By Frank Gazzola

East vs. West:

East versus West; Canadians are obsessed with this never-ending duel.

Whether we’re talking about Edmonton versus Hamilton in the Grey Cup or the classic battle of Calgary versus Toronto in the quest for Lord Stanley’s cup, we love to see a good fight.

Friends, we have found yet another arena to cheer in. Yes, the great battle of electricity markets is now on.

In one corner, we have the giant, Ontario’s quasi deregulated electricity market, holding the world title of “Hybrid” market fueling an economy that has taken a few on the chin lately. In the other corner, is the pint-sized market—Alberta’s open access, merchant-based deregulated market—that is currently fueling one of the largest growing energy economies in North America.

Ontario’s Electricity Market:

Ontario plays a central role in Canadian commerce and industry. Its electricity market comes with a complex set of rules, legislated rebates, diverse generation mix, and creative conservation and demand management programs. The historical Hourly Ontario Electricity Price (HOEP) is showing that prices for electricity have been averaging a reasonable 5.0¢/kWhr and forecasts are predicting a continued healthy supply - demand balance. Despite all of this, the market is no where near the level of competition that the market design committee had anticipated.

It all starts with the generation mix in Ontario. Essentially, there are five types of generation with a Maximum Continuous Rating or Capacity of 31,300 Mega-watts. Figure 1 demonstrates the electricity generation breakdown from the largest producer down to the smallest.

Figure 1: Ontario’s Generation Mix

Beyond the diverse, balanced mix of fuel types, Ontario electricity is generated by over 30 different companies. Coupled together, these two facts should make for a competitive marketplace. The competitive glitch is the size segment of electricity generation open to competition. Roughly 70 per cent of total available generation comes from the government-owned Ontario Power Generation (OPG), leaving only a small portion of the market for private producers.

Does this explain why prices for electricity in the spot market are so low?

Historical spot market prices, shown in Figure 2, shed light on some of the pain that Ontario has experienced with high electricity prices. For example, take note of the year 2005 and the first six months of the open market. Since that period we have seen some considerable changes.

Figure 2: Ontario Monthly Weighted Average Electricity Price

It started in November of 2002 when, after just six months, the market started to come unraveled—at least in the eyes of the provincial government of the day. Electricity prices began averaging three to four times higher than what had been predicted and a quick decision was made to alter the market rules. This kicked off the process to create the first “Hybrid” electricity deregulated market.

Government intervention in 2002 led to the creation of two legislated government-sponsored rebates designed to act as price controls on Ontario Power Generation (OPG), still currently in place. The government sponsored rebates effectively fix the price for 75 per cent of electricity consumed by most industrial and commercial consumers, leaving only 25 per cent exposed to true market pricing. The price controls mitigate the risk in Ontario’s electricity market. Smaller consumers and those in the residential sector have been placed in a regulated rate plan that is adjusted bi-annually to better reflect the true cost of power.

With close to 60 per cent of electricity generated by low cost nuclear and hydro, just how much volatility can there be in the market? Volatility is certainly mitigated by the two rebate programs. However, there are remaining merchant plants that continue to set the market price at certain times, and with natural gas generation quite often setting the price there are still instances of prices exceeding the 8¢/kWh threshold.

But, let us not forget one important point about Ontario’s electricity market: when it first deregulated, there was a staggering debt of some 3.6 billion dollars in the system. This debt is now off the Provincial Governments books, is administered by a separate company (Ontario Electricity Financial Corporation) and is being repaid through the Debt Recovery Charge, collected from every rate payer. Here is some simple arithmetic to ponder, provided in Table 1: if we take the 3.6 billion dollars and spread it out over 10 years—adding 3.6 billion dollars to each year’s total electricity production costs—the impact on the annual average price is striking.

Table 1: Comparing the Annual Average Market Price of Ontario Electricity with and without Debt Repayments

So what’s in store for Ontario? On one hand, the ever changing economy is a big concern as demand for electricity has recently been on the decline. Supply, on the other hand, is booming with the anticipation of 4,000 MW of new gas fired generation coming on line in the next 18 months, an additional 1500 MW of renewable energy, some 3,000 MW of Conservation and Demand Management and a commitment to phase out 6,400 MW of coal fired generation by 2014. Pending environmental legislation is also on the horizon and will undoubtedly add to the cost.

Alberta’s Electricity Market:

Alberta, on the other hand, has been functioning as a truly free enterprise market, with a dozen or so merchants operating 88 different generating stations. The generation mix however, is not as well-balanced as Ontario’s and is roughly one third of the size, with a total capacity of 11,500 MW.

Figure 3: Alberta Power Generation Mix

The heavy reliance on Coal and Natural gas fueled generation has not been good for Alberta and has created a volatile situation that has put a lot of pressure on the power pool pricing. Power pool pricing is the hourly price for electricity set by the Alberta Electric System operator and is comparable to Ontario's default, “Hourly Ontario Electricity Price.”

Alberta has experienced a series of problems with the fleet of coal generation plants, specifically relating to unplanned outages. This problem is largely due to the fact that these units are old and little has been done to upgrade them to meet today’s standards. As a result, we have seen large swings in the pool price whenever there are extreme weather conditions and the base load coal plants are unavailable.

Prices in Alberta are much more volatile and generally higher (Figure 4). Alberta’s historical average price at 6.79¢/kWh, sits 20 per cent higher than Ontario’s historical average price at 5.62¢/kWh (not including any debt value).

Figure 4: Alberta Weighted Average Electricity Price

Alberta has taken steps towards environmental responsibility and passed its own environmental legislation. The legislation set intensity limits for a specified group of large emitters which calls for substantial penalties if they fail to comply with the legislation.

Alberta’s outlook for commerce and industry may be very promising, but from the standpoint of electricity supply, things are looking somewhat bleak.

The shape of the supply and demand curve indicates trouble ahead, with industry experts anticipating a two and a half per cent rate of annual growth (equates to 250 MW per year). There has been little new expansion or additional capacity planned for the province. There is no relief in sight until the latter part of 2010, when the new 450 MW Keephills 3 project should come on line and in 2011 when an additional 1200 MW of gas fired generation from Enmax is expected. Until then, prices will likely continue to hover in and around the historical average price of 6.79¢/kWh.

Alberta is also fundamentally different in that the market has continued to thrive without any government support through rebates or price caps. By allowing the market to manage itself, a fairly liquid forward market has developed that creates space for consumers to participate in various hedge products to manage their electricity portfolio.

This leads us to the next market dynamic, natural gas pricing? With close to 40 per cent of the generation mix coming from natural gas it is no surprise that there is a strong correlation of natural gas prices to forward electricity prices. This is most evident in the forward price curves shown in Figure 5.

Figure 5: Forward Prices Comparison: Electricity and Natural Gas

It is interesting to note that this effect is also holds for forward prices for Ontario, where the marginal cost for On Peak electricity is set by natural gas. As you read this article the world is experiencing an unprecedented increase in crude oil pricing which has dragged along natural gas prices with it. The impact is staggering, yet one must ask: are these price levels truly sustainable? And, if so, is it time for a new era in the energy markets?

Win, Lose or Draw?

Which one is poised to come out the winner? It is a tough call and perhaps one that cannot be made just yet. One thing we do know is that industry and commerce are powerful forces in this country, as is the drive to be successful. If there is opportunity to be had in Alberta, it is only a matter of time before someone steps up to the plate and takes it. Perhaps Ontario has had its day in the sun, but the sun always rises each morning...

It seems, for the time being, we have to call this one a draw.