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In considering the various options available, we should bear in mind what the Government of New Brunswick said in its discussion paper, Electricity in New Brunswick - Beyond 2000: "One of the Government's key objectives is to create and maintain jobs through competitively priced electricity for the people and businesses of New Brunswick while ensuring safety, reliability and environmental protection."

It is interesting to note that no other objective is identified in the discussion paper. So, the primary goal in mapping the future of the electricity industry in New Brunswick is to ensure a competitive market while maintaining a number of factors that are potentially in conflict with that objective. We have, accordingly, cast our views on the options for restructuring in that light.

The discussion paper does not set forth as an objective maximizing the return from any privatization. Maximizing the return may well provide a contrary result to "competitively priced electricity." For example, if NB Power were sold to a single private buyer, turning over the government-owned monopoly to a private owner, proceeds may well be maximized. The private owner would then be in a strong position to exercise market dominance (to the detriment of customers) and therefore would likely pay more for that privilege. But in accordance with the government's objective, we have only looked at options in the context of proceeds from any privatization remaining subsidiary to the question of competitively priced electricity.

As we have indicated earlier, the status quo may no longer be sustainable. That being the case, change can be evaluated on three bases:
1. Ownership (Public vs. Private)
2. Market Structure (Monopoly vs. Competitive)
3. Business Structure (Integrated vs. Segmented)

In looking at change, we must always keep in mind which question we are addressing. Each has a set of issues and objectives which will best be met by certain structures.

1. Ownership

Business ownership, whether "public" (meaning, by government) or "private" (by private interests), brings benefits of control and potential profit to the owners - but also the burden of risk and potential loss. In an earlier section, we discussed the contrasts between public and private ownership. Both offer certain advantages while, at the same time, labouring under certain disadvantages. For the private owner, the disadvantages include the increased cost of capital the owner requires to support the business. (Debt interest rates are higher for the private owner than for government; more important, equity capital is more expensive than debt capital, as equity investors require substantially higher returns than debt investors.) And the private owner must pay taxes.

In the context of competitiveness, the issue of private versus public ownership reduces to the question of whether the efficiencies typically achieved in the private sector outweigh the burden of costs of capital and taxes which the private sector bears. The world-wide experience with privatization, not only in the electricity industry but over a wide range of businesses, tends to support the view that, on balance, private enterprise is more economical and therefore should best be able to provide competitively priced electricity to customers. In our consultations, we were given numerous examples from around the world to support this view.

We recognize that the control which public ownership brings is important in supplying an essential commodity like electricity. But the ability to execute public policy mandates, such as cross-subsidization of electricity rates and the obligation to serve all parts of the province, can be achieved through a regulatory regime. Through new regulation, the government could exercise public policy mandates and require the operator of the monopoly wires business to comply and to pass along the related costs to the customer. (Currently, public policy mandates are exercised by the government through their ownership of NB Power and the costs are effectively incorporated into our power rates.) The regulatory regime can also be revised from time to time so as to remain responsive to current conditions.

2. Market Structure
A monopoly market stands at the opposite end of the spectrum from a competitive market. Given the government's objective of "competitively priced electricity," our view is that the market needs to be competitive, not monopolistic. In this section, we analyse NB Power in terms of its component parts and assess which of those parts might fit into a competitive market structure.

As already noted, the electricity system consists of the following parts: generation, transmission (the high voltage wire transport system), distribution (the wire transport system from the transmission lines to customers), and marketing. The transmission and distribution functions are often referred to as the "wires" business. Marketing is the sale of electricity, either wholesale (in which customers such as Saint John Energy, the City of Edmundston, and outside utilities purchase electricity for resale) or retail (in which customers purchase electricity for their own use). This last group, the retail customers, includes: large-scale industrial users, such as pulp and paper mills, mining operators, and an oil refinery; medium-scale users, such as food processors, small manufacturers, stores, schools and hospitals; and small-scale users, such as residential customers.

Generation is the process of producing electricity from primary energy sources. NB Power generates electricity by using water flowing from behind dams (hydro), by burning fossil fuels, such as oil, orimulsion and coal, and by nuclear fission. NB Power also buys and sells electricity to balance its needs and its generating capacity.
Like all manufacturing businesses, generation is generally thought of as a natural business for competition. Through competition, generating companies (abbreviated "Gencos") compete with each other to supply marketers with the least expensive electricity. If one Genco is not competitive, the marketer will buy electricity from another. In other words, market discipline is used to create a competitive electricity market.

If the generating segment of New Brunswick's electricity industry is to be made competitive, a number of issues have to be dealt with:
o Security of supply
o Competitive market
o Co-generation
o Stranded costs
o Point Lepreau Nuclear Generating Station

The question of privatizing NB Power's generating assets applies to both the conventional generating facilities and the Point Lepreau nuclear generating station. However, because a number of unique issues relate to nuclear generation, we shall deal with Point Lepreau separately.

Security of Supply
If NB Power's generating assets were privatized, agreements would have to be put in place to ensure that electricity generated within the province would remain available to us, at least until competitive sources are brought on stream. Marketers, which may still include NB Power, would be required to secure contractually, with appropriate creditworthy guarantees, adequate supplies of electricity. We should add that our border interconnections with adjacent jurisdictions - as a percentage of our total system capacity - are the greatest of any utility in Canada. The interconnections are a major avenue to ensure adequacy of supply from out-of-province suppliers. NB Power has confirmed to us that "it would indeed be possible to contractually secure all reasonably expected additional electricity requirements through Hydro Quebec and Nova Scotia interconnections."

Competitive Market
The concept of a competitive generating environment requires a separate study to ensure that competition is maximized while, at the same time, our core interests are protected. A sale of all of NB Power's generating assets to a single entity would not maximize competition. To replace a government-owned monopoly with an effective private monopoly would not serve the government's objective.
Competition can come from a number of sources: there could be multiple owners of NB Power's generating assets; independent power producers (IPPs) could be allowed to generate electricity inside New Brunswick, or to sell into the province from outside; outside utilities could also sell into the province; and there could be co-generation, in which a private company generates power for its own industrial operations, selling its excess electricity into the grid.

In relation to United States-based generators as possible suppliers of electricity to our competitive internal market, it should be noted that our direct interconnections through Maine allow the total transfer capability of 820 megawatts to Maine, but only 180 megawatts from Maine. We understand, however, that overcoming this obstacle would not be a major undertaking.

We are also aware that line loss in the transport of electricity, and the cost of using transmission lines for transport, create two additional costs which outside suppliers would either have to absorb, giving them lower profit margins, or pass on to customers by means of higher prices. But if, as in the case of electricity bought from Hydro Quebec, generation costs are low enough, these additional transport costs may be incorporated into pricing and the price could still be competitive with domestic suppliers.

It should be noted that, while the price of electricity in U.S. markets appears to be significantly higher than ours, the selling price for our electricity is below our cost of production. (As noted earlier, NB Power has been losing money for the last three years on an operating basis.) With deregulation of many markets in the United States, private generators are becoming increasingly efficient and will look to all markets to sell electricity. Eventually, competition can be expected from the U.S. market.
The ability to achieve a competitive market varies, depending upon customer class. For large industrial customers, a competitive market may be achieved by allowing co-generation and out-of-province generators access to those customers. But load pocket considerations (i.e., demands in a specific area), peak usage patterns, and the sheer number of residential customers make competition for residential customers more difficult to achieve.

In summary, if the objective is to achieve competitively priced electricity, this is likely to occur with the maximum number of suppliers to the marketplace. Accordingly, consideration should be given to opening the market to all suppliers.

A typical co-generation arrangement would involve a private company building its own generating facility, using the electricity (and heat) it needs, and selling the balance to a utility at an agreed price. That agreed price is often defined as the "avoided cost" - the cost the utility would otherwise have paid for an equal amount of electricity.
At present in New Brunswick, no one is allowed to operate a generator in excess of 500 horsepower without approval of the New Brunswick Cabinet. Thus, generation remains essentially a legislated monopoly for NB Power. We were not advised of any other jurisdiction in North America where this is the case. Several participants in our meetings expressed a strong desire to co-generate power.

Allowing a current customer of NB Power to co-generate has several implications. With natural gas and the latest generating technology, a customer may be able to generate electricity more cheaply than it can be obtained from NB Power. But if NB Power's generating capacity is no longer used to supply that customer, that unused generation, if it cannot be economically sold, becomes a burden on NB Power. This may give rise to what is known as a "stranded" cost. At the same time, however, the possibility of co-generation - if accompanied by elimination of the legislated monopoly - could ensure that any new generating facility would be built on an economical basis. In this way, co-generation could provide a competitive element to the supply of electricity in New Brunswick.

Stranded Costs
Many definitions can be found for the term "stranded costs." Essentially, they are the costs a monopoly utility like NB Power incurs in meeting its obligation to serve customers - costs which, in a subsequent competitive environment, might not be recovered. The main potential for stranded costs will arise from NB Power's generating assets (its biggest investment). But before we can ascertain whether stranded costs will indeed arise, we must look at all of the NB Power assets which might be privatized. Some may well be worth more than their book value, and some may be worth less. If all of these assets were privatized, and were sold below their total net book value, then stranded costs would arise.

So the question becomes one of whether the efficiencies of the new market will, in economic terms, outweigh the stranded costs, if any, of the old investments. The jurisdictions which have opted to open their electricity markets to competition have generally concluded that the short-term pain of stranded costs are outweighed by the long-term benefits of a competitive electricity market. A more detailed discussion of stranded costs and their recovery is dealt with in the Change Issues section of this report.

Point Lepreau Nuclear Generating Station
Nuclear generating facilities around the world have always engendered a high degree of public controversy. Of late, things have taken a turn for the worse. A significant number of those facilities have been in the news recently with shutdowns, operating problems, and questions about their future operations. Point Lepreau has been no exception.

While we were writing our report, a report on Point Lepreau by Hagler, Bailly, a consulting firm commissioned by NB Power, was completed. We did not receive a copy of that report and did not wish to delay the release of our report by reviewing it in detail. However, in discussions with NB Power, we understand that, according to the consultant's report, Point Lepreau is not expected to operate beyond 2008 without substantial new investment. NB Power has advised us that $450 million of the original fixed costs for Point Lepreau will be left unamortized as of 2008. Accordingly, there has been a mismatch between the depreciation rates and the useful life of the facility. By 2008, if current depreciation schedules are still used, the total cost of producing electricity at Point Lepreau would be understated by $450 million. Incorporating that amount into cost calculations would have a significant effect on the price per kilowatt-hour of electricity produced at Point Lepreau.

Nuclear generation has high fixed costs and low variable costs. Conventional thermal generation has relatively lower fixed costs and relatively higher variable costs. To compare the relative costs of generation, proper amortization of fixed costs is essential. To compare only variable costs of generation is useful for generation dispatch decisions, but can be misleading for new investment decisions. The decision NB Power and the government will make regarding investing to extend the life of Point Lepreau beyond 2008 will involve a comparison between the total costs of electricity production at Point Lepreau and the total cost at an alternative facility.

We note that the recent federal government initiative to deal with permanent storage for spent fuel failed to identify a solution acceptable to all interested parties and ended this year without resolution. Such costs, therefore, remain unknown. However, we did note that the operator of Maine Yankee (a nuclear facility in Maine) is suing the U.S. federal government for US$125 million in connection with permanent storage for spent fuel at that facility. The potential numbers can apparently be quite large.
The above factors require us to address the question of Point Lepreau separately from the conventional generation facilities. No participant in our process, including NB Power, was able to cite an example of the sale of a nuclear facility anywhere in the world where all the benefits and risks have been transferred to a purchaser. We were advised that nowhere has the risk of the permanent storage of spent fuel, or the risk associated with decommissioning, been transferred to a buyer. When the British government privatized its nuclear facilities, a financial limit was put on the liability which the privatized entity, British Energy, would take. The balance of the liability was left with the government. The existing and potential future sales of nuclear facilities have been more akin to operating and management contracts, with the vendors retaining residual liabilities and effective ownership risk. The purchasers/operators do, however, take the operating risks. We understand that British Energy has been negotiating with Ontario Hydro on this basis. We also understand the potential "sale" of Boston Edison's Pilgrim nuclear facility is being put forth on a similar basis.

Finally, to reduce the concern expressed to us regarding the operation of Point Lepreau if it were transferred to private sector hands, we have been advised that the operation, whether by NB Power or a new operator, will still be subject to the authority of the Atomic Energy Control Board (AECB). AECB has a mandate from the federal government to regulate the operation of all nuclear facilities in Canada. Accordingly, the concern expressed to us regarding the potential for lower safety standards (in aid of higher profits) is so severely restricted by AECB as not to be an issue, in our view. We also believe that any private sector entity which would contemplate operating/purchasing Point Lepreau would likely have a very significant level of nuclear operating experience before they would risk the future of their company on such a contract. This expertise may well be a benefit to Point Lepreau operations.

Summing up, we believe that any privatization of Point Lepreau may not be a "sale" in the normal sense of the word. However, if NB Power's conventional generation facilities are to be privatized, we would be in favour of privatizing Point Lepreau to the extent possible to enhance operating performance through the private sector and to encourage competition in generation. If Point Lepreau has stranded costs associated with it, those stranded costs should be recoverable in the same manner as all other stranded costs, as detailed later in this report.

Transmission and Distribution (the "Wires" Business)
The wires business is a natural monopoly. It is impractical and inefficient to string two sets of wires for two competitors. Rather, it is more efficient to ensure the wires are operated by a monopoly regulated to ensure that the users of the lines (the Gencos, marketers and customers) get open, non-discriminatory access on a transparent cost basis, i.e., on a basis where the costs of the wires operator are open to scrutiny. The regulator is the appropriate way to provide scrutiny. A more detailed discussion regarding rates is found in the Change Issues section under "Regulator."
To ensure competition, access should be provided to generators to provide transmission within the province; into the province (to allow competition from outside suppliers); through the province (to allow transport of electricity through the province); and out of the province (to allow electricity generated here to be sold outside the province). These four types of access combine to allow maximum competition within the province and to ensure reciprocity with other jurisdictions. Through reciprocity, we ensure that electricity from outside the province is available to us and that markets outside the province are available to our generators. NB Power currently provides access for out and through transmission. Access for within and into has not been necessary because the current electricity system does not allow competition to NB Power in the province. Access combined with regulated transmission rates will provide the basis for a competitive electricity market.

In addition to providing the "roads" over which electricity is "transported," the wires business provides an extremely important function to the overall operation of a stable and reliable electricity industry. In their presentation to us, NB Power stressed the importance of the ancillary services the entire wires network (the "grid") provides. Unlike other forms of energy, which can generally be stored and used when needed, electricity in the grid must be maintained in balance at all times. Electricity is not elastic. As it is drawn off the system to be used, more must be added to maintain the balance. This is an area too complex to detail here, but we cannot overlook the importance of these ancillary services to a properly functioning electricity system. Any new regulatory regime must ensure that these services are always there, and that all costs associated with them are incorporated into the wires tariff. As North American utilities continue to tie into a common grid, these issues become increasingly complex and important.
All participants in the electricity system need to use the wires, so the wires business is the key mechanism government can use to effect public policy. For example, the government may wish to pursue environmental public policy matters, such as providing development funds for so-called "green power" and conservation-based demand management programs. The costs for such public policy programs may be appropriately levied on users of electricity, and the wires tariff mechanism provides the ideal mechanism with which to do so. Postage stamp rates for residential customers (discussed later) can also be effected through the wires tariff.

The wires regulatory framework does not need to be set in stone but, rather, should be flexible to adapt to changes in the industry. As such, it would remain the instrument by which the government could continue to influence and direct development of the electricity industry in New Brunswick. That being the case, ownership of the wires business, whether public or private, is less important. Again, the same analysis would need to be done as in the generation segment: will the efficiencies of private operators, less the burdens of private operators (cost of capital and taxes), outweigh any advantages accruing to the public sector? If the answer is yes, then there is no reason to maintain public ownership of the wires business.

Marketing is the business of finding a customer who wants electricity, buying electricity (either directly or indirectly from a Genco), and having that electricity delivered from the generation facility to the end user. In the current structure, this function is performed by NB Power, but is not visible to customers. With no competing marketers, NB Power does not need to market. If you want electricity, you simply call NB Power. The profit in the marketing business essentially lies in the difference between the buying and selling prices. Where there is no competition, there is no incentive to keep selling prices as low as possible.

Given the Government of New Brunswick's objective of ensuring "competitively priced electricity," creating a competitive marketing segment is a logical step. In a competitive marketing environment, customers would seek out the most competitive supplier. This would cause marketing companies to create efficiencies to reduce costs and perhaps to reduce their profit expectations. Global experience shows that marketers will also seek to add or "bundle" certain services (for example, a security monitoring service) to provide an overall competitive offering.

Based on the experience of many jurisdictions, the theory of competitive marketing appears much easier to deal with than its actual implementation. Two issues that must be addressed are: to which classes should marketing be applied and should there be a default supplier?

There are two basic categories of customers for electricity: wholesale (customers buying for resale) and retail (customers buying for their own or their corporate group's consumption). In defining these two categories, usage rather than volume is the relevant factor. So, even large customers are retail, rather than wholesale, if they are buying for their own use. In our view, competitive marketing should apply to both groups.

In New Brunswick we have only two wholesale customers, Saint John Energy and the City of Edmundston. Other wholesale customers for NB Power exist outside of the province, but we cannot control the marketing environment in those jurisdictions.
The retail customer base is much more difficult to deal with because it spans large numbers (residential), large users (the large industrials, such as pulp and paper mills, mining operations, and an oil refinery), and medium users (commercial customers, including food processors, small manufacturers, stores, schools, and hospitals). All customers want competitively priced electricity. For residential customers, uncompetitively priced electricity can range from being annoyingly expensive to life-threatening (as in the case of a low income family living in an electrically heated home in a cold winter). For manufacturing customers who operate in a global marketplace, uncompetitively priced electricity can be the cost which tips that facility into unprofitability. Such facilities, when owned by large corporations as part of a portfolio, are constantly reviewed with the aim of reducing overall corporation costs. This can lead to decisions to shut an expensive facility and to expand less expensive operations. In these cases, expensive electricity can be the difference between life and death for marginal facilities.

Based on the experience in other jurisdictions, large-scale users of electricity (both wholesale and large retail), particularly private sector businesses, are more price-sensitive and change marketers more readily. Accordingly, large-scale users generally call for marketing competition before residential users do.
We believe that all classes of customers should have access to competitive marketing as soon as it is technically feasible for each class.

Default Supplier
One of the most important concerns in moving to a competitive marketing environment is to ensure that every customer who wants electricity has the opportunity to get it. In the monopoly environment, NB Power has an obligation to serve all customers. In a competitive environment, this would not necessarily be the case - both the marketer and the customer would have to come to an agreement to ensure service. We would suggest that NB Power (that is, NB Power's marketing business) be obligated to supply electricity to customers who do not want to move to a new marketer, under a standard contract offer (approved by the regulator). This arrangement may only be an interim step until the new competitive market is fully operational. Further study, based on experience in other jurisdictions, is necessary to design interim and final forms of the marketplace.

3. Business Structure

The issue of a competitive market involves the question of whether electricity in New Brunswick should be provided by a single entity - an integrated utility, in which the businesses of generation, transmission, distribution, and marketing would be handled by a single company - or by several entities, where the businesses would be "segmented" into separate companies. With one exception, participants in our meetings were of the view that competition required separating the businesses. We were not informed of any jurisdiction seeking to create a competitive market that did not segment the electricity industry.
To examine the question of segmentation, we have looked at the relationships among the component businesses of an integrated utility.

Separating Generation from Wires and Marketing
Segmentation is most clearly appropriate for the generation part of the electricity business. At one end of that business, electricity is produced at a generating facility; at the other end, a customer receives and uses electricity. Most people acknowledge that, to promote competition in the pricing of electricity, it is necessary to have multiple suppliers/Gencos of electricity. A properly designed market will ensure that Gencos do compete, and, as electricity is a commodity, the competition will be on price. It would be possible to provide that competition by requiring NB Power to purchase electricity produced by IPPs on some formula (usually based on avoided cost, as explained earlier), but such a stage is generally seen as an interim step towards full competition. It was the first step the United States implemented in 1978 in initiating that country's move towards competitive electricity markets. With the benefit of that experience, other jurisdictions have moved directly to competitive generation environments. On balance, it seems to us the interim step of allowing IPPs to supply competitive electricity to NB Power is an unnecessary delay to full competition.

To maximize competition, the distributors/marketers should be able to purchase electricity from different Gencos and thereby create real competition among those Gencos. If NB Power operates the distribution/marketing business, while also generating electricity, an extremely strong bias will exist to purchase electricity "in-house," rather that from an outside Genco/IPP, thus thwarting real competition.
In the United States, combining generation assets with transmission assets has been viewed with great concern during the deregulation process because of the potential for market dominance. The Federal Energy Regulatory Commission has insisted on open and transparent access to transmission for all participants as a mechanism to enhance competition.

Given the above, we see separating NB Power's generation business from both the wires business and the marketing business as a logical first step in developing a competitive electricity market.

Separating Transmission/Distribution (Wires) from Each Other and from Marketing
The next questions relate to whether the wires business should be broken into separate entities for transmission and distribution, and whether these businesses should be separated from the marketing business.

As noted earlier, the wires business is, by its nature, a monopoly business. As such, it makes sense to have the wires business segmented from competitive businesses, such as generating and marketing. The same logic, however, does not apply to separating the two parts that make up the wires business - transmission and distribution. Both are monopoly businesses, although they perform different roles in the electricity industry, transmission being the conveyance of high voltage electricity, like a kind of limited access highway, and distribution being the conveyance of low voltage electricity, like the roads around towns. Both are absolutely essential to the movement of electricity. Accordingly, we see no reason to separate the transmission and distribution functions from each other.

Gencos and marketers must, in some way, share the cost of using the wires to transport electricity to their customers. In a competitive environment, access to the wires and fairness of the charges are essential to ensuring a level playing field for competing players. Allowing NB Power (or that segment of NB Power which performs the marketing function) to be a marketer in a competitive marketing environment, as well as controlling the wires business, may be seen as problematic by new marketers. If the NB Power marketer also operates the wires monopoly, concerns will be expressed regarding the fair treatment of the other marketers' customers. Will they receive the same level of service the NB Power marketer's customers receive? In addition, the status quo supplier has the advantage that residential customers are generally reticent to change to a new supplier unless the pricing differentials are substantial. In the absence of such a difference, they prefer to stay with the supplier they have known and relied upon for many years.
In jurisdictions where regulators have allowed a single entity both to operate the wires and act as a marketer, a code of conduct is usually introduced to ensure a level playing field (i.e., to ensure that the wires company provides the same level of service to all customers). We are aware of the success in deregulating the long distance business in the telephone industry, where the wires business was not separated from the competitive long distance marketing businesses. On balance, we believe that if the Select Committee and the government would like to keep the wires business and NB Power's marketing functions together, with an appropriate code of conduct, it should not inhibit the development of a competitive market.

While we noted that in some jurisdictions the wires business is separated between the transmission business and the distribution business, we were not provided with any arguments to do so in New Brunswick. In many jurisdictions, local distribution/marketing companies (e.g., Saint John Energy and the City of Edmundston) own the distribution systems and are also marketers. Based on our view that, with a proper code of conduct, one company could own the distribution network and be a marketer, we see no reason to consider trying to put these local distribution functions into a provincial wires monopoly.

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