Electricity Infrastructure Renewal: The Third Cost Wave

January 2012

• In an April 2011 report, the Conference Board of Canada estimated that Ontario would spend about $21 billion on distribution facilities over the period 2012 to 2030, with nearly $17 billion of the $21 billion being used to sustain existing capability.
• This wave of infrastructure renewal costs will be the third cost wave to hit consumers and by the time it arrives, consumers will have already experienced the first two - costs associated with generation procurement as a result of policy changes in 2004-2005 and costs resulting from the implementation of the Green Energy Act.
• The cost wave for infrastructure renewal will pose significant challenges for consumers, regulators and policy-makers in Ontario.

In an April 2011 report, the Conference Board of Canada estimated that Ontario would spend roughly $86 billion between 2010 and 2030 on electricity infrastructure.

Projected spending for generation accounts for nearly three quarters of this estimate ($60 billion). Investments of $21 billion in distribution facilities and $5 billion in transmission facilities are foreseen. The distribution and transmission expenditures are not solely for additions to the network, but also for replacement of existing assets dating from the 1950s and 1960s.

The Conference Board reports that Ontario's projected expenditure of $21 billion on distribution includes nearly $17 billion for sustaining its existing capability.

This wave of infrastructure renewal, or more specifically the cost of this renewal, will pose significant challenges for electricity consumers, regulators and policy-makers in Ontario. Electricity consumers will be buffeted by three major cost waves.

The first wave has already reached the consumer. This wave was associated with the policy changes first implemented in 2004-2005, and developed over the next five years. In the late 1990's and early 2000's, confusing and inconsistent provincial energy policy forestalled investment in new generation, with the result that in 2002 and 2003, there was insufficient generation to meet peak electricity demand, and Ontario was highly dependent on imports.

With a change in government, the Ontario Power Authority was created to oversee power planning and procurement, and there began a series of directives from the government specifying several major procurement programs. The Global Adjustment mechanism was created to fund this procurement activity. Many would argue that while this policy initiative was effective in jump-starting new generation development, the effort was significantly overdone. In a few short years, Ontario has gone from a generation shortfall to a significant surplus of generation, and costs in the Global Adjustment have climbed to more than $5.3 billion per year in 2011, representing more than 4 cents per kWh on the average consumer's bill.

Consumers have begun to express frustration as they have seen their costs climb. But a second wave of cost increases is just appearing on the horizon.

In 2009, the government implemented the Green Energy and Green Economy Act. This legislation established preferential rates to be paid for greener forms of power generation. The act also set out provisions that would require utilities and transmission companies to expand their network to enable new renewable power generators to connect to the grid. Hence, the Green Energy Act imposed costs related to above-market rates for renewable power, plus costs for infrastructure to connect that power.

According to the Ministry of Energy and Infrastructure, Hydro One has spent more than $7 billion since 2003 on transmission and distribution projects in Ontario including connection of new wind energy sources to the grid but also replacement of existing transformer stations and modernization using "Smart Grid" infrastructure.

Renewable power procured under the Green Energy Act gets preferential access to the grid, such that when this renewable power is available (for example, when the wind is blowing), it often displaces other forms of generation. This happens because Ontario has too much generation capacity for most operating conditions.

However, many generators that are displaced are generators whose power output was contracted for under the first cost wave. They receive price or revenue guarantees for their output, so that in most cases, even if their output is displaced by renewable power, these generators get paid anyway.

The cost impacts of the Green Energy Act are only beginning to be felt, but consumers will see the full impact of this cost wave over the next 2 or 3 years. Analysis by Aegent indicates the cost of the Global Adjustment will rise from $5 billion to $8 billion over the period to 2014, supporting a similar conclusion recently made by Ontario's Auditor-General.

This increase to the Global Adjustment, and related cost increases for transmission and distribution and other costs driven by initiatives within the Green Energy Act, will amount to a unit cost increase of about 3 cents per kWh for the average consumer in that 2 to 3 year time frame.

Costs associated with basic infrastructure renewal (poles, wires, transformers) would represent a third cost wave that would start to be felt in the next 3 to 5 years. For example, an expenditure of $5 billion on distribution infrastructure renewal over the next 5 years would result in a rate increase of about 0.7 cents per kWh.

By the time this third wave arrives, consumers will have already experienced the first two waves. The cumulative effect of the three waves could be economically damaging.

The first cost wave has already crashed ashore, and the second wave is coming and cannot be stopped. As the third wave begins to gain momentum, consumers will argue that they cannot afford to absorb that third wave, and they may be right. The regulator and governments will be under tremendous pressure to prevent that wave from arriving.

The regulator will properly perform its function of ensuring that the proposed capital replacement programs are prudent and cost effective. The danger arises if it becomes policy to defer necessary capital replacement as a means to keep a limit on overall cost increases. Many of the costs of the first two waves could probably have been reduced or avoided with different approaches to procurement and renewable power generation. If the costs of the first two waves now have the effect of making it unaffordable to tackle necessary infrastructure renewal, then Ontario will end up with an electricity system that is both expensive and unreliable.

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