• The creation of competitive wholesale and retail markets for electricity that opened May 2002; and

• The breakup of Ontario Hydro into five successor entities (companies) on April 1, 1999; namely:

  • Ontario Power Generation (OPG) Inc. for electricity generation (wholly owned by the Province);

  • Hydro One for wholesale power transmission and retail distribution (owned by the Province);

  • The Electrical Safety Authority (ESA) for electrical inspection (agency of the Province)

  • The Independent Electricity System Operator (agency of the Province) to manage the power grid and the wholesale electricity market.  IESO** is a not-for-profit, non-taxable corporation that in 2007 was also designated by regulation as the Smart Metering Entity (SME) pursuant to the Electricity Act, 1998; and

  • The Ontario Electricity Financial Corporation (agency of the Province) to manage the legacy debt and other liabilities not transferred from Ontario Hydro to successor companies.  This entity and the matter of stranded debt is the focus of this article.

**Foot note: Pursuant to provincial legislation in July 2014 amending the Electricity Act, 1998, the IESO and the Ontario Power Authority (OPA) were amalgamated and continue as the IESO effective January 1, 2015.  Among the objectives of the OPA was (is) to forecast electricity demand and adequacy & reliability of electricity resources, planning for electricity generation, and promoting the use of cleaner energy sources and electricity conservation. The OPA was first established 10 years earlier pursuant to the Electricity Restructuring Act, 2004.  All to say, the hydro system has been undergoing a series of changes over the past 15 years.

Table 1 – Financial impact of restructuring - stranded debt ($ billion)

Sources:  2014 OEFC Annual Report, 2011 Report of the Auditor General of Ontario as based on Ministry of Finance data.

1. The estimated present value of future “payments in lieu of taxes” (PIL) from electricity sector companies (OPG and Hydro One and municipal electrical utilities);
   

2. The estimated present value of “cumulative annual combined profits” of OPG and Hydro One (owned by the Province) in excess of $520 million a year (being the then annual interest cost of the government’s  investment in the two companies); and

3. The Debt Retirement Charge to cover the “residual stranded debt” – being the initial stranded debt remaining after deducting the total estimated value of the two above future revenue streams (i.e. $20.9B minus $13.1B = $7.8B starting residual stranded debt).  More on this later.

Chart 1- History of Residual Stranded Debt & Unfunded Liability of OEFC

Source:  OEFC data and annual reports

Note that what is called initial stranded debt ($20.9B) at April 1, 1999 becomes “unfunded liability” at March 31, 2000 as reported by the OEFC.  

Table 2:  Changes in OEFC liabilities from March 2000 to 2014    In $ billion

Source:  OEFC financial statements

Notes:

1. Debt is comprised of amounts maturing anywhere from 1 to 50 years out and are repayable in various currencies.  In 2014 the effective rate of interest on the debt was 5.47% (compared to 8.29% in 2000).

2. Power purchase contracts and support agreements were inherited by OEFC from Ontario Hydro as were entered into with Non-Utility Generators (NUGs).  Contracts provide for the purchase of power from NUGs in excess of future market price.  The contracts expire on various dates out to 2048.  Accordingly, a liability was recorded on April 1, 1999 of $4.3 billion on a discounted cash-flow basis when the former Ontario Hydro continued as the OEFC.  Subsequently, under the Electricity Restructuring Ac, 2004, the OEFC began receiving actual contract prices for power from electricity consumers and no longer incurs losses on these contracts.  As a result, the bulk of the liability would be eliminated  and is being amortized to revenue over 12 years (see Table 3 and subsequent analysis).

3. Nuclear risk funding represent a liability arising from nuclear waste management and asset removal.

4. As established by the stranded debt retirement plan, the Province committed to dedicate the cumulative combined income of OPG and Hydro One in excess of the Province’s interest cost of its investment in its electricity subsidiaries.  The Province recoups all interest on its investments before any income can be recognized by OEFC. The $3.9 billion represents the cumulative amount due from the Province each year after deducting the Province’s $520 million interest cost of its investment in OPG and Hydro One.

5. Readers are encouraged to view OEFC annual reports (available on line) to get more information.

Some things to observe from Table 2:

• Who holds the stranded debt has shifted.  Most of the stranded debt is now held by – owed to - the Province. The Province holds about $19.1 billion in debt instruments or about 70% of total OEFC liabilities. The rest ($7 billion) is guaranteed by the Province.

• There has been more in debt turnover than retirement – unless you consider replacement of debt to be a retirement. The Province has, in effect, replaced half the debt held by others.  In 2000, Provincial debt represented 1/3 of total stranded debt.  In 2014 it accounted for over 2/3 and the Province still guarantees the debt held by others.  More interest revenue for the Province.

• Total debt is reduced by a reported $5.2 billion over fifteen years with a further reduction in other liabilities of $6.3 billion coming from reduction in power purchase contract liabilities and the nuclear risk funding liability.  The reduction in power purchase contract liabilities arises from changes in legislation (as per note 2 above) and not from debt payment as such.

In conjunction with the Ontario Financing Authority (OFA), the OEFC has renewed/replaced debt as they came due.  Total debt as such has not reduced substantially over the past fifteen years.  Interestingly, the total long term debt of the OEFC of $26.1 billion as of March 2014 is almost the same as the long term debt of the old Ontario Hydro as it was in March 1999 ($27.7 billion).  Seems not much is retired in regard to “debt” per se.  See next section on where the money went.

However, the unfunded liability of OEFC has dropped by half (from about $20 billion to $10 billion).  On one hand this is good news, on the other maybe another 15 years to go – making a 30 year time horizon for dealing with the financial fall out of hydro restructuring.  

The OFA (also an agency of the Province) manages the Province’s debt and borrowing program.  The total debt portfolio of the Province is in the order of $314.5 billion.  The OEFC has no employees. It is OFA staff doing the work. The Chief Executive Officer (CEO) of OFA and OEFC are one and the same person for the past fifteen years. The Chairmen of the Board of Directors of both entities is currently also one and the same, but other members of each of the two governing Boards differ as between the OFA and the OEFC.  

What happens in the end – what is the bottom line?  Well it depends on how you look at it and how far you track the numbers.    

Each year, OEFC financial results are assimilated into provincial accounts on a line by line basis when the OEFC accounts are consolidated into Provincial financial statements (Public Accounts).  So it all comes out in the wash when reporting Provincial annual deficit and accumulated deficit.  At the end of the process DRC pops out as “non-tax revenue” for the Province.    

I do not know what happens to the rest of the numbers. Wouldn’t it be magic though if amounts offset each other and the net effect on the accumulated deficit of the Province is a virtual zero—except for debt owed to external parties.  But, I speculate.

How has Debt Retirement Charge money been used?  

To get at this question, one has to appreciate that the OEFC engages in a number of activities beyond retiring stranded debt.  Its mandate and activities include:   

• Managing the stranded debt portfolio.

• Managing power supply contracts and related loan agreements.

• Risk managing debt and derivative financial instruments.

• Supporting the implementation of the Government’s electricity policies.  The OEFC supports the Industrial Electricity Incentive (IEI) program by providing payments to the Ontario Power Authority (OPA) to offset the cost of the DRC portion of the electricity bill paid to OEFC on IEI-eligible incremental consumption by IEI participants.  This is designed to be cost-neutral for the OEFC.  So the DRC is being compensated for some power users.  It is not clear just how this works and how much is relieved to IEI participants.

• Providing financial assistance to successor corporations and supporting new electricity supply projects.  For example, providing the Ontario Power Generation (OPG) with financing for new generation project developments in the form of 10-year and 30 year notes, providing for up to $1.6 billion in loans for the Niagara tunnel project, providing up to $700 million in support of OPG’s investment in the Lower Mattagami project, and providing OPG a credit facility for up to $500 million expiring on December 31, 2014 for general corporate requirements including the Darlington refurbishment project.

• Refinancing and sometimes increasing notes receivable including, for example, those with the Independent Electricity System Operator (IESO).

In an attempt to show how the DRC has been used, Table 3 shows the total revenues and expenses of the OEFC over the same fifteen year period as Table 2.

Table 3 –A summary of OEFC Revenues & Expenses – 2000 to 2014 in $ million

Source:  OEFC table - not audited

A few things to note from Table 3 along with other information: 

• DRC revenue is comingled with other revenues for the OEFC to use in meeting all its mandate.  As with other revenue streams, the DRC is not set aside to service or pay any debt in particular.  The DRC is a contribution to a pot.

• Debt retirement related revenue has not kept pace with debt related servicing costs. The DRC revenue ($11.5 billion) plus other dedicated revenue ($13.5 billion) intended for retiring stranded debt total $25 billion.  This does not cover debt interest expense ($28.2 billion) plus debt guarantee fee ($2.1 billion) and the nuclear liability interest ($0.9 billion) – expenses totalling $31 billion for servicing debt.  So if we were speaking debt repayment in ordinary terms (principal and interest), no amount of principal would be paid down. If not for other revenues there would be no reduction in the unfunded liability of the OEFC.

• There is money moving from left to right pockets in terms of the Province both receiving and paying interest on amounts due from and to itself.

• As the result of legislative reform in 2004 to the electricity market, the liability for estimated future losses ($4.3 billion) on power purchase contracts as inherited from old Ontario Hydro is now being amortized by the OEFC as revenue over a 12 year period since losses are no longer incurred on power purchase contracts.  This is reflected in the $3.6 billion of net reduction in power purchase contracts as reported as revenue by the OEFC.

• In regard to power supply contract costs ($14.9 billion) and recoveries ($14.2 billion) since 2000.  The 2004 legislation (Electricity Restructuring Act) shifted the burden of power purchase contract losses from the OEFC to hydro ratepayers.  Previously, the OEFC purchased power from the NUGs and sold the power at market prices lower than cost, thus incurring losses.  Starting in January 2005, the OEFC began receiving actual contract prices for power from ratepayers thus eliminating losses going forward on power purchase contracts.  Power supply contract recoveries have doubled for the OEFC when they averaged about $600 million a year to 2005 and now at about $1.3 billion a year.

• The same Act also resulted in a combination of regulated and competitive electricity sector pricing with different generators receiving prices set through a variety of mechanisms.  Electricity pricing is complicated with consumers paying a blend of costs including pass-through of regulated prices for OPG’s regulated plants, the full costs for existing and new contracts for generation, and spot market prices for other generation facilities.  This no doubt a complex a variable pricing structure.

Considering the foregoing and seeing the total long term debt of OEFC is almost the same as it was for the old Ontario Hydro fifteen years ago….it seems not much has changed regarding debt proper.  Debt as such is still largely with us.  The change is more about other liabilities and other revenue and expense streams – in particular regarding power purchase contract obligations and the flow of interest in and out.  

Coincidently, it is interesting to note that in its final report of 1999 the old Ontario Hydro commented (on page 42) that estimates of stranded debt were “preliminary” and the actual stranded debt would be known once a final determination can be made for other items; principally valuing power purchase obligations”.  Whether such a final determination was made I am not certain.  What is clear is that subsequent legislative changes in 2004 began eliminating losses on power purchase contracts and the burden going forward shifted to ratepayers. Some other form of liability reduction charge has been instituted.  Just how this works I do not know.  

In the end analysis, there is no clear answer as to where DRC money went in particular. DRC is revenue for the Province and no particular or specific debt repayment is obvious except to say in “Toto” debt proper of the OEFC has reduced by about $5 billion since 1999 and its net unfunded liability (including debt) reduced by $10 billion (about half).  

Interestingly, while there is regulation setting out how residual stranded debt (RSD) is to be calculated and how the RSD value is to be published each year, there appears to be nothing requiring the Minister to periodically state publicly what the value of the stranded debt is at any particular time.  One could presume or assume this would be the “unfunded liability” of the OEFC as shown in Tables 2 and 3 previous.  

Permanently retiring outstanding stranded debt of $26 billion would entail liquidating assets of the OEFC and covering any shortfall.  Doing so would be a major policy decision and no doubt not a simple endeavour.  I wonder if anyone has assessed the option of “calling it a day” on stranded debt?  

The DRC helps defray costs and reduce unfunded liabilities of the OEFC – much of which is debt owed to the Province.  One could view this as debt owed to the people of Ontario in common that is being paid back or carried by the people of Ontario as hydro users directly or indirectly as consumers of goods and services or as investors in business.  

There is good news.  As proposed in the May 2014 Provincial budget the DRC may come to an end for residential hydro users after December 2015 – saving a typical homeowner about $70 a year.  However, it is expected to continue for non-residential users until the end of 2018 when the RSD is anticipated to be “retired” in full.  This could change if the RSD spikes north as it did in 2004, especially if the economy goes south.  Stay tuned and keep your fingers crossed especially since the latest news is about economic downturn.  

All so far illustrates the consequences of government decisions are often not known until long after the decisions are made and those who made them are long gone.  At the same time we live the consequences of past decisions and need to learn from the past.

Why HST on DRC?   

A final question.  Ok, if debt is being paid, why do we pay HST on the DRC?   By rough estimation, hydro consumers have paid about $1.5 billion in sales taxes on top of $11.5 billion in DRC; a total of $13 billion.  

The Canadian Revenue Agency sent information to explain.  Apparently I am the first person in ten years to ask. It comes down to “based on the application of subsection 154(2) of the Excise Tax Act (ETA), the DRC forms part of the consideration for the supply of electricity”.  As the DRC has not been prescribed in regulations as an exclusion and as the supply of electricity is a taxable supply, GST applies to the value of the consideration, including the DRC, for the supply of electricity pursuant to subsection 165 (1) of the ETA.     

Translation - from the federal perspective, the DRC is revenue in exchange for services.  It’s not debt payment but a charge for services - as it was under old Ontario Hydro that sought to cover all costs in its pricing for electricity, including paying debt principal and interest.  We are now back to where this all began.

In Closing  

It seems nothing changed in substance for paying hydro debt – just the players and method of payment.  From this author’s perspective, people and enterprises of Ontario are, for the most part, paying a debt owed to their own government (i.e. to themselves) and paid $11.5 billion plus HST in doing so.     

The DRC has helped fund various activities of the Ontario Electricity Financial Corporation (OEFC) in carrying out its mandate.  Money to retire debt is comingled with other revenues to service debt and other liabilities left behind by the former Ontario Hydro.  

While difficult to comprehend and follow, the DRC is not necessarily a bad thing and may have helped produce positive results for the people of Ontario.  It is part of a big picture of “hydro reform” that deserves clear accountability and transparency by the Government of Ontario including whether reform has been worthwhile especially in terms of low as possible hydro rates and debt retirement.  A comprehensive evaluation of results (intended and unintended) could reveal lessons learned that may inform future public policy decisions.   

The DRC is not what was first expected and old hydro debt per se is not significantly retired after 15 years.  However, there has been progress reducing the combination of debt and other liabilities of the OEFC.  

The deeper question is – has reform of the hydro system been successful?  What has been achieved for the public good and are lessons learned?   Have debt retirement dollars been worthwhile?  

In doing this article I learned more about the hydro system and kind of understand the DRC - but then again not.  I empathize with Alice and Dorothy and look forward to a happy ending.  

The OEFC was given the opportunity to comment on a draft of this article but did not respond.  A big thank you to Doug, Neil, Roseann, Sam, and Phyllis for their encouragement and review comments.    

Disclaimer:  The information used in this article comes from publicly available sources.  The analysis and conclusions are those of the author and do not represent the views of any organization the author may be associated with.

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