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SUMMARY OF OPTIONS


The government asked us to invite comments on its discussion paper Electricity in New Brunswick - Beyond 2000 and to submit a report on options to a Select Committee of the Legislative Assembly. Accordingly, it is beyond the mandate of this task force to make specific recommendations or to map out a detailed course of action. Our task was to survey stakeholders and others to ascertain whether there was a desire to change the current electricity system and, if so, in what direction.

The electricity industry is extremely important and complex. Change must be made with a great deal of thought and after consultation with stakeholders. It also requires the assistance of professionals who have been through the process of change in other jurisdictions.

This report deals with the status quo by outlining its advantages and disadvantages and provides options for change. However, much work remains to be done if change is to be introduced, if only because any new plan must be detailed and comprehensive. For example, one cannot contemplate selling generation assets without setting out the new regime in which private generators would operate. If firms wanted to buy some part of NB Power's generation, they would want to know how they could transport their electricity to market, at what price it could be sold and under what terms it could be exported - or, for that matter, could it all be exported? Accordingly, the whole structure must be clearly spelled out.

While the maintenance of the status quo - NB Power operating as a monopoly provider of electricity in New Brunswick - is possible, we believe that it is problematic. The energy world, particularly electricity, is changing rapidly all around New Brunswick. Based on what we heard, we do not believe that it is in the interest of New Brunswickers to try to build a protective wall around the province. In addition, NB Power is confronting important financial challenges and uncertainty around its nuclear power plant. It is for these and other reasons outlined in this report that we believe that the status quo is fraught with problems and that it would potentially inhibit future economic development prospects in New Brunswick. Some of New Brunswick's largest employers, such as those in the pulp and paper sector, spend a large portion of their operating budgets on electricity. Electricity for these firms has always been an important factor determining their competitiveness, and for reasons outlined elsewhere in this report, the cost of electricity will become an even more important factor in the years ahead. All of this suggests that embracing the status quo could serve to inhibit New Brunswick economic development prospects.

If, however, the Select Committee of the Legislative Assembly and the Government of New Brunswick decide they would like to maintain the status quo, then several options should be considered. NB Power, for example, could be directed to operate like a private sector entity. Given the financial position of NB Power (including the contingencies introduced for Point Lepreau), a very substantial infusion of capital will likely be required. In addition, corporate governance issues would need to be addressed. To be sure, the provincial government has taken important steps in recent years to give NB Power considerable room to operate like a private business. It should continue this process and provide NB Power the freedom to operate effectively in a competitive environment. To do this, the government may opt to incorporate a new NB Power under the New Brunswick Business Corporations Act and to become its sole or principal shareholder. The purpose would be to transform NB Power into a commercial business enterprise with the overall mandate of maximizing shareholder value. As a commercial enterprise, it would have to put in place profitability targets, dividends policy, retained earnings policy and debt coverage action. In turn, the management would be free to manage as it sees fit and be held accountable for its decisions, activities and performance. In addition, in order to ensure that our power can be sold in other jurisdictions, it may become necessary to provide greater reciprocity of access together with independently regulated transmission rates.

If, however, the Select Committee of the Legislative Assembly and the Government of New Brunswick should decide that the status quo is either not viable or not the best way to go forward, taking into account changes which are occurring around us, then a series of options is available. These are outlined below, as items 1 through 10. But, first, we want to review three questions which, in our view, define the agenda for change.

Public Versus Private Ownership
The debate over whether New Brunswickers can better be served by the public or private sectors in generating, transmitting, distributing and marketing electricity can never be settled to the satisfaction of all New Brunswickers. The debate speaks to issues of political ideology, history, change and economic interests.

What we can report is that independent studies have been carried out to determine which sector is more efficient in specific cases where the activities were privatized. There is no denying that the private sector comes out on top in the majority of cases in terms of economic efficiency. But there are other issues, including level of services and the pursuit of public policy objectives, which cannot be ignored. We also note, however, that by its own admission NB Power does not have the financial and human resource skills (i.e., commodity marketing, retail merchandising, and energy risk management skills) to compete in a deregulated marketplace.

It is beyond our mandate to take a position in the debate. That said, we do wish to point out once again that the original public policy objective of establishing a crown corporation to generate and distribute electricity everywhere in the province at a postage stamp rate has been met. As noted elsewhere, the objective can now be maintained through regulations.

New Brunswickers can also profit from the experiences of other jurisdictions that have opted for privatization. Important lessons have been learned, putting New Brunswick in a position to avoid mistakes made elsewhere should it decide to privatize the assets of NB Power, either in whole or in part.

Notwithstanding any mistakes made, we know of no jurisdiction, which having opted for privatization, is now seeking to reverse direction. Indeed, it appears that privatization is firmly taking root wherever it has been introduced.

Last, if the Government of New Brunswick wishes to introduce a "deregulated and competitive environment" in the electricity sector, then it will wish to look at selling some, if not all, of NB Power's assets to the private sector. We believe, for example, that careful consideration should be given to selling generation assets.

Monopoly Versus Competitive Market
The overwhelming view presented to us during the consultation process was that monopoly market structures are much less likely to result in competitively priced electricity than open, competitive markets. In a competitive market, participants compete on the basis of price and service. If the Select Committee and the Government of New Brunswick decide that a key objective is achieving competitively priced electricity, then it follows that the market should be made open and competitive. For generation, this would involve opening the market to independent power producers, to co-generation projects and to out-of-province suppliers. For the wires business, it would involve providing open, non-discriminatory access to the transmission and distribution lines on a transparent costs basis. Finally, it would also involve licensing marketers to compete in selling electricity to all customers in New Brunswick.

Integrated Versus Segmented Industry
The wires business should remain a monopoly business, controlled by a regulator (which is, in turn, responsible to the government). The generation and marketing businesses are ideal for competition. To maximize competition among multiple participants in the generation segment, it is important that the generation and wires businesses be owned by separate companies. Allowing generating companies to control the wires business could preclude having a level playing field for competitors. It appears to be less important to separate the wires business from the marketing business. The overriding consideration for competition is that all participants in the electricity system should be allowed equal access to the wires on a transparent costs basis.

Options for Change

1. Generation

Privatizing NB Power's generating assets would involve a number of issues. It would be important to ensure that these assets would continue to be available to serve the needs of New Brunswick, and that a competitive market for electricity supply would be created. If the privatization of generating assets is pursued, we strongly urge that further study be carried out to ensure that the above objectives are met. It seems likely, however, that sale of NB Power's generating assets to a single buyer would not maximize competition, even taking into account the competition which would come from independent in-province producers, from co-generation, and, through interconnects, from suppliers outside the province.

2. Point Lepreau
The future financial health of NB Power is dependent on Point Lepreau. NB Power's Business Plan for 1997-2002 assumes an operating rate at the nuclear station of 85 percent. Based on recent experience, this rate may well be extremely difficult to attain. And failure to meet this operating rate could have a substantial effect on NB Power. The consulting firm Hagler, Bailly has produced a report on the remaining useful life of the facility, but, as already noted, we have not seen this report. However, based on reports of its contents, it appears that NB Power, together with the government, will need to evaluate the implications for the future of Point Lepreau. If Point Lepreau does not operate beyond 2008, $450 million of its capital value will remain unamortized. The financial implications are significant.

Given these uncertainties and the questions regarding the permanent disposal of spent fuel, together with the decommissioning costs of the facility at the end of its useful life, we believe that it would be extremely difficult to privatize Point Lepreau at this time. We did hear input regarding how the public sector elsewhere is dealing with nuclear facilities. In some jurisdictions, private firms, whose portfolios of businesses involve the operation of nuclear facilities, are brought in to operate nuclear plants. The relationship has been to engage these companies to operate and manage the facilities, taking the risk of operation, but leaving the existing liabilities with the current owners. The objective of such arrangements is to reduce operating risks to the owner and to enhance performance and safety.

3. Wires
The wires business will, in all likelihood, remain a monopoly and, as such, must be regulated through a government-controlled regulator. The ownership of the wires business, whether by NB Power or in private hands, is, in our view, largely a financial question for the Select Committee and the Government of New Brunswick to consider. It does not impact the competitive structure of a new electricity market. A sale of the wires business may generate a profit which could be used against potential stranded costs. The benefit of such a profit should be weighed against the transmission rates that would be necessary to provide a market return to the new owner. Regulation can be provided through a detailed study of the operation of the wires business in other jurisdictions. Regulations could cover rates for transmission within, into, out, and through the province. This is essential to ensure that competition can come from both inside and outside the province. Transmission rates should be based on cost, with the possibility of premium pricing where demand outstrips available transmission capacity. Regulation should also require maintenance and the building of new lines as part of an obligation to provide service. Returns to the owner of the wires business should be incentive-based to ensure that the owner is motivated to keep rates as low as possible.

4. Marketing
Multiple marketers would enhance competition. Marketers would need to be assessed (possibly through the Public Utilities Board) to ensure that they have the financial strength to meet obligations. All customers should have access to choice. Experience in other jurisdictions suggests that, should New Brunswick opt for multiple marketers, it should phase in marketing competition, so that the system learns to cope as it grows. Large-scale users are few, and for this reason, many jurisdictions have introduced competition at this level first. A mechanism must be designed to ensure there is a default supplier who will serve any customer on a standard offer basis.

5. Technical Implementation
An Independent System Operator is essential to ensure the electricity system continues to operate reliably and safely with multiple participants. In the interests of efficiency, the ISO could be part of the wires business. But, if the wires business is privatized, it may be appropriate to have the ISO set up as a government-owned entity. In addition, a marketplace would be needed for buying and selling electricity. This power exchange or PX could also be part of the wires business. Again, if the wires business is privatized, it may be appropriate to have the PX and ISO as a government-owned entity. We received very little input on the question of the PX - whether it would operate on a pool basis or by matching bilateral arrangements. It is, therefore, an area requiring further study.


6. Stranded Costs
All participants in our process recognized their responsibility for stranded costs, if they should arise. Accordingly, such costs should be borne through the tax system, or as a user cost through wires tariffs, or, for users leaving the system, through an exit fee. User fees tend to be regressive and to temporarily distort energy choice because of the added cost. Income-based taxes tend to be progressive and do not distort energy choices. If the Select Committee and the Government of New Brunswick consider the exit fee principle to be appropriate, the structure should be designed to ensure that no party is able to gain a financial advantage by leaving the system before all stranded costs are paid for.

7. Environment
We can hardly overemphasize the importance many of the representations made before the task force attached to environmental issues. While a competitive market may address demand management issues through creative pricing options, the Select Committee should explore ways to promote demand management more aggressively. It is probably not wise to rely exclusively on the participants in the electricity system to promote demand side management. A number of options exist. The government could ask the Department of Natural Resources and Energy, or the Department of the Environment, or, perhaps, it could contract with private firms or non-profit groups, to provide the service. Participants also made a number of other important points about energy and the environment and the reader can review them by reading the environment section of this report.

8. Cross-subsidization of Residential Rates
Everyone, including NB Power, acknowledged that cross-subsidization exists within the residential class and flows to the residential class from all other classes. Cross-subsidization within the residential class provides for "postage stamp" rates, ensuring that all residential customers pay the same wires charge for electricity, regardless of where they live in the province. All stakeholders in our process agreed that postage stamp rates should be maintained in an open and competitive market. This will continue to be possible through the regulation of the monopoly wires business.
Cross-subsidization to the residential class, which the government's discussion paper detailed, is more difficult to maintain in an open and competitive market. This form of cross-subsidization is principally based on differential generation costs for each class of customer because of peak usage requirements. In a competitive market, the price for electricity (as opposed to the wires charge) will be set by the market. The PUB has already set an objective for NB Power to reduce the level of cross-subsidy to the residential market. While we heard no objections to the principle of reducing this form of cross-subsidization, concern was expressed to ensure that it is phased out over time to avoid rate shock.

Finally, if the Select Committee and the Government of New Brunswick decide they would like to provide cross-subsidies to specific groups of residential customers, such as low income or disabled people, the burden for doing so should rest with the government. It can do so through its own budget process rather than asking NB Power or the new participants in an open and competitive electricity industry to do so.

9. Natural Gas
If the Select Committee should conclude that additional energy sources will enhance competitiveness in the electricity market, it may wish to recommend that a public process be used to study how best to introduce natural gas into the New Brunswick marketplace to the greatest number of customers. Based on the information which was presented to us, natural gas holds a number of distinct advantages. It offers environmental benefits over many of our current forms of generation. It is also the most cost effective method of conventional production of electricity. Generators should be encouraged to utilize this method of generation - particularly to replace aging and environmentally unfriendly NB Power generation facilities.

10. Methods of Privatization
If the Select Committee and the Government of New Brunswick decide that privatization of all or part of NB Power is appropriate, there are a number of ways that the sale (or sales, if privatized in parts) could be effected. These include: an initial public offering of shares, an income trust, a private sale, and an operating and management agreement. As we noted, the optimum structure is a function of the objectives of the process (for example, maximizing value or keeping long-term power rates low). Having met with a number of professional advisors involved in similar processes in other jurisdictions, we believe that their creativity could add greatly to the process. Without the experience of other jurisdictions, we risk problems associated with "re-inventing the wheel."



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