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The Story Behind Recalibrating Ontario’s Electricity Policy

Published on
August 28, 2017

Much has been written about Ontario’s electricity policies, many by advocates of one aspect or another, usually to promote their position versus someone else’s. There are pundits who are concerned about the price increases Ontario consumers have experienced, with no shortage of proposed solutions (good and bad). What they all have in common, however, is they usually provide an argument which does not consider the broad context of the electricity system – not just policies, but physics and economics as well.

The starting place in any critical review should be remembering the overall objective of the North American grid – the lights must always stay on. The societal expectation backed up by Mandatory Reliability Standards established by the North American Reliability Corporation is one of near perfect reliability. Electricity has “physical” attributes very different from other energy commodities in that it cannot be stored as electricity. As such, the system must be controlled such that the customer instantaneous demand must always be balanced with supply.

In the Ontario context, on a pleasant summer day in mid-August (August 14th for example), the lowest demand was around 12000 MW at 3 am, with a peak demand of 19000 MW at 6 pm. This requires real-time minute-by-minute management to ensure that supply is balanced with demand. To compound this challenge further, the need for electricity varies greatly through the year, in the range of 12000 to 14000 MW from the absolute low, to the 220000+ MW at the absolute high. Very few people fully comprehend how dynamic our electricity system must be, in order to ensure the lights stay on. This reality is due purely to physics, and the laws of physics cannot be subjected to the whims of politics.

In addition to the physical reality of electricity systems, we also have several economic realities, much of which have been determined through the intersection of public policy and technology.

One of the key public policy decisions made almost twenty years ago was for Ontario to have a “market” for electricity, introducing competition where hourly price is determined by the offers to supply generation into the market. Ontario was not alone in this direction – Alberta went the same direction. More importantly for Ontario, all the electricity systems in the Northeast and Midwest US also went to market based systems.

Ontario has strong interconnections with the US Midwest, New York and Quebec. Quebec has strong interconnections with New York and New England. While Quebec does not have a market based system like Ontario and the others, it plays a strong role in all those markets by virtue of its flexible large hydro system. The result is any policy decision made in Ontario must consider the impact of the market interactions – there is no fence around Ontario.

When electricity markets opened, the prevalent economic theory was electricity was no different than any other energy commodity. This might have been true if it was physically possible to store the finished product, but it isn’t. Therefore, in almost all hours of the year, the amount of potential generation is greater than the actual demand (there is always a reserve amount of generation on hand to cover surprises such as equipment failures). Prices in markets with a supply surplus tend to drop to the marginal cost of production, which does not cover all a generators cost. Most markets have or are moving to two forms of market pricing – energy and capacity, to address this.

In the Ontario provincial election in 2003, another public policy consideration was introduced, specifically the lowering of greenhouse gas (GHG) and other emissions by eliminating the use of coal as quickly as possible. Many other jurisdictions across North America are now looking to similar measures that Ontario instituted starting over a decade ago to reduce GHG emissions in their electricity markets.

Much has been said about baseload generation (the minimum required always) and peaking generation (during the peak hours of the day/year), but just as critical is intermediate load generation. It not only fills the gap between the base to almost the peak, but also follows the load up and down through the day ensuring supply balances demand (and thus keeping the lights on). Historically, Ontario’s coal fleet played this role well. It was flexible and economical, but did not meet the societal environmental expectations, so it had to be replaced.

A little over a decade ago effort was commenced to replace the coal fleet with new natural gas fired units, restarted nuclear reactors, and new sources of renewable energy. The challenge for the government at the time was the competitive generation sector saw considerable risk in the relatively new market place, and would only invest the necessary billions of dollars if there was a contractual backstop to protect their investment. As a result, contracts were introduced which had a fixed payment component and a market payment component (not unlike those markets which have both capacity and energy market payments). Recovery of these “above energy market” costs resulted in charging the Ontario customer a Global Adjustment (GA). The GA would become the catch-all for all out of market cost recoveries covering many different technologies. Concurrently, the province also commenced the development of large-scale renewable power generation, largely in the form of new wind and solar projects, procured competitively on the basis of price originally and then on the ability to connect to the provincial grid (eventually with consideration given to the local support for projects).

In all jurisdictions, there is also a third public policy consideration, and that is the cost of electricity impacts not only individual consumers, but industry as well, and as such there is a link to overall economic health.

While the electricity sector participants must continually balance supply and demand to keep the lights on, politicians must balance economic and environmental objectives while not compromising the ability to balance supply and demand.

Changing technology on how we produce and use electricity is also an important factor. Technological change is improving the economics of wind and solar and other supply side technologies. It is also starting to allow us to think of demand in different terms. Typically, supply was always adjusted to meet demand, but now it is becoming possible for demand to be adjusted to meet supply.

So far, the discussion has been about electricity, but what if we expand our horizons and think about energy services? Climate change mitigation requires a change in our energy system to low carbon, transforming our electricity supply but also transportation and space heating.

“Utility” control of electric vehicle charging and thermal storage represent technologies which can make demand variable – another tool to balance supply and demand.

Lastly, let’s expand our thinking beyond Ontario and to the interconnected energy system which exists today. Decisions about future investments and choices with respect to both supply and demand sides must consider we do not operate in isolation of our neighbours in the US and Canada. Decisions made without this consideration puts us into the land of unintended consequences. For example, when the market price in Ontario goes close to zero because that is the marginal cost of production, then it will be attractive for commercial entities to buy out of the Ontario market and sell into adjacent markets. The price typically is well below what the generator is getting paid (for those under contract). And if you have a large hydroelectric system with significant capability to store large volumes of water, then you can buy low out of Ontario, and sell high back to Ontario is times of peak prices. (That same entity could also send power into Ontario and then sell the same amount out to other markets.)

Ontario electricity policy is therefore incredibly complex. But it is bounded by these realities:

  1. Energy policy is also socio-economic and environmental policy, very real concerns for today’s and future generations.
  2. Ontario operates a very dynamic electricity market which interacts with several other markets and jurisdictions. These trade relationships are significant (and over the past several decades have resulted in enhanced reliability and economics for Ontario customers).
  3. Technology is always changing. As a result, the economic realities of what is possible is also changing. Evolving technologies on the supply and demand side, as well as the information technologies to better integrate the two make planning significantly challenging.
  4. Electricity is a very capital-intensive business, and past investment decisions take decades to pay down.
  5. The laws of physics are fixed – supply must equal demand in real time to keep the lights on.

Failure to understand this broad context can put Ontario customers, big and small, into a land of unintended consequences which they will be paying for decades to come. The task of managing expectations and public needs in this incredibly complex area should give any pundit or policy-maker pause.

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Jim Burpee
Sussex Affiliate
Jim Burpee is a Senior Counsel in the Energy and Environment Practice at Sussex, and brings to the firm almost four decades experience as one of Canada’s most senior strategists in the electricity industry.
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