Benjamin Dachis is a senior policy analyst at the C.D. Howe Institute
The Globe and Mail reported Tuesday that the government of Ontario is contemplating selling a piece of Hydro One, the province's wholly owned electricity transmission and distribution company, jolting Queen's Park and markets. The province is on the right track in looking to privatize its electricity utilities; it could make taxpayers even better off by letting private investors take the lead in creating a private distribution or transmission system.
Hydro One has two main business units. The largest, by value of assets, is its transmission arm. That unit delivers electricity over long distances across the province. About three-quarters as large is Hydro One's local distribution business. Distribution companies deliver electricity on the last leg to homes and businesses. Hydro One provides that service for many rural Ontario customers, and in a few cities, such as Brampton.
Last year, the government created an Advisory Council on Government Assets, led by Ed Clark. In its fall interim report, the council recommended that the province look to consolidate many of the 70 municipally owned local electricity distribution companies, along with the Brampton business, in a new distribution business unit, in which the province over time would dilute its interest.
Premier Kathleen Wynne and her cabinet's new thinking involves acting faster and more aggressively than the council's recommendations, by selling shares in Hydro One itself, through a public offering.
What are the merits of that route, as opposed to the Clark panel's suggestion?
Numerous studies have found that smaller electricity distribution utilities have higher costs of operations than larger ones. Merging small distributors together would mean lower costs of operations. That could result in either lower prices for consumers, higher profits, or both. That suggests that after consolidating the distribution companies, the government could then sell its stake in a newly enlarged, and presumably more valuable, Hydro One.
There's a limit, though, to the savings from mergers. Distribution companies that grow very large do not have lower costs per customer.
And there's a bigger question: should the government decide which distribution companies should merge? Probably not: investors, whoever they are, are usually best placed to make those decisions. Private companies, in a freed-up ownership market, would bear the consequences of poor choices, but reap some of the rewards of good mergers.
Private companies can bring much needed capital to the municipally owned distribution companies. Cities could benefit, too, by selling their electricity distribution assets, and getting town councils out of the business of running businesses.
What will any sale mean for your electricity bills? The likely answer: not much. Private companies will face the same regulatory scrutiny as municipal distribution companies. The Clark panel found that sales of electricity utilities to private companies in regulated jurisdictions did not lead to higher electricity prices
That is why the government's plan to sell parts of Hydro One is a good start.
Yet, there is a catch. A private company that wants to buy an electricity utility faces a steep tax. It must pay a tax of up to one-third of the value of any purchase of a municipal utility. That has made it all but impossible for private companies, as opposed to government-owned ones, to buy municipal electrical utilities.
To fix that, the province should create a level field for private and public buyers, by cutting the taxes on sales of electrical utilities, before embarking on a consolidation program.
What about the second option of selling both arms of Hydro One?
The government wants to be seen as having control over future price increases. Reports say the government is exploring a cap on the number of shares any one private buyer could hold. The government is also considering retaining the power to appoint the board chair.
That means buyers would be at the mercy of government choices for day-to-day business decisions, and therefore willing to pay less for shares than otherwise.
And it would be unnecessary, given transmission prices easily could be regulated. That would be akin to how natural gas utilities are regulated by the Ontario Energy Board. The government could include any other mandates – such as the need to build transmission connections with Quebec, or prescribing head office or job locations – as part of the sale terms. However, such mandates too would cut into the sale price.
No matter what route the province takes, it is on the right track of bringing in more private investment. However, the province and taxpayers will be better off if private investors take the lead in merging distribution companies or taking control of a regulated transmission company.