Global Adjustment Costs: Changing the Allocation

September 2009

• Over time, Smart Meter time-of-use RPP prices have trended towards convergence and away from the original 3:2:1 ratio in relation to pricing for the on-peak, mid-peak and off-peak periods.
• The convergence is largely the result of Global Adjustment costs becoming a greater proportion of total supply costs and being allocated uniformly.
• As of November 1, 2009, the Ontario Energy Board intends to re-allocate Global Adjustment costs to move back towards the original ratio.
• It remains to be seen if the re-allocation will be successful and the extent to which non-RPP customers will be affected as a result of changes to the allocation of actual Adjustment costs .

Global Adjustment Recap

The Global Adjustment (GA) is the difference between the total payments made to certain contracted or regulated suppliers of electricity and conservation services and any offsetting revenues they receive from sales to the Ontario spot market. Customers' effective net commodity price (excluding wires and other charges) is the combination of the spot market price and the GA. The adjustment is not well understood by consumers and yet this mechanism has a large and growing impact on the true cost of electricity.

The GA distributes costs arising from contracts with legacy non-utility generators, Ontario Power Generation, and contracts entered into by the Ontario Power Authority with others. At current and expected future market prices, all of these deals are 'under water'; that is, the prices paid generally exceed spot market prices. This means the GA has been and will likely continue to be a debit or charge.

Currently, all GA costs incurred in a given month are recovered through a 'postage-stamp' charge, with the total costs spread across the amount of energy consumed in the province. The result is a uniform charge in dollars per MWh (or cents per kWh), charged to loads regardless of when they use electricity.

RPP-Related Background

Under the Regulated Price Plan (RPP) and more specifically the Smart Meter RPP, the Ontario Energy Board (OEB) has set time-of-use (TOU) electricity prices for eligible consumers that have 'smart meters', since May 2005. The Smart Meter RPP has three prices that apply to three different time periods: on-peak, mid-peak and off-peak. The first two in combination largely align with the generally accepted notional on-peak period of 7 a.m. to 11 p.m. on weekdays that don't fall on holidays.

At the outset of the Smart Meter RPP, on-, mid- and off-peak TOU prices were set roughly in the ratio 3:2:1, mainly due to time-differentiated pricing seen in other trend-setting markets such as California, with a view to motivating customers to shift load. The Ontario Power Authority's Conservation Bureau played a strong role in setting these original numbers.

Using energy proportions provided by the OEB, the Smart Meter RPP on- and mid-peak target prices can be blended together to create a notional on-/off-peak ratio of 2.4:1.0, as shown below.

Over time, Smart Meter TOU RPP prices have evolved so that they more closely match actual and expected spot market prices for the three time periods, adjusted for the uniform GA. This is consistent with the OEB's mandate to set conventional and Smart Meter RPP prices so that they recover the actual costs of electricity used by RPP customers. In recent years, due to an improving supply/demand balance, on-peak Hourly Ontario Energy Prices have been at a smaller premium to off-peak prices. The result is a trend towards convergence related to pricing for the three periods. The current Smart Meter RPP TOU prices of 9.1, 7.6 and 4.2 cents per kWh indicate a ratio of 2.2:1.8:1.0. As shown below, using energy proportions from the OEB, the Smart Meter RPP on- and mid-peak period prices can be blended together to create a notional on-peak period price of 8.25 cents per kWh and an on-/off-peak ratio of 2.0:1.0.

Targeted Re-Allocation of GA Costs

In April 2008, the OEB issued a discussion paper on design and price-setting issues related to Smart Meter RPP prices. In May 2009, changes were announced and then in July 2009 the OEB issued a revised RPP Manual.

At page 30 of the new manual, the OEB states:

In subsequent years, TOU price forecasts tended to converge, primarily the result of GA costs becoming a greater percentage of total supply costs and being allocated uniformly. In response to this trend and as noted earlier, effective November 1, 2009 the Board will allocate GA costs non-uniformly according to when these costs are generated, i.e., during peak, mid-peak or off-peak hours. The [OEB's] analysis shows that this type of GA cost allocation will offset some of the convergence trend and partially restore the [3:2:1] ratio that was assumed by the Board to be an adequate incentive for consumers to shift load.

The OEB's stated intention then is to disaggregate or re-allocate GA costs to different time periods, so that those costs can be linked to forecast spot prices for each of those periods.

Aegent's Analysis of GA Cost Re-Allocation

Aegent's preliminary analysis indicates the OEB may be challenged to achieve its stated intention to reverse the convergence trend and restore the 3:2:1 ratio. The analysis used data for the period August 2008 to July 2009, during which the GA averaged $18.15/MWh.

Making assumptions about the re-allocation of certain GA costs, the notional on-peak to off-peak ratio of the total, the GA inclusive commodity price was about 1.91:1.00, as shown below.

It should be noted that this analysis used time-differentiated load data for the whole Ontario market. Actual RPP use is slightly skewed towards the notional on-peak period, so the actual Smart Meter RPP ratio is probably somewhat higher than 1.91:1.00.

One factor that will cause this ratio to rise is the nature of new GA costs. These new costs will likely be allocated to on- and mid-peak Smart Meter RPP TOU periods.

Another factor that would cause the ratio to rise is if contracts for base load generation, which currently moderate the on-/off-peak GA split, were in the future held on the 'GA books' as separate on- and off-peak deals. The impact of such a change on the ratio would be much more pronounced.

Implications for Actual GA

The OEB will release new Smart Meter RPP TOU rates in mid-October, which will take effect November 1, 2009. It remains to be seen the extent to which they will be successful in achieving their stated intentions.

Also of interest to non-RPP consumers will be the extent to which this initiative will affect the allocation of actual GA costs. At some point, will GA costs be split out into different time periods for all customers? If so, how will costs be split, into how many periods and how will it affect individual customers?

Global Adjustment: Change in Behaviour Has Implications for Hedging Read more »