The Benefits of Alberta’s Deregulated Power Market

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All premiers have the best interest of the province and its people at heart. Each one believes in a different way to make Alberta the best it can be, and different doesn’t necessarily mean wrong. Today, changes are being made to Alberta’s electricity industry and we are seeing a tug-of-war between two very different ideologies.

On one side we have the vision of former Premier Ralph Klein who pushed for deregulation, created a positive business environment designed to encourage private sector investment, and made deep government cuts. On the other side is current Premier Rachel Notley, who supports stronger government role in determining how power should be generated, and is using tax dollars to subsidize the regulated utilities. How are these two different views reconciled?

One of the most widely misunderstood pieces of Alberta’s electricity market is what exactly occurred during de-regulation, and how it has affected the province. We are continually fielding comments and questions about how Ralph Klein sold off Alberta’s assets and ruined the power market.

This week, Deanna McArthur, Marketing and Communications Manager at Utility Network and Partners sat down with Evan Bahry, Executive Director of the Independent Power Producers Society of Alberta (IPPSA) and Nick Clark, one of the owners of Utility Network and Partners Inc., to hopefully shed some light on the subject and clear up some of the common misconceptions that exist.

Alberta’s Electricity Market – The Basics

Most Canadian jurisdictions have regulated power monopolies; meaning that power is generated and distributed by a Crown Corporation (examples include BC Hydro, SaskPower, Manitoba Hydro, or Hydro Quebec).

Alberta’s history is different. Alberta has always had private companies produce and distribute power. In the past, these companies were regulated; where projects were approved by regulators and their costs were then allocated to consumers. First Misconception: The government never owned the generation plants and Klein didn’t sell the generation plants off. Generation has always been privately owned.

Almost 20 years ago, Alberta deregulated the generation and retailing of electricity in the province. This was done to create price competition between generators, create retail choice for consumers, and to shift investment risk from consumers to generators.

“I remember the early days of deregulation,” said Clark. “Until the kinks were worked out of the experiment, the de-regulated market was like a roller coaster. Prices soared, consumers had to deal with billing errors and retail contracts that locked them in for years at a time. Many called de-regulation a failure.”

However, things improved dramatically. Private investors put $20 Billion into Alberta as new generation facilities were built. Consumers were given a choice of retail options and competitive retailers are now offering no-penalty contracts, new services, and long term guaranteed energy prices. Additionally, the wholesale cost of energy over the last few years has been the lowest in North America. The market stabilized. It is well functioning and Alberta was a great place to invest into.

Today, on the other side of the ‘tug of war’ we are now facing major policy changes which, some feel, are having a negative effect on Alberta’s power market and investment climate.

In a presentation to IPPSA members in June of this year, Aaron Engen, BMO Managing Director of Investment & Corporate Banking and Co-Head, Power & Energy Infrastructure, touched on a number of items related to this topic.

In his presentation he stated that capital spending in Alberta is winding down and there is a common theme in Alberta’s electricity sector as global investors are taking a “wait and see” approach. He mentioned that there is investment interest but the rules in the Alberta market are uncertain, there is a fear of stranded assets at risk, and the government’s handling of coal generation under the NDP Climate Leadership Plan sets a worrisome precedent.

Additionally, Engen mentioned that proposed new rules may limit investment interest as Alberta’s capacity market (covered in more detail below) is not for every investor/developer.

“Consumers should be concerned because the changes to the market will increase the cost of energy in the province,” said Clark

“The bottom line and complexities of the Alberta market are far more intricate than our government leaders are painting. Politicians are marginalizing the significance of what is happening. What is going to happen to the billions of dollars in proposed subsidies, financed out of the carbon tax, if there is a change in government, like what happened in Ontario?”

With that said, stakeholders have invested the last 15 months in working on a design with the intent of making it work to attract new supply and achieve the Climate Leadership Plan, according to Bahry.

“There are more details to be made clear, but generators are invested in working with the AESO to build a successful capacity market,” said Bahry.

But, Clark feels Alberta isn’t as attractive of a market to invest into right now as it once was, and says there are a few examples in Alberta that make his point.

“ATCO will open its next generation plant, not in Alberta, but in Mexico. Direct Energy recently sold off its natural gas holdings in Alberta to a consortium in China, and it is rumoured that ENMAX will follow the same path as EPCOR who invested in utilities in the United States. Money and jobs are leaving Alberta,” said Clark.

To Regulate, or Not to Regulate… That is the Question

Were consumers better off under deregulation? The cost of energy fell, customers were given the choice of retailing options, and billions were invested by the private sector into Alberta.

“Some consumers complain that their utility bill has gone up since deregulation,” says Clark. “The truth is that delivery charges increased. This portion of the bill is still regulated by the government. Only the generation and retailing part of the system was deregulated and for the last few years, electricity prices were at an all time low.”

Unfortunately, a lot of people still don’t understand Alberta’s deregulated market. Let’s start with trying to demystify it. To make this a bit easier to digest, lets think of Alberta’s power market like the airline industry.

In the airline industry you have airlines, airports, the airport authority, and travel agents. In comparison, in the electricity industry you have generators, wires companies, the systems operator (AESO), and retailers.

Airlines (Power Generators): this is a competitive business, where power producers (like airlines) compete to serve customers. They buy the equipment (plans or power plants) at their risk and the price is set by the open market. The price they charge is shaped by the downward pressure of competition.

Airport (Distribution and Transmission System): all airlines use common carrier facilities like airports, just like generators use common wires systems to distribute and transmit power across the province. Just like you wouldn’t want separate airports built for each airline, you wouldn’t want a new set of transmission lines built for each power generator.

Airport Authority (the Alberta Electric Systems Operator): All of the above is facilitated by the airport authority (AESO) which plans expansion of the airport (expansion of the transmission system) and tells planes when they can fly (dispatches generators produce power). If the airport needs to expand, the fees incurred are flowed through to consumers in their ticket costs, just as distribution and transmission fees are on your utility bill.

Travel Agent (Energy Retailers): travel agents sell goods (flights or energy) to consumers and often bundle their offerings together with hotels or rental cars (green energy or other services) to entice consumers to buy.

In a competitive market, the investor bears the risk of its investment. If the airline does not provide good service, no one will fly with them, its profits are likely to take a hit, and, eventually it will go out of business.

In a regulated market, consumers bear the risk of the investment. If the airline does not provide good service, the airline can still charge consumers for the bad service, and they stay in business. The consumer has no choice.

“If a generator bears the risk of investment, you can bet that the generator will be operating in the most efficient way possible,” said Bahry. “And the competitive pressure in a deregulated market means the efficiencies are passed on to consumers.”

At the time of de-regulation, Alberta was growing, which meant power demand was increasing. About $20 billion was subsequently invested over the last 20 years by the private sector in building a fleet of generation facilities to meet this demand.

This is unlike other provinces who financed the building of generation plants, which added the cost to the provincial debt and where consumers saw rates ‘pancake’ as each new plant’s costs were added to consumers’ bills. In Alberta, oversupply has meant that prices have come down.

“Alberta’s open market has attracted sufficient supply to meet one of the fastest growing demands for power in North America,” said Bahry. “If you look at other areas of the province such as roads, healthcare, and education, we are behind, we are playing catch up. This was largely because of the flexibility of the deregulated market, which allowed generators to build facilities across the province.”

Moving to an Open Market – The PPAs

Before deregulation there were three power utilities, TransAlta, ATCO, and Edmonton Power (now Capital Power). At the time, the government needed to mitigate the market power that each of these companies had, but the government didn’t want to force these companies to divest their generation assets.

Instead, they opted for a virtual divestiture, in which Power Purchase Agreements (PPA) for each generating plant in the province was created and then sold at auction.

Each PPA had a different cost, which included all aspects of running and maintaining these assets from 2001 to 2020. The PPAs were designed to keep the generators who owned the assets whole until 2020.

The PPAs were taken to auction, where the companies could not bid on their own PPAs, but could bid on others. The generators were obligated to produce power for the buyer of their PPA for the entire term.

Example: Say the cost of a PPA was set at $30/MWh. A buyer thinks that the market price for power over the term of the PPA will average about $40/MWh. In the auction the buyer bids $35/MWh for the PPA to ensure they make a profit on the purchase.

The difference between the PPA cost ($30/MWh) and the price paid ($35/MWh) was considered “residual value” and given back to consumers through a government agency called the Balancing Pool. The PPAs of a number of plants were not sold during the auction, and were managed by the Balancing Pool. The profits from these PPAs were also given back to consumers, which would have shown up on a consumer’s bill in the form of a credit each month. The sale of the PPAs has generated some $2.8 billion in residual value for Alberta power consumers since 2001.

“Overall the Power Purchase Agreements enabled new generators to enter the market, and created investor confidence,” said Bahry. “We have gone from having three utilities, to over 40 suppliers and 200 market participants in Alberta.”

In order to provide certainty to buyers of the PPAs, a provision was included that stated if the government changed the laws in a way that impacted the economics of the PPAs, the buyers would be able to back out of them.

This scenario became a reality when in 2015, Alberta entered a recession and power rates plunged to two-decade lows, making the agreements unprofitable. This loss would have remained the responsibility of the companies who had purchased the PPAs, but when the increase to the provincial carbon levy was announced, this made the PPAs “more unprofitable” which gave a number of buyers an out of their agreements.

The NDP government of today claimed they were not aware of the clause, and that it was illegal. They in turn launched a lawsuit to attempt to have it overturned, forcing the companies to live with the contracts for the 20-year duration rather than dropping out four years early. In the end, in all cases the PPA terminations were accepted by Alberta and the money losing PPAs of these buyers were turned over to the Balancing Pool.

According to the 2017 provincial budget, the Balancing Pool (aka the government) will borrow $2.35 billion to cover the cost of the PPAs. The money will be paid back by electricity consumers, through a monthly surcharge on their bills for the next decade.

“This would never have happened if the government didn’t try to tinker with the market contracts,” said Clark. “Mismanagement needlessly cost Alberta consumers over $2 billion in penalties and the cost of electricity has doubled compared to what it was last year.”

Opening the Doors for Competitive Retailers

Deregulation opened the door for a number of things. Companies like UTILITYnet were able to expand their business in Alberta. They launched their Energy Marketer program, which has helped incubate over 20 local companies like NewGen Energy that offer competitive rates for electricity, natural gas, and green energy. This group of companies is now known as The People’s Utility.

Just as Bahry stated earlier, competition works. Today, competitive retailers like NewGen Energy are offering rates lower than the government regulated rate cap of 6.8 cents/kWh, guaranteed out as far as 2024. Not only has a competitive market helped keep prices low, but it has bore a number of customer centric programs and services offered by retailers trying to win over consumers.

“Competitive markets are the way that most of our basic human needs such as food, shelter, and clothing are provided,” said Bahry. “Competition ensures these needs are met through the lowest cost possible.”

More Changes on the Horizon

As if the electricity market wasn’t already complex enough, in the coming years we will have another layer to peel back and understand. The introduction of a Capacity Market.

Alberta is one of a few jurisdictions globally that uses an “energy only” market. In an energy only market, electricity prices are based on supply and demand. Generators are only paid for the electricity they generate and sell to the market.

In an energy only market, it is up to supply and demand to send price signals to encourage new investment. Alberta will need up to an estimated $25 billion of new investment in electricity generation by 2030 to support the governments transition toward 30% of Alberta’s electricity generation to come from renewable sources by 2030.

The way to encourage new generation to be built in light of the coal retirement policy and renewables addition policy is to create a capacity market. The government has said that a Capacity Market will ensure that the AESO will have enough capacity available when it is needed. In essence, this is capacity signaled in advance so that new generation can be built for when it’s needed.

Capacity market revenue is to combine with energy market revenue and to enable generators to recover both their fixed and their variable costs. Performance penalties are designed to ensure that the supply that’s being paid for is in fact there when it’s needed.

If we continue with my airplane analogy from earlier, think of it as booking a flight ahead of your travel date. You know you want to go, the air traffic controller (AESO) assumes the demand will be there in the future and you book and pay for your seat ahead of time.

In a Capacity Market, consumers will be charged both capacity and energy market costs and capacity market costs will represent a new floor of electricity costs for consumers, since they will continually be paying for capacity.

The tug-of-war in Alberta’s electricity market continues. To ensure consumers are not negatively affected by the changes, it will be essential to find some middle ground with a good balance between the two ideologies.

It is expected that the transition to a capacity market in Alberta will be operational in 2021. Only time will tell how the transition to a Capacity Market will truly affect Albertans and if the Carbon Tax will be repealed or expanded.