Global Adjustment: Problem or Symptom?

February 2010

• The Global Adjustment is a symptom of larger problems: the Ontario electricity market is broken and the total energy price is rising rapidly.
• Fixing the market would be a monumental task.
• With respect to rising costs, one of the most helpful things the Ontario Government and its agencies could do is be more transparent about costs, including providing greater detail and frank talk concerning their direction.

Of late, the Global Adjustment (GA) has been garnering increased attention. More and more, customers are realizing that while hourly electricity prices have been fairly low since March 2009, the total energy price on their bill (the hourly spot price plus the GA) has stayed the same or is rising because of the GA. This raises the question: "Is the GA the problem or a symptom of some other problem?"

Background

The Global Adjustment, also known as the Provincial Benefit, is an Ontario electricity market mechanism used to transfer costs between the market at large and customers. Costs arise from the difference between electricity prices paid by consumers and those paid to certain generators, plus expenditures on conservation and demand management.

The large majority of GA costs arises from contracts with generators. A good portion of these contracts are at fixed prices, or they have elements that behave as fixed-price arrangements. Directionally then, when spot prices are low, the GA is high and vice versa. The extent to which there is a perfect offset between the two price components is an indication of the percentage of total market supply falls under these contracts.

The remainder of the GA costs is for conservation and demand management. These costs are largely unaffected by spot prices and so they are generally additive.

Recent GA Behaviour

A readily-available and appropriate benchmark is the total energy price, the sum of the electricity price and the GA. Different consumers will pay different average electricity prices because they have different load profiles, so to simplify matters we use the arithmetic average electricity price or Hourly Ontario Energy Price (HOEP). Selecting GA values is not dead simple. The IESO web site references three different sets of monthly values. For a clear picture of what's happening, the numbers applicable to market participants provide an accurate view. In particular, the amounts applied to non-regulated customers should not be used, as time shift and smoothing operations distort the GA's behavior relative to HOEP.

The graph below shows monthly values from 2009 for the GA and the total energy price (excluding wires and other non-energy charges) plotted against HOEP.

The total energy price data are somewhat dispersed, but one can generally conclude that the total energy price paid is relatively independent of HOEP, even over a wide range of HOEP values.

The Real Problem(s)

The GA appears to be a problem, but in reality it's a symptom of larger problems.

• Ontario Electricity Market Is Broken

Problem number one is that Ontario's electricity market is broken. By this, we mean that electricity prices are not an indicator of electricity costs and so can't be effective in motivating consumer behaviour.

At the opening of the market in May 2002, the Market Power Mitigation Agreement effectively fixed about 50% of users' electricity commodity price at $38/MWh. Consumers were then about 50% exposed to spot price fluctuations. In November 2002, the Ontario Government effectively re-regulated the commodity price on a retroactive basis; i.e., to the opening of the market.

The government's move was the first step in stuffing the rest of the genie back into the bottle. Since that time and especially since the advent of the Ontario Power Authority (OPA), the Ontario "market" has been getting to be less and less of an actual market.

The fact that the OPA exists guarantees its continued need. They have a hand in most existing and virtually all new supply, meaning that very few generators are actually exposed to fluctuating spot prices. Gas-fired generators have to pay some attention to and respond to varying hourly prices but if they're smart, they are still largely insulated from varying prices. All other generators are essentially indifferent to the spot market's goings-on. Also, this indifference creates a number of undesirable dynamics indicative of economic inefficiencies.

If total energy costs are largely insensitive to variations in the spot price, then informed consumers should be largely indifferent to spot price fluctuations. Today, very little of the genie is sticking out of the bottle.

• Total Energy Price Rising Rapidly

Problem number two (and some would say it deserves top billing as it affects everyone's pocketbook) is the rapid and likely continued rise in the total energy price.

The graph below shows monthly values for 2009 for HOEP, the GA and the total energy price.

A disturbing upward trend in the total energy price is quite noticeable. The slope of a fitted line is a little less than $12/MWh/year, though we believe there are transitional dynamics at work that make the picture look worse than it actually is. (About $2/MWh is related to lower energy demand as a result of the recession.) Still, if say half of the increase can be attributed to these other factors, we're still left with a $6/MWh increase over the 2009 calendar year.

GA costs would appear to be on the rise, from contract price escalators, new gas-fired and renewable generation and rising conservation costs. All of these price pressures are likely to continue in the near-term, given that the OPA is only part way through replacing the province's coal-fired generating units and given the Green Energy Act's wide-open door to new renewable generation and its attendant but less visible costs, such as those for enabling wires investments.

Making It Better

• Fixing the Market

This task is monumental. It's taken a long time to get us into the situation we face today and should someone embark on attempting to fix the market, that too will take a long time.

One school of thought is that the OPA could continue to add supply, to the point where Ontario has a significant supply overhang. Capacity could then be sold off, but Ontario would almost certainly be left with a second, large residual debt; call it "Son of DRC" or "DRC2" (with DRC referring to Debt Retirement Charge). The first DRC of $7/MWh is likely to remain in place until at least 2017, so the thought of a second, likely much larger DRC, would hold little appeal for consumers. A fundamental change to Ontario's electricity market might also be required. While Ontario's energy-only market was never given much of a chance, many still believe a capacity market is the way to go. Finally, the economic and operating impacts of unfettered renewable generation development would still be significant and challenging.

• Rising Costs

In many ways, the horse has left the barn on this issue. We suggest that one of the most helpful things the government and its agencies could do is be more transparent about costs, including providing greater detail and frank talk concerning their direction. Currently, published GA costs are broken down into three categories, related to fixed pricing for Ontario Power Generation output, contracts with legacy Non-Utility Generators and for OPA-administered contracts.

In particular, the OPA cost information could be much more detailed, without giving away commercially-sensitive information. Specifically, many details of the Bruce Power arrangement are already in the public domain and aggregated data for each of the OPA's other procurement initiatives (CES I, etc.) could be released. Lastly, conservation and demand management expenditures could be made more visible. One outcome of this might be a lessened belief that this initiative is cost-free.

Local distribution companies and the Ontario Energy Board make some efforts to point out to consumers the existence of the GA. These efforts are likely ineffective, dwarfed by the fact that consumers on the Regulated Price Plan (RPP) don't even see the GA, though it makes up a significant part of the RPP rates. Finding a way to make the GA visible to RPP consumers would be an improvement.

Global Adjustment Costs: Changing the Allocation Read more »

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