NB VOTES

Analysis

The future of NB Power

No. 17 in a series of expert articles on major issues in the 2010 N.B. election

Last Updated: Monday, September 20, 2010 | 7:35 AM ET

CBC News

Charting the price of electricity in New Brunswick since 1960. (Kenneth Sollows)

The time has come for voters to think seriously about NB Power and our energy future. True enough, we all had our own, visceral reaction to the proposed sale of NB Power by the current (Liberal) government.

A few years ago, people were also upset by the actions of the previous (Conservative) government on the NB Power file (New Brunswick Energy Policy, 2001, New Brunswick Market Design Committee — Final Report, 2002).

Most of us will have forgotten that a prior (Liberal) government started that ball rolling with reports into the future of NB Power (Electricity in New Brunswick and Options for its Future in 1998 and final report of the select committee on energy in 1999).

No doubt all of these initiatives were flawed, but one fact stands out: Every government that has come to power in the last 20 years has seen the need to spend a great deal of time and political capital on the NB Power problem.

What is this problem? It is rooted in the 1973 oil embargo, the rapid and substantial increase fuel prices it caused, and our inadequate response to those events at that time and since.

A solution to this problem will be found, at least partly, in our ability to consider and resolve the following questions:

Who should pay?

What is the ‘right’ price for electricity?

Economic theory supports pricing energy at its true cost. Pricing in this way is generally agreed to result in an optimal allocation of resources and in the "right" demand for energy.

Finding the price is best done by a free and competitive market; the 2nd best solution is an independent regulator to review costs and set prices.

Defining the cost is no easy matter in the case of a monopoly supplier such as NB Power, but it is commonly done — to some level of satisfaction — by regulators the world over.

'If a whole industry cannot pay its own way in the world, it is a poor investment for the owners and certainly no basis for our future prosperity.'— Kenneth Sollows

An alternative view is that some uses of energy are so important to a society that the price should be artificially lowered by government edict or regulatory léger de main.

Gasoline prices found in some petroleum producing countries, for example, can be well below the price that would be earned from selling the fuel on the international market; the lost revenue is effectively a subsidy.

The Atlantica Centre for Energy's discussion paper Electricity: A Regional Vision for Sustainability argues the case for subsidized electric pricing for large industrial customers.

I take a dim view of price subsidies. I suspect that cost-based pricing is well worth any hardship it may cause energy users, particularly large ones.

If a company cannot cover the cost of its own inputs, the owners should seriously consider replacing their managers.

If a whole industry cannot pay its own way in the world, it is a poor investment for the owners and certainly no basis for our future prosperity.

It remains a legitimate policy option to subsidize certain individuals, companies and/or industries. If we choose to do so, we should not do so blindly and should still determine the true cost of their service.

If we choose the subsidy route, we must also decide who shall pay it; taxpayers or ratepayers — two very different groups in New Brunswick.

The impact on the people and businesses of the province will be substantially different, depending on which group pays the subsidy.

Debt levels

What is the total cost of service and how much of NB Power's debt should ratepayers assume?

Assuming we opt for cost-based pricing, we need to decide on the cost. The naïve approach to this is to simply accept all costs claimed by the company and carried on its books.

This was the approach taken by government when it placed NB Power back under limited regulatory review following completion of the market design committee report in 2002.

The legislation under which the review was done ordered the regulator to accept almost all proposed costs, no matter how unreasonable or imprudent they might have been.

Normally, regulators examine the costs of utility companies in great detail and routinely decide which of those costs should be charged to the customers and which should be left for the owners to bear.

What kind of costs might not be passed on to customers? Excessive costs, costs that are not commensurate with the benefits obtained, can be excluded from rates; so too can imprudent expenditures for things that simply are not needed or useful for serving the customers.

In NB Power's case, these might include:

• The cost of replacing a tall chimney for a new plant because the original was poorly built.
• The cost of repairs to major equipment arising from the failure to remove temporary scaffolding in a piping system before it was put back in service.
• The cost of repairs to major electrical equipment damaged as a result of mismanaged commissioning of a new plant.
• The extra costs associated with the construction of a new power plant long before it is actually needed to meet the need for energy.
• The costs associated with the decision to refurbish a power plant, the economic case for which the regulator had previously considered and found lacking.
• The costs associated with the conversion of a power plant to use a fuel that cannot be bought.

Any or all of these could be argued to be imprudent and thus not recoverable from the ratepayer, or argued to be prudent and recoverable.

There is only one thing we can be sure of before the facts are examined and the arguments heard: Neither the owner (government) nor NB Power should be allowed to decide the matter.

Some of the costs associated with these and other expenditures that might be open to review may have already been unilaterally assumed by government, but the long history of laissez-faire oversight of NB Power suggests at least some of its debt might properly belong on the books of the government, not on the books of the company.

Needed revenue

How should NB Power's legitimate revenue requirements be allocated among customer classes?

NB Power has subsidized large industrial power consumers dating back to the 1960s. (CBC)This question lays at the centre of a major and long-standing conflict over NB Power's rates. Reviewing some history helps us understand why this is so.

As the accompanying illustration shows, the 1960s and early '70s were the good old days in the electricity business.

The real cost of electricity was falling; new power plants cost less than their predecessors, per kilowatt of output, and burned less oil as well. Even the price of oil was going down in real terms.

Electricity prices reflected this reality. The average, inflation-adjusted price for electricity from the New Brunswick Electric Power Commission, NB Power's forerunner, peaked at 15.2 cents a kilowatt-hour (¢/KWh) in 1961.

At that time residential and commercial (retail) customers were paying an average 26.4¢/KWh, a 74 per cent premium. Industrial customers paid 8.34¢/KWh, a 45 per cent discount off of the average price.

By the time of the first oil embargo in 1973, retail customer prices had fallen to 7.3¢/KWh and were only 20 per cent above the average price for all electricity sold.

Industrial prices had trended up and then down, but always sold at a discount to average price.

By 1969 this discount was only seven per cent and "incentive rates" (a.k.a. rate subsidies) for large industries were introduced. The discount for industrial customers increased to 35 per cent the following year and was still at 29 per cent in 1973.

Commencing in 1974, NB Power did not report revenue by customer class in its annual reports, so from 1974 through to 1993 only the average price is illustrated.

This moved up to about 10¢/KWh by 1979 and stayed near that level until 1987.

The detail reappears in the 1993 annual report with the average price at 7.6¢/KWh, retail sales at a 16 per cent premium on that, and industrial sales at a 22 per cent discount.

Government then changed the law so that NB Power could increase rates without regulatory review.

This state of affairs remained in place for the rest of the 1990s and industrial price discounts varied between 23 per cent in 1994 and 17 per cent in 1999.

In the same time period, retail price premiums trended upwards from 16 per cent in 1993 to reach a peak value 38 per cent above the average price in 1999.

Since then, industrial discounts have got larger and retail premium discounts have got smaller. Industrial discounts peaked at 28 per cent in 2006 and were 25 per cent in fiscal year 2008.

Retail premiums were 19 per cent and 20 per cent in those same years.

In short, NB Power had price subsidies to industrial users that provided a 29 per cent discount in 1973. Thirty-five years later the discount is still 25 per cent.

It may well be that a careful and proper allocation of costs between customers will support these discounts, but any reasonable person would be skeptical of the claim until such was provided.

The regulator did examine these cost allocations a second time in 2005-06.

NB Power's evidence at that time was much more consistent with the case presented by large industry in the early 1990s, supporting larger discounts on average price for industry.

NB Power customers pay "absurdly high" monthly fees based on the way the utility calculates its transformer costs. (CBC)The public intervenor's witness in the matter testified that the allocation of costs decided by the Public Utilities Board in the 1990s should remain in place.

In any case, the regulator decided that NB Power should stay with the cost allocation it had requested and received in the early 1990s while it revised and improved its more recent cost allocations.

In my opinion the cost allocations must be reviewed and revised.

The need for such a review is perhaps best illustrated by the absurdly large monthly service fee NB Power charges most customers.

This high fee is predicated, in part, on a misallocation of transformer costs that flies in the face of the basic laws of physics, which dictate that all such equipment is used to satisfy demand for power and should be allocated accordingly.

Instead, some $25 million of their cost is collected in the monthly service charges that people must pay whether or not they contribute to the demand the transformer serves.

Sadly, relying on NB Power's historical records and proposed cost allocation methodologies requires the kind of willing suspension of disbelief that is best reserved for a magic show.

This is not so much a criticism of the good staff at the utility; they have struggled with a very difficult situation over too many years, one made much more difficult by the self-interested meddling of elected and appointed officials and the lack of continuous regulatory oversight.

If NB Power had been subjected to competent and careful regulation for the last 30 years, one could be much more confident in their cost allocations.

Our history on this file means that reasonable people will find it difficult to accept any assertion of fact in the matter without a time-consuming and costly verification process.

There are other ways to allocate costs between customers. These offer a way forward that is relatively inexpensive and easily understood.

Their greatest advantage, unfortunately, is also their greatest drawback: They make it much more difficult for interested parties to place their fingers on the scales of justice.

NB Power's ownership

Who should own NB Power or its various pieces?

This question, or their answer to it, seems to be the first consideration for many people when they look to our energy future.

It is less important than most people suppose; what matters most is how it is managed and how it is regulated.

'When the choice becomes one between better health care and education or slightly cheaper electricity, it's not so clear that government ownership is best.'— Kenneth Sollows

Certainly the cost of capital can be lower for government-owned utilities; whether this is a good thing is debatable.

It reduces the cost of capital projects by substituting debt for equity financing, shifting the balance in investment decisions toward more capital-intensive projects.

Whether this results in lower cost energy or better overall outcomes is very much open to question.

As we have seen, debt can accumulate to the point that other, more important government initiatives are cut back or abandoned.

When the choice becomes one between better health care and education or slightly cheaper electricity, it's not so clear that government ownership is best.

There are options.

We could, for example, break up the NB Power distribution company and distribute it among several regional service commissions much as we have done for garbage service, and should be considering for water and sewage services.

There is evidence that suggests the "optimal" size for an electric distribution utility is closer to 50,000 customers than it is to the 335,000 customers served by NB Power; in many cases the same people can serve different roles in smaller, more efficiently structured organizations.

The perhaps larger advantage in such an approach is the comparative performance data that it provides to the regulators and utility managers.

Regulators the world over hear the same plea, again and again, from the companies they regulate: We're different, we're unique.

A regulator with several similar utilities to regulate is in a much better position to protect ratepayers and might even foster limited competition among different franchises to reveal efficiencies.

A regulator with only one electric utility to oversee has very limited bases of comparison.

The future

Right now we have an opportunity to ease the transition to fair, cost-based electricity prices. According to the U.S. Energy Information Service, oil prices peaked most recently in 2008.

They fell back from that peak by 36 per cent in 2009 and are expected to close out 2010 still 21 per cent below the peak; the outlook for 2011 has prices still 17 per cent below their peak.

'If we choose not to deal with these problems, as we have done since 1973, there will still be groups of winners and loser in the short run. This difference is that we will all be losers in the long run.'— Kenneth Sollows

If this pause in the increase of world oil prices is properly reflected in NB Power’s revenue requirements, it can provide the kind of breathing room we need to change the rates while holding NB Power’s revenue constant.

These changes will create both winners and losers, but we all must prepare to accept them.

Many will win as their electricity bills fall, to match their low cost of service. Those who see their bills rise to reflect the cost of their consumption will feel some pain; NB Power, and both the provincial and federal governments should have a transitional role to ease that pain.

Large industry will continue to buy electricity at a discount; residential and commercial customers will continue to pay a premium. The size of both should change as rates begin to reflect actual service costs.

Set fair rates and customers that use electricity only in the summer months should expect the largest reductions in their bills, some 30 per cent or more. These customers don’t contribute to the demand for power at winter peak and therefore shouldn’t pay for the power plant that provides it.

Their cost of service is limited to the cost of fuel for the energy they use (plus some small margin) and whatever it costs to meter and bill them.

Customers who use roughly the same amount of electricity each month of the year will see much lower bills than they pay now; even small customers that use slightly more electricity in the winter months should save a little money over their current bills.

Large residential and commercial/institutional customers, particularly those who use extra electricity in the winter months, should be prepared to reduce their consumption or pay more.

Prominent among these will be schools, hospitals and other public institutions, so tax-paying electors and politicians alike should be ready to shoulder their fair share of the burden when the Legislature reconvenes.

Those who see their cost rise to the true cost of their consumption will feel some pain, and both government and NB Power will have a transitional role to ease that pain.

If we choose not to deal with these problems, as we have done since 1973, there will still be groups of winners and losers in the short run.

The difference is that we will all be losers in the long run.