The electricity industry's wildfire deregulation
The deregulation of the electricity industry worldwide is the largest ever, announces Sam Kanes, senior analyst with Scotia Capital Markets in Toronto. The process is already well under way in various northern European countries, in Australia and New Zealand, and in the US. Now Ontario and Alberta are spearheading it in Canada.
Electricity deregulation follows on the heels of the gas and telecoms industries, but it promises to be more significant than either of these. This industry is larger than gas and telecoms combined, in Canada accounting for C$27 bn in annual revenue. While electricity has long been considered a natural monopoly because of the importance of maintaining supply and because the necessary infrastructure is so costly, new ways of generating power on a much smaller scale are now beginning to call into question the rationale for state-owned monopolies.
In the US, only retail electricity sales are controlled by each state, but Canadian electricity deregulation is almost entirely a provincial issue. Alberta and Ontario have moved to open the electricity market, though other provinces, especially those with abundant, cheap hydroelectric power, may continue to have electric monopolies for some time.
'Canada has the luck of having abundant water-based power,' says Kanes, explaining this keeps the cost structure lower. Still, deregulation in Ontario and Alberta will certainly attract US competitors.
Alberta started deregulating in 1996 with a 20-year plan that includes opening up retail sales in January 2001. Accepting the need to make some major changes, provincial utility TransAlta recently decided to sell off its retail assets, concluding a deal subject to regulatory approval with UtiliCorp of Kansas City, Missouri. TSE-listed TransAlta will concentrate on power production, both in Alberta and in the US where it has already bought a large capacity plant in Washington state.
Meanwhile, financing new power companies is where investor relations will come into play. Stonebridge Financial Corporation and Probyn & Company have set up their 'small power funding program' because they believe that the small power sector in Canada will be a growth market. The program is currently providing equity and debt to energy and power projects in the $1-20 mn range, with results already shown by small alternative power companies which are poised to compete even without a production tax credit like that in the US.
Canadian Hydro Developers is an independent power producer specializing in 'run-of-river' hydroelectric plants. 'We are able to divert water from a river, through a power plant, and back into the river without a dam,' explains company president John Keating. The company has built nine plants and is poised for growth under deregulation in both Alberta and Ontario. A big part of Canadian Hydro's IR story is that they're 'not just a feel-good investment', says Keating. The company is on record for 'a decade of environmentally sound and financially sensible initiatives.'
Another example of alternative power is Vision Quest Windelectric, which launched a wind-powered plant in 1997 in Alberta. Vision Quest did not simply want to watch deregulation unfold; it wanted to play in the game. 'One of the things that deregulation is about,' explains executive director Jason Edworthy, 'is customer choice.' The old electricity model meant customers just wanted lower costs, but deregulation means they have other criteria to consider. Edworthy calls Vision Quest's wind-electric power a 'premium product'. 'We claim ownership of emissions reductions and we transfer that ownership to our customers,' says Edworthy. So Vision Quest sees an opportunity in the coming retail deregulation in Alberta, when customers will be free to choose their electricity suppliers. The company also has plans for Ontario, with one site already picked out for a wind plant and more exploration underway. Though Vision Quest is a limited private company with no active program to attract investors, it has helped back its development by the issuance of flow-through shares.
In contrast to Alberta, Ontario seems to be deregulating its electricity industry almost overnight. In 1997, shortly after the embarrassment of Ontario Hydro about the state of its nuclear facilities, the provincial government produced a white paper on the industry and the 'unbundling' of Ontario's electricity monopoly began. Over 250 municipal electrical utilities (MEUs) became property of their municipalities, with the rest of Ontario Hydro replaced by five successor companies in April 1999. The two biggest are Ontario Power Generation (OPG), which runs the province's 80 remaining power stations, and Ontario Hydro Services Company (OHSC), responsible for the transmission grid.
Under the original plan, OPG must 'decontrol' its Ontario market share from 86 percent down to 65 percent by 2004 and finally to less than 35 percent by 2010. But events are racing ahead of schedule, with the power generation market slated to open up in November - three years early. TransAlta is already building a plant in Sarnia, Ontario, and plans were recently announced by US-based Sithe Energies to build two plants in Mississauga and Brampton. Bob Culliver of Stonebridge Financial reports that the small power funding program is already going strong in Ontario, but he admits that companies will not take too much risk until the rules are clear.
OPG, which has a capitalization of $8.5 bn, doesn't plan to shrink, even as it partly pulls out of generation in Ontario. It wants to remain a major player in the province and a competitive exporter to New York and Michigan. Indeed, with Ontario opening up to wholesale and retail access for US companies after November, OPG's path to the US is clear. This is where the capital raised from the sale of assets comes in. It can be used to build new plants outside of Ontario, perhaps in the American midwest where electricity prices have skyrocketed over the last two summers. Swapping plants would be another way of expanding OPG's horizons.
OHSC, a commercial company now like OPG, also has new opportunities. Not restricted to transmission, it's bidding to acquire MEUs which it can get at a 33 percent discount because it's also helping recover Ontario Hydro's $26 bn debt under the terms of the break-up. However, OHSC faces formidable competition in US companies like UtiliCorp and American Electric Power. Canada's Westcoast Power and Enbridge are also interested in MEUs. 'There is profit in the wires business, within the regulated structure,' explains Westcoast Power's investor relations manager, Tom Merinski. 'It resembles the old utility model, giving a steady return - and there's also a performance-based component.' But for Westcoast energy, acquisition price is key. 'We don't want to overpay,' says Merinski.
Gaining ownership of an MEU can also position a company to be a retail supplier in that area. Westcoast Energy and Enbridge are in the market already with their gas subsidiaries, Union Gas and Consumers Gas respectively. 'Ontario is a market that we know and a place where we already do business,' says Merinski. ' To explore some potential synergies makes pretty good sense.'
Both Westcoast Energy and Enbridge intend to be 'one-stop energy suppliers', delivering both gas and electricity. There is a potential to layer in other products as well, like metering for managing consumption. OHSC is considering selling electronic security systems, air-conditioning and portable generators as part of its retail package.
Clearly electricity deregulation in Canada is creating opportunities for many public companies in both power generation and retail distribution. But these opportunities come with risk, and not all players will succeed. Consolidation followed the deregulation of the gas industry, and now some of the most successful gas companies are expanding into the electricity industry. This tends to support the conviction, as expressed by Ontario Power Generation CEO Ron Osborne in his speech to the Canadian Club in February, that 'size matters in the electricity business.'
After a year on their own, OPG and OHSC have yet to issue new debt though both have IROs preparing for the day when they will be publicly traded - a day that may come sooner than anyone expected. At the end of March, the Ontario government was busy deciding which Bay Street biggies would preside over the divestment of Ontario Hydro's successor companies, which should mean IPOs or simply auctioning companies off to corporate buyers within a year. In the meantime, the IROs are busy securing credit ratings for future debt issuance and making plans for online annual reports - 'Scoping out all the IR responsibilities,' as one insider puts it. 'We have to crawl before we can walk and finally run.'
However the opening of competition in electricity proceeds, it will affect more than the companies directly involved. There are so many industries dependent on electric utilities, including the high-tech industry which receives so much more attention. 'Try to turn a computer on without a plug in the wall,' concludes Kanes.