ENERGY MARKETS B U L L E T I N

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1 ENERGY MARKETS B U L L E T I N August 18, 2004 Ontario Government Issues Consultation Versions of Bill 100 Regulations and Consultation Paper on Price Regulation of OPG Nuclear and Baseload Hydroelectric Plants Activities to be carried on by Ontario Power Authority in developing integrated power system plan Factors to be addressed in OPA procurement processes Prescribed generators and generation facilities for the purpose of regulated pricing BORDEN LADNER GERVAIS LLP

2 ONTARIO GOVERNMENT ISSUES CONSULTATION VERSIONS OF BILL 100 REGULATIONS AND CONSULTATION PAPER ON PRICE REGULATION OF OPG NUCLEAR AND BASELOAD HYDROELECTRIC PLANTS By James C. Sidlofsky and Shane Freitag Introduction: In June of this year, the Government of Ontario introduced Bill 100, the Electricity Restructuring Act, 2004, which reflects its decision to implement a hybrid model for the Ontario electricity sector regulating prices for certain consumers; regulating the output from power plants owned by Ontario Power Generation ( OPG ); expanding the role of the Ontario Energy Board (the Board ) as the sector regulator; and creating a new agency; the Ontario Power Authority (the OPA ), with a broad mandate concerning supply and conservation measures, while apparently preserving some elements of competition. Bill 100 contains numerous proposed amendments to the Electricity Act, 1998 (the Electricity Act ) and the Ontario Energy Board Act, 1998 (the OEB Act ). Among the proposed responsibilities for the OPA is the development of appropriate procurement processes for managing electricity supply, capacity and demand in accordance with its approved integrated power system plans. The integrated power system plans and proposed procurement processes are subject to approval by the Board. The OPA would have the authority to enter into contracts in accordance with its procurement processes, and the OPA will not be permitted to enter into a procurement contract that does not comply with the Regulations. The Government has now issued two draft Regulations under the Electricity Act that would require the OPA to carry out certain activities in developing its integrated power system plan, and to take certain factors into consideration in determining whether to initiate its procurement process. In addition, as we reported in our June 17, 2004 Energy Markets Bulletin, Bill 100 provided considerable latitude to the Government to prescribe generators and facilities whose output would be subject to selling prices to be set by the Board. The Government has now issued a draft Regulation under the OEB Act that prescribes generators and generation facilities that will be the subject of regulated pricing. In conjunction with the draft Regulation, the Government has issued a Consultation Paper on the Price Regulation of OPG Nuclear and Baseload Hydroelectric Plants (the Consultation Paper ), which addresses, at a general level, the isses associated with establishing those regulated prices. Draft Electricity Act Regulations: Activities to be Undertaken in Developing the Integrated Power System Plan: The first draft Regulation would require the OPA to carry out the following activities in developing an integrated power system plan: BORDEN LADNER GERVAIS LLP Page 2

3 1. Consult with interested parties, including industry experts and groups representing consumers and the public interest in order to ensure that their priorities and views are considered in the development of the plan. 2. Consult with the Advisory Committee that would be established to provide advice to the board of directors of the OPA or the Mnister. 3. Identify and develop innovative strategies to accelerate the implementation of conservation, energy efficiency and demand management measures. 4. Identify and develop innovative strategies to encourage and facilitate competitive marketbased responses and options for meeting overall system needs. 5. Identify measures that will reduce reliance on procurement by the OPA of electricity supply or capacity, or demand side management measures. 6. Identify factors that it must consider in determining that it is advisable to enter into procurement contracts for electricity supply or capacity, or demand side management measures. 7. Ensure that safety and economic and environmental sustainability and environmental protection are reflected in the plan. The OPA would be required to publish all integrated power system plans approved by the Board on a publicly accessible website, also to be approved by the Board. Factors to be Considered in Developing and Commencing the Procurement Process: The second draft regulation deals with principles to be applied by the OPA in developing its procurement processes; factors to be considered prior to the initiation of the procurement process; and the terms of contracts entered into by the OPA for the procurement of electricity supply or capacity or demand side management measures. In developing its procurement processes, the OPA must comply with four principles: 1. Procurement processes and criteria must be fair, open, clearly stated and accessible to a broad range of interested bidders. 2. To the greatest extent possible, the procurement of electricity supply and capacity and the procurement of reductions in electricity demand shall be achieved through competitive processes. 3. No conflict of interest or unfair advantage shall be allowed in the selection process. 4. Evaluation criteria and processes must be transparent and clearly stated for all interested bidders. Prior to commencing the procurement process, the OPA must consult with the Board and the Independent Electricity System Operator (the proposed new name for the Independent Electricity Market Operator), and must access the capability of the IESO-administered markets to meet the need for electricity supply or capacity, including supply or capacity to be generated using alternative energy sources, renewable energy sources, or both; or to supply demand side management measures. The OPA must not commence its procurement process unless it has considered the factors identified in its integrated power system plan in respect of the advisability of entering into contracts, or in the OPA s opinion, after consultation with the IESO, BORDEN LADNER GERVAIS LLP Page 3

4 extraordinary circumstances exist that would justify proceeding with a procurement process without considering those factors. Finally, the OPA would be required to ensure that, to the greatest extent possible, any contract it enters into under its procurement process does not contain terms or conditions that have the effect of restricting entry into the IESO-administered markets by generators who are not parties to a procurement contract with the OPA. This provision reinforces the Government view that the wholesale market will have a role in encouraging the development of new electricity capacity. Draft OEB Act Regulation, and Government Consultation Paper: Draft Regulation - Prescribed Generator and OPG Nuclear and Baseload Hydro Electric Plants for the Purpose of Regulated Pricing: Bill 100 contains a new proposed new section 78.1 of the OEB Act that would require the IESO to pay prescribed generators, with respect to output generated by units at prescribed generation facilities, an amount determined in accordance with Regulations. The proposed new Regulations do not yet establish the basis for determining the price for that output, but the Government has issued a Consultation Paper on the methodology for setting prices for the designated facilities. In the meantime, the draft Regulation prescribes Ontario Power Generation Inc. ( OPG ) as a generator for the purposes of the proposed section 78.1 of the OEB Act, and prescribes the following generation facilities for the purposes of that section: 1. Sir Adam Beck I; 2. Sir Adam Beck II; 3. Sir Adam Beck Pumped Generating Station; 4. De Cew Falls I and II; 5. The RH Saunders Hydro-Electric Generating Station on the St. Lawrence River; 6. Pickering A and Pickering B Nuclear Generating Stations; and 7. Darlington Nuclear Generating Station. A review of the Regulation raises a number of issues which require further consideration, such as the inclusion of the Beck Pumped Generating Station and DeCew Falls in the list of prescribed generation facilities and/or the exclusion of other OPG hydroelectric facilities. The Consultation Paper: According to the Consultation Paper, the Government s intention is that the regulated electricity price would be set to recover allowed costs and to earn an appropriate return on assets employed by OPG based on a forecast output level. That regulated price would then apply to all of the facility s baseload output. The Government also contemplates the regulated price incorporating the recovery of allowed capital and other costs incurred to maintain or expand output from the regulated facilities (the Consultation Paper cites the example of the approved Niagara Tunnel, which would increase output at the Beck Generating Stations, and the costs of which would need to be recovered from the regulated prices.) Similarly, the Consultation Paper BORDEN LADNER GERVAIS LLP Page 4

5 also refers to costs related to the return of Pickering A Unit 1, and other Pickering A units to service, being incorporated into the regulated price in respect of the output from the Pickering Station. The regulated price would be based on an estimate of the output from the facility, and may be based on a certain percentage of that estimated output. The capacity of expansions of existing baseload capacity would be incorporated into the regulated price. However, OPG would earn the wholesale market price for the remainder of its output beyond any percentage incorporated into the regulated price. Once the Board has responsibility for approving changes to the regulated price, it could establish variance and/or deferral accounts to address costs over which OPG would have limited control, such as water levels, nuclear performance issues, and legal and regulatory changes. The Consultation Paper proposes that the regulated price should be on a per kwh basis. It anticipates that the Regulation will set separate prices for the output from (1) the regulated baseload hydro facilities; (2) Darlington GS; and (3) Pickering GS. Alternatively, the Consultation Paper suggests that the nuclear price could be combined for the Darlington and Pickering output. The prices will include an allowed rate of return, and the Consultation Paper recognizes that a typical utility regulated by the Board is allowed [an] after tax rate of return in the range of 10%. The Consultation Paper suggests that the Government could decide to set the price on the basis of that level, accept a lower return for its assets, or decide to phase in the return in stages over the years to which the Regulation applies. As for the expected duration of the initial price, the Consultation Paper anticipates that the price initially established would be in place for 2005 and 2006, and possibly When the Board assumes responsibility for establishing the future regulated price for the designated facilities, the Consultation Paper suggests that the Board would need to take into account the asset values assigned to the facilities for the purposes of this Regulation and any approved investment to increase output from the designated station or to refurbish or add operating capacity to the designated station. As noted above, the regulated price would also apply to additional output from the facility related to the investments to increase output or to increase operating capacity. The Board would have discretion in establishing the ongoing methodology for setting the regulated price, except where otherwise specified by Regulation. The Discussion Paper contemplates a Shareholder Declaration for OPG, that would address the bidding behaviour and the shareholder s expectations regarding performance for OPG s nonregulated assets. This would be addressed independently of the Regulation that would deal with the specified facilities. A review of the Consultation Paper raises a number of issues which require further consideration, such as defining what constitutes all of a station s baseload output; the prudence and appropriate amount of costs incurred in refurbishing or expanding facilities; how OPG would be permitted to bid the balance of the output of the baseload units into the wholesale market; the setting of appropriate capital structures for OPG or any successor OPG companies; and whether excess wholesale revenues associated with the non-regulated assets will be returned BORDEN LADNER GERVAIS LLP Page 5

6 to the ratepayers who have paid for those assets in the form of a rebate similar to the rebate provided under the Market Power Mitigation Agreement. The Government has provided an opportunity to comment on the draft Regulations and Consultation Paper. We would be pleased to work with you in the consultation process, and we invite you to contact Linda Bertoldi at (416) or Mark Rodger at (416) in this regard. This publication has been prepared as a service to clients and friends of Borden Ladner Gervais LLP and other persons involved in energy markets. It is not intended to be an exhaustive statement of law or an opinion on any subject. If you have specific areas of concern or require further details we would be pleased to elaborate on any of the matters set out above. Please contact the following lawyers listed below: Linda L. Bertoldi Tel: (416) lbertoldi@blgcanada.com Co-Chair, Energy Markets Law Group J. Mark Rodger Tel: (416) mrodger@blgcanada.com Co-Chair, Energy Markets Law Group Rick F. Coburn Tel: (416) rcoburn@blgcanada.com Bruce Fowler Tel: (416) bfowler@blgcanada.com W. Paul McCarten Tel: (416) pmccarten@blgcanada.com Michael Shadbolt Tel: (416) mshadbolt@blgcanada.com Christine E. Long Tel: (416) clong@blgcanada.com Elizabeth A. Jordan Tel: (416) ejordan@blgcanada.com Stephen J. Fyfe Tel: (416) sfyfe@blgcanada.com Shane Freitag Tel: (416) sfreitag@blgcanada.com James C. Sidlofsky Tel: (416) jsidlofsky@blgcanada.com Richard J. Morelli Tel: (416) rmorelli@blgcanada.com William R. McLean Tel: (416) wmclean@blgcanada.com Vinay Mehta Tel: (416) vmehta@blgcanada.com BORDEN LADNER GERVAIS LLP Page 6

7 Meaghan Bethune Tel: (416) Ottawa Office Contacts: Peter C.P. Thompson Tel: (613) Kent D. Howie Tel: (613) BORDEN LADNER GERVAIS LLP IS AN ONTARIO LIMITED LIABILITY PARTNERSHIP. FOR MORE INFORMATION ON THE FIRM S CANADIAN ENERGY MARKETS ISSUES AND OTHER LEGAL SERVICES, CONTACT ONE OF OUR OFFICES BELOW: Vancouver Office: 1200 Waterfront Centre 200 Burrard Street P.O. Box Vancouver, British Columbia V7X 112 Tel: (604) Fax: (604) Toronto Office: Scotia Plaza 40 King Street West Street Toronto, Ontario M5H 3Y4 Tel: (416) Fax: (416) Ottawa Office: World Exchange Plaza 100 Queen Street, Suite 1100 Ottawa, Ontario K1P 1J9 Tel.: (613) Fax: (613) Montreal Office: 1000 de La Gauchetiere Street West Suite 900 Montreal, Quebec H3B 5H4 Tel: (514) Fax: (514) Calgary Office: 1000 Canterra Tower 400 Third Avenue S.W. Calgary, Alberta T2P 4H2 Tel: (403) Fax: (403) BORDEN LADNER GERVAIS LLP Page 7