Why bother with an independent energy regulator?

By Ian A. Mondrow^[1]

Because facts matter.

The energy sector is complex. The energy transition is making it even more complex. Energy policy makers will have to make some choices in the coming years and implementing the outcomes arising as a result of those choices will not always be easy.

An independent and expert energy regulator is critical to thoughtfully executing on the details of overall energy policy within the regulator's areas of responsibility. The transparent, inclusive, fact-based processes that our independent energy regulator – the Ontario Energy Board (OEB) – engages in to do its work results in robust outcomes and public acceptability of those outcomes.

So, for the Minister responsible for an increasingly complex portfolio that really matters, like energy, an independent regulator guiding the sector through complex, and sometimes turbulent, changes would be of critical value. It would be of value both for the quality of the detailed regulatory determinations that it makes to execute government policy choices, and for facilitating public confidence in, and acceptability of, those determinations and their outcomes. Taking care to avoid unnecessarily undermining the work of that regulator would be important.

Curious, then, that just hours after the recent issuance by the OEB of an important distribution rate decision with respect to Enbridge Gas Inc. (EGI), Ontario's Minister of Energy issued a statement publicly criticizing the decision and announcing his intention to overrule it. It appears that the Minister may have been incompletely and/or inaccurately briefed. The precedent that this approach sets is less than ideal.

What is happening with Enbridge?

At 6 p.m. on December 21, the OEB publicly issued a comprehensive decision on an application by EGI for approval of Ontario gas distribution rates commencing January 1, 2024. The decision is the result of a thorough public hearing process, which involved more than a year of review, thousands of pages of company and expert evidence, a comprehensive oral hearing and a thorough process for submissions by EGI, OEB staff, and a number of informed, indeed expert, customer and public interest intervenor representatives. The comprehensive, well-written and fully reasoned decision is 147 pages long (including a three page partial dissent).

Early the following day after the release of the OEB decision, Ontario's Minister of Energy released a statement expressing that he was "extremely disappointed" with the OEB's decision regarding a new gas connection revenue horizon. The Minister asserted that the OEB's determination on this point "would mean costs that are normally paid over 40 years would be owed in full up front, could lead to tens of thousands of dollars added to the cost of building new homes, and …. would slow or halt the construction of new homes, including affordable housing."

If those facts were true, then the Minister could well have a legitimate and immediate housing policy concern. They facts as determined in the OEB's decision do not, however support a "tens of thousands of dollars" increase in home costs, and it does not appear that the decision will in fact "slow or halt the construction of new homes." The conclusions expressed in the Minister's statement are inconsistent with the facts relied on, and determinations made, by the OEB's three-member expert panel of commissioners as a result of the comprehensive hearing process undertaken.

What is a "revenue horizon" and why does it matter?

The OEB determined, as one of many determinations made in the case, that in evaluating new residential and small commercial gas customer connections after January 1, 2025, EGI should use a "revenue horizon" of zero. The Minister's statement is correct in saying that this OEB determination means that costs for new natural gas connections that have historically been paid over 40 years in gas delivery rates would, starting in 2025, be payable in full up front.

The current rules for evaluating the economics of new customer connections include calculating the revenue to be earned from the newly connected residential and small commercial customers over a 40-year period. These revenues are then set off against the cost of the new connection to determine whether the new connection is "economic" on its own – i.e., will be paid for, over time, by the new customers connecting to the system. If not, then, in order to protect the interests of existing customers, a "contribution in aid of construction" (CIAC) from the new connecting customer is required up front to preclude undue cross-subsidy of new connections by existing customers.

Like many things energy, the energy transition prompts questions about the continued appropriateness of this historical approach. Considering both the near term and the longer term implications of the energy transition, including Ontario's plans for a "clean energy future" characterized by increasing electrification, the OEB determined that

• it is as no longer appropriate to assume that the assets required for new gas customer connection will continue to be "used and useful" 40 years into the future;
• future gas customers now face a risk of underutilized gas delivery assets and potential associated stranded asset costs;
• the current practice of providing no-cost (to home builders) new gas connections shifts the risk of stranding of these new gas connection assets to homebuyers and future customers and is no longer appropriate; and
• customers are better protected by encouraging new home builders and their customers to weigh the cost of new gas connections and associated gas heating equipment against the alternative of using already-required electrical connections in conjunction with available high efficiency electric heat pumps, and then making the most economic decision in servicing the new home.

To support proper and informed consideration by builders and new home buyers of today's energy choices and associated costs, the OEB determined that new gas connection costs should be paid by new home builders (under a zero "revenue horizon" model), rather than deferred for payment through ongoing gas delivery rates by gas customers decades into the future. In making this determination, the OEB considered the evidence before it that:

• The average historical cost to connect a home to gas service is $4,412 (weighted average of new construction and existing homes)^[2], and that it would take approximately 31 years, on average, to recover these costs from future home owners.^[3]
• The effect of a new-home builder choosing to include gas service and paying the associated gas connection cost up front would be to increase the cost of the house by ~$4,400  on average, and less in new developments, while at the same time reducing the operating cost of the house through lower gas rates – largely a wash for homebuyers.^[4]
• The other choice for new home builders is to decide against gas servicing and avoid the up-front connection cost, thus lowering the cost of housing and lowering the operating energy cost of the house – a win for homebuyers and an outcome for developers that keeps them competitive on price in the housing market.^[5]
• Electrifying heating in a single-family Toronto home would result in energy savings over the useful life of the heating equipment of ~$16,750. The expert analysis considered by the OEB Hearing Panel indicates that new home buyers would save 37% on their first year energy bills, and 46% over the 18 year average useful life of new heating equipment, all prior to application of available federal and Ontario energy efficiency rebates. ^[6]
• Requiring new connection costs to be paid up front would reduce EGI capital costs, costs, which could become stranded in the future, in the range of a billion dollars over the EGI proposed five-year rate plan period, and would significantly reduce gas delivery rates as a result.^[7]

In making its revenue horizon determination, the OEB specifically noted:

In laying out its energy strategy, Ontario has identified a need for reliable electricity especially as households increase their consumption to heat and cool their homes and power their vehicles.^[8] [Powering Ontario's Growth, page 39]

…

The primary consideration throughout this proceeding has been the risk of stranded assets resulting from the energy transition. The OEB's finding of a zero revenue horizon fully addresses that risk for new connection projects. When a developer is faced with the full cost of including gas service in a development, that developer will be fully incented to choose the most cost effective, energy efficient choice in a manner that not only achieves efficiency in the cost of housing in a competitive market and lowers the operating cost of that housing, but also maximizes the contribution to the government's decarbonization policy goals. It also eliminates the split incentive problem [under which the developer makes the energy choice while the future home owner pays the cost of that choice].^[9]

In fact, the OEB also directed EGI to develop a rate credit for buyers of new homes with gas connections so that they don't pay the connection cost twice: once through the purchase price of the home, and once again through gas delivery rates that include historical costs for connecting new customers. As noted in an analysis by two associate professors at the Ivey Business School at Western University^[10], new home-buyers generally pay for their homes over time through mortgage financing, and the OEB directed rate credit would offset, on a monthly basis, any incremental financing costs for the new home owner of their builder's choice to provide that home with natural gas service.

What about the Minister's concerns?

On the facts, it appears that the Minister's expressed concern that the OEB's new revenue horizon policy "could lead to tens of thousands of dollars added to the cost of building new homes, and …. would slow or halt the construction of new homes, including affordable housing" is questionable.

In fact, the analysis by the Ivey Business School associate professors concluded that:

…the Government's decision to override the OEB should have virtually no effect on affordable housing in the province. Based on our admittedly rough estimates, their policy might reduce the annual cost of buying a home by $92.74 or it could possibly increase it $32.90. Hardly seems worth damaging regulatory independence for.^[11]

If the OEB has its facts right (remember the comprehensive hearing process that resulted in this thoroughly evidenced and carefully reasoned regulatory decision based on numerous submissions made by sophisticated, well-advised and well-informed parties having a variety of interests), the only party really prejudiced by the OEB's revenue horizon determination would appear to be EGI. As a regulated utility, EGI earns its profit on the basis of the equity invested in its asset base. Historically, EGI finances the capital cost of new gas connections and recovers those costs from gas customers over 40 years. During that period, the unrecovered new connection costs are added to EGI's asset base, on which it earns a return on investment. That's about one billion dollars of asset base and associated return on investment over five years of new customer connections. The new OEB policy would mean that, starting in 2025, EGI's rate of asset and earnings (i.e. business) growth would drop off significantly. If one were to assume that the risk of the future stranding of such investment rests with gas customers rather than EGI's shareholder, one can certainly understand why this impact on business growth would be a significant concern for EGI.

What if the facts are wrong, or incomplete?

What if the OEB is mistaken?

Perhaps EGI has additional concerns that it has shared with the Minister or his staff? Perhaps, though not raised during the hearing process, those concerns involve impacts on customers not accounted for in the OEB's determinations? Perhaps new home builders have raised concerns? Is it possible that the OEB made a mistake, or left something important out of its analysis?

There are well-established mechanisms for addressing such concerns. EGI can appeal the OEB's decision, first to a fresh panel of OEB commissioners, and if needed, then to the Ontario Court. Though the OEB's decision does not apply until 2025, if necessary, EGI could request a suspension of the decision while those appeals can be properly disposed of. If the OEB is mistaken, there is a proper, informed, highly credible and independent review process to rectify the problem. There is no need at this point for the Minister to override the considered and well-reasoned determination of the independent and internationally very well-respected Ontario energy regulator.

If, after all that, there remains a public policy problem with implementing the OEB's revenue horizon regulatory policy determination, the Minister can, and perhaps should, intervene. Does the end of the era of steady gas distribution business growth present a public policy problem? Perhaps it does. Does an increase of ~1% in the up front cost of a new home, even if offset by reduced gas delivery rates going forward, present a challenge to the Ontario government's housing affordability policy? In such events, government intervention might be appropriate, and can, and should, proceed by way of legislation, transparently tabled, debated and enacted in the legislature. There is a longstanding and well-regarded process for that too.

What might the Minister do now?

The energy sector is complex. Public policy objectives like decarbonizing our economy and promoting clean energy growth may sound simple enough, but getting from here to there will not be. The costs – new and stranded – are potentially huge. There will be winners and losers. Navigating this transition will not be easy and probably won't be cheap.

Fortunately, we have a well-established, properly resourced, transparent, expert, and independent energy regulator in Ontario with the wherewithal and commitment to guide us through that transition, in the public interest, and with the public and stakeholder respect necessary to legitimize its determinations.

At the same time, broader public policy trade-offs are not always dependant on facts. It is the job of elected officials to consider and direct these broader public policy trade-offs. The regulator's job is to implement the broader public policy directions that have been determined and set by publicly elected representatives. Though they should ideally be informed by fact, sometimes political trade-offs and judgements are required. Reasonable people may, of course, disagree on such trade-offs. Our government and its appointed ministers are elected to make those decisions in a manner that they determine the general public wants. There is an open and generally balanced legislative process through which they do that.

The legislature reconvenes in February, so any legislative action on the EGI decision must wait until then. Between now and then the Minister and his advisors will have some time to fully consider the OEB's decision, understand its implications, take input from those affected as the Minister deems appropriate, and determine how, and when, to proceed from a fully informed public policy position. They might also consider the existing processes in place to review OEB regulatory determinations, which maintain transparency, consistency, public accountability, and a thoughtful and reasoned balancing of interests in the often complex field of detailed regulatory policy. Perhaps those existing regulatory processes can be appropriately engaged to review, test as required, and better understand the detailed facts and their implications.

That, after all, is the reason for an independent energy regulator.