The long road to privatization of Hydro One

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Ontario Premier Kathleen Wynne is poised to embark on one of the largest privatization gambits in province's history, selling off part of a Crown corporation that has bedevilled her predecessors. Her goal: to rationalize the province's electricity market with a major reform and find money to pay for her many infrastructure projects.

Three previous premiers have considered selling ownership stakes in Hydro One Inc., which runs most of the province's electricity transmission and distribution to some 1.4 million customers. However, previous truncated or abandoned efforts, and other missteps, have left Ontario's electricity system struggling to cope with inefficiencies and competing demands.

Now, Ms. Wynne is eyeing an initial public offering of the company. The plan is to use the money raised from the IPO to help fund her ambitious $29-billion program of new subways, rail lines and roads and to spur consolidation of province's patchwork of local electricity distributors. With an estimated value between $15-billion and $16-billion, Hydro One is an attractive target for privatization.

Privatization of government-owned entities has a mixed history in this country. It has worked for companies such as Potash Corp. of Saskatchewan and Canadian National Railway Co., while the long-term lease of Ontario's Highway 407 to private interests has led to increased costs for consumers and less money for government. Some private power deals in Ontario – including the cancellations of two gas-fired power plants – have also added to electricity rates.

Ms. Wynne's plan is certain to meet opposition from the unions representing Hydro One workers as well as the NDP, who characterize the plan as a proposal to enrich big business while depriving the province of a long-term revenue source.

The Premier must also please investors who argue the government should privatize the entire operation, giving stakeholders more control over the business. Hydro One also has enormous pension costs, with employees putting in only a fraction of the money needed to cover their benefits, with hydro ratepayers and the government picking up the rest. Many believe it will take a private owner to negotiate more forcefully with the unions.

Asked whether Ms. Wynne has the resolve to push forward where others have balked, Infrastructure Minister Brad Duguid said Friday: "This Premier has the steel to make these decisions. She's determined to ensure that we get full value out of those assets, not just for the sake of doing so, but to make sure we have the ability to invest in building a stronger province."

Staggering toward privatization

The roots of Ontario's electricity privatization woes date back a generation, when Ontario Hydro was the province's all-encompassing utility. In the early 1990s, power prices skyrocketed, along with the size of Ontario Hydro's debt, due to massive cost overruns and delays in the construction of the Darlington nuclear facility east of Toronto. In 1993, the NDP government of Bob Rae froze energy prices and they remained frozen for nearly a decade. By 1999, Ontario Hydro's $38.1-billion in debt accounted for about a third of total provincial borrowings.

Mike Harris promised sweeping changes to reform the electricity market when his Progressive Conservative Party swept to power in 1995. Under his watch, Ontario Hydro was split in two, with one part holding its generation assets (Ontario Power Generation) and the other owning its transmission business (Hydro One). Eventually, Hydro One became the province's biggest distributor, buying utilities from many rural municipalities.

The big test came in 2002, when the government unfroze prices and prepared to sell Hydro One in an IPO. However, it was an unusually hot summer and excessive electricity use caused prices to spike. Facing widespread backlash, new Conservative premier Ernie Eves cancelled plans for an IPO and, in November, 2002, again froze electricity rates. The province was left with a botched, unfinished privatization effort and no easy solution to the hydro debt burden.

"Our attempt to create competition in one segment of the industry [power generation] where it's feasible, frankly, failed," said Michael Trebilcock, who worked on an Ontario government committee in the late 1990s to prepare for the market reforms that ultimately fell short.

Dalton McGuinty's Liberals, who replaced Mr. Eves's government in 2003, continued to toy with privatization of Hydro One. In 2009, they hired bankers to evaluate the possibility of selling parts of the province's Crown corporations, but those plans did not materialize.

The province did, however, move ahead with private power generation. As part of a larger push to close coal-fired power plants, the government contracted various companies to build gas plants. While most of these deals came to fruition, two of them went spectacularly wrong because of political interference. In the lead-up to the 2011 election, the Liberals killed two unpopular plants in the suburbs west of Toronto in what was widely seen as a move to save local incumbent MPPs from defeat. The move cost an estimated $1.1-billion, much of it borne by ratepayers.

Another significant problem has been the inefficiency of the province's distribution system, with 70 local distribution companies and Hydro One selling power across the province. The resulting inefficiencies have kept rates high while taxes and red tape make it difficult for municipally owned utilities to attract private investors.

The Wynne government, elected last year, has proven open to privatization. Wary of the mistakes of the past, she was determined the process should be well-thought out and protect the interests of ratepayers. Last year, she appointed former banker Ed Clark to lead a study of government assets and figure out how the province could extract the most money out of them without giving up control. Mr. Clark's team, which includes former Ontario cabinet ministers Janet Ecker and Frances Lankin, has become a quasi-arm of government, working closely with Ms. Wynne and a handful of senior ministers, including Mr. Duguid, Finance Minister Charles Sousa and Energy Minister Bob Chiarelli.

Their original recommendation for Hydro One, unveiled last fall, was to hive off the distribution arm of the company and sell part of it to the private sector while leaving transmission in government hands. The more recent idea, keeping the company intact and selling shares on the stock market, came after potential investors encouraged them to consider other options, and after unions, who are opposed to any form of privatization, signalled they would prefer keeping Hydro One whole than splitting it up.

The final recommendation is expected to go to cabinet in April, and be formally unveiled with the budget, expected shortly thereafter.

'A mixed bag'

Public ownership of the electricity sector has been fraught with challenges for decades. The business of generating and transmitting energy is often seen as a natural monopoly, while distribution is not. But the political will to sell even part of the business often runs into stiff public opposition.

For example, former Hydro-Québec CEO André Caillé acknowledged it would make sense to privatize the utility's distribution arm – an asset he estimates is worth more than $6 billion. But he added that will likely never happen. "Quebeckers see Hydro Quebec as a big achievement and [believe] it should not be touched," he says.

In contrast, the electricity business in Alberta has been the wheelhouse of public companies and even foreign investors. Last year, Berkshire Hathaway Energy, the power and utility arm of Warren Buffett's conglomerate, bought AltaLink, the province's largest electrical transmission company.

The most obvious forerunner for what Mr. Clark and Ms. Wynne are contemplating was the privatization of Halifax-based Nova Scotia Power Corp., the province's electric generation, transmission and distribution giant.

In 1992, Nova Scotia premier Donald Cameron wanted to improve the province's credit profile by moving the utility and its $2.4-billion in debt off the balance sheet. The original plan was to sell more than half the company in an IPO so it could fund itself on the market. Nova Scotia eventually sold the entire utility in a share offering worth more than $800-million and the company's named changed to Emera Inc. in 2000.

Two decades later, Emera has been successful in many ways. The company is financially solid and has expanded into the United States and the Caribbean. Still, Nova Scotians pay among the highest prices in the country for power.

"I think that experience is something of a mixed bag," energy consultant Tom Adams said. "Although Nova Scotians pay high energy prices, Emera and Nova Scotia Power are good corporate taxpayers."

Ms. Wynne is calculating that a partial privatization – for which there is little precedent – will be a compromise everyone can live with. Investors will be able to own a piece of a good asset while government retains control, placating the fears of customers and keeping the unions satisfied.

However, investors are unlikely to pay top dollar for the company's stock if the government retains control, Mr. Trebilcock warns. "This complicates the picture. You have to think of private investors as the government retains an influence over the way things are run," he said. "The government may have all kinds of non-financial objectives that it could impose these on the enterprise."

Leo de Bever, who worked for Ontario Teachers' Pension Plan Board in the early 2000s, when it bid to buy Hydro One alongside the Ontario Municipal Employees Retirement System, said such a deal would be more like investing in a bond, because there might not be the growth in Hydro One that he would expect from an equity investment.

"You can't have it both ways: controlling the assets and not owning it at the same time. Selling means giving up control and relying on fair regulation to balance public and private interests," he said.

The unions, meanwhile, have been running anti-privatization ads, pointing to previous troubled power privatizations and arguing a sell-off will mean higher rates.

Ms. Wynne's government is vowing to stand firm. "We believe we have the right rationale for doing this in the first place," one senior government source said, arguing the plan would be to shift dollars from one government asset to a new use, infrastructure. "That rationale is important. We know why we're doing this and we know why it's worthwhile to do."