should reduce rate subsidies. Subsidies have climbed to $6.5-billion in the budget for the 2021-22 fiscal year. That same budget proposed to spend $5.8-billion in taxpayer dollars on long-term care. That seems misaligned to society’s priorities these days.

These subsidies were the only quick way to address the existing problem of high-cost contracts. But it is time to turn the corner on these subsidies. Starting in 2021, a large share of the taxpayer support will cover the cost of contracts the previous government signed to purchase low-emissions electricity. Subsidies over and above this amount have little economic justification. The province should phase them out. It has a few ways to reduce this subsidy in a politically palatable way. One is to make subsidies means-tested. Another is to limit subsidies up to a certain amount of consumption.

Electricity prices have long been the third rail of Ontario electoral politics. Taxpayer supports for the sector may be one day, too. But with smart reforms, the province can address these problems first.

Benjamin Dachis is Director of Public Affairs for the C.D. Howe Institute, where Joel Balyk is a researcher.