June 1998
Government of Alberta

Backgrounder on the Electric Utilities Amendment Act, 1998

Overview

The Alberta government has introduced legislation to move forward with the restructuring of the provinceís electric utility industry. This restructuring brings competition to the industryís generation and retail services markets in place of regulation. Unleashing these competitive forces increases incentives for efficiency, eliminates future regulatory burden, promotes customer-oriented service, puts downward pressure on electricity prices and enhances the Alberta Advantage.

The first step in the process was the passage of the Electric Utilities Act in 1995. The Act created an open-access, competitive power pool through which electric energy is traded in the province. In addition, it introduced an industry structure and regulatory reforms designed to increase efficiency in the electric industry.

Since that time, Alberta has gained considerable hands-on experience with electric industry restructuring. The industry and the government are now able to move further with this important process and remain leaders in the field. As part of this evolution, stakeholders asked the government to identify a clear vision of the future of the industry and set a firm pace for reaching that vision.

The Alberta Department of Energy worked with stakeholders through 1997 to clarify that vision, identify balanced solutions and lay out a prudent and orderly timetable for achieving that vision. The Electric Utilities Amendment Act, 1998 results from that process.

Focus of New Legislation

The focus of the new legislation is on deregulation of electrical generation from all existing regulated plants. As well, the legislation includes steps towards full retail competition in the industry.

The new legislation eliminates the need for future regulatory hearings on generation costs, enables customers to choose their retail supplier of electricity, creates better market incentives for efficiency and puts downward pressure on electricity rates.

The legislation immediately starts putting in place new mechanisms to ensure a level playing field for all buyers and sellers of electricity. That means the existing utilities will not have unfair advantages in the market over new participants. It opens the way for potential new generators and marketers of "green power" such as wind energy.

The change from regulation to competition will be fair to both customers and to owners of existing regulated generation. It will allow owners a fair opportunity to recover the investments they have made in generating plants. Customers will continue to receive the benefits of low-cost power from the existing plants.

Main Elements

Following are the main elements of the legislation:

• By 2001, long-term power purchase contracts will replace the current mechanism for capturing the costs and benefits of existing generation. An open auction of the contracts will increase competition by diversifying the number of sellers in the Power Pool through which all electrical generation is bought and sold in the province. These contracts do not require divestiture of assets.
• A financial balancing pool will net the proceeds from auctions of the long-term contracts. These proceedsówhich will reflect the value of the existing, low-cost generationówill be collected over time and distributed to customers. All customers across the province, old and new, will share in the low cost of generation built under regulation.
• Competition will be fostered through development of a level playing field for industry participants. As part of this process, the Power Pool will be governed independently rather than by stakeholders. The Power Pool Council will be given greater authority to monitor markets, investigate complaints and resolve disputes.
• A framework will be put in place for a phase-in of customer choice. Under this process, customers will be able to choose between competing retailers of electricity and related services. The phase-in will start in 1999 with large industrial customers and extend to all other customers by 2001.
• Regulations made under the original Electric Utilities Act, such as the industrial systems policy, are being brought into the legislation. The industrial systems policy has proven to be a stimulus to environmentally friendly cogeneration power projects.

Background to the Changes

The Electric Utilities Amendment Act, 1998 is a continuation of the restructuring process that started with implementation of the Electric Utilities Act (EUA) in January, 1996.

The Act created an independently operated power pool through which electricity is bought and sold in Alberta. The Pool is governed by the Power Pool Council, which is responsible for its fair, safe and efficient operation. As well, an independent transmission administrator oversees the use of the transmission system by buyers and sellers to ensure fair rates, non-discriminatory access for all market participants and the safe, reliable operation of the system.

Under the Act, all consumers share the costs and benefits of the generation facilities in existence in 1995 when the Act was passed. This sharing is accomplished through legislated financial arrangements (hedges). The costs for new generation brought on line after the passage of the Act are not shared. The addition of new generation facilities is now based on market considerations.

These were all significant steps taken in anticipation of a gradual transition to a fully competitive market. The 1995 Act and the new 1998 legislation allow Alberta to remain one of the leaders in the field.

Deregulation of Generation

Regulation of a market that can be competitive is costly to consumers, stifles innovation and reduces the need to be efficient. A primary goal of deregulation is to create an environment in which generators have incentives to reduce costs. In this kind of environment, decisions by generators about pricing and investment are guided by competitive market forces.

Deregulation is based on the principle that all consumers in Alberta share both the benefits and the costs associated with existing regulated generating units. Customers will benefit through greater choices for their power needs and downward pressure on rates that result from increasing competition. Generation owners will benefit from the elimination of regulation. This will enable generation owners to focus on being more efficient, rather than preparing for regulatory hearings.

Transmission and distribution wires systems will remain regulated since they are natural monopolies. The existing distribution utilities will continue to provide connections to customers and maintain the distribution wires. In addition, the Alberta government maintains ongoing responsibility for monitoring the market and ensuring that it is working fairly and efficiently.

How will deregulation happen?

Starting January 1, 2001, the owners of generating units built before 1995 will recover their fixed and variable costs (including a fair provision for return on investment) based on a rate or formula set by an independent expert body, called the "Independent Assessment Team." This arrangement will effectively end any further regulation of the generating units by the Alberta Energy and Utilities Board (EUB) or any other body.

The Independent Assessment Team will establish long-term contracts (called power purchase arrangements) for the life of a generating unit, including a life extension period, to a maximum term of December 31, 2020.

The power purchase arrangements will replace existing regulation, while ensuring that utilities have an opportunity to recover investments made in a regulated environment and that customers continue to receive the benefits associated with existing low-cost generation.

A power purchase arrangement transfers to independent marketers the right to sell the output of a plant into the Power Pool. These arrangements remove the ability of utilities to use their portfolio of supply to manipulate the Pool price. They do not require the utilities to divest themselves of any plant.

All arrangements made by the Team are subject to review by the EUB. The EUB may alter any arrangement or determination made by the Team. The grounds for the EUB review are narrow to avoid the possibility of a second, unnecessary review.

What is a stranded cost and why should customers pay stranded costs?

Prior to the passage of the Electric Utilities Act, utilities built new generation on the understanding that they could recover their investments as long as the EUB deemed these investments to be prudent. The utilities did not have a contract with the provincial government. Both sides, however, had a clear understanding of the rules of the regulatory environment.

Today the provincial government is changing that environment, moving from regulation to a competitive market. Some generating plants in Alberta may not be able to recover all their costs in this market environment. To the extent that they cannot recover their investments, those costs have become stranded.

Replacing regulation with competition changes the way utility companies earn their income. It would be unfair to change the rules on cost recovery for investments that have already been made and approved under regulation.

What is a residual benefit and why should customers receive this benefit?

Residual benefit is associated with a generating plant if, solely by virtue of moving to a market environment, the owner is able to earn an excess profit that would not have been earned under a regulatory environment.

Under regulation, once the EUB determined that an asset such as a generating plant was required, utilities recovered their costs through regulated rates. These electricity rates were set and approved by the EUB so that utilities could recover their investments from consumers, including a provision for depreciation and a return that included a risk premium.

In effect, once the EUB approved the purchase or construction of an asset, consumers shielded the utility from most of the risks associated with the investment by paying the regulated rate.

How are residual benefits and stranded costs currently measured and shared?

At present, residual benefits and stranded costs are measured and shared on an ongoing basis by legislated financial arrangements (hedges) set up under the Electric Utilities Act.

These legislated arrangements require regulatory approval and were never intended to achieve deregulation of generation. They were established to allow a smooth transition from the old regulated structure to the new structure. Although they perform two important functionsósharing of costs and benefits and creating a disincentive to abuse of market poweróthey still require regulatory approval.

How will this arrangement change under the new legislation?

Under the new arrangements, the legislated hedges will be replaced by long-term (20-year) power purchase contracts. The long-term contracts ensure that:

• Consumers receive the residual benefits created by the transition to a competitive marketplace.
• Owners of regulated generation have a reasonable opportunity to recover any costs that may become stranded by the transition to a competitive marketplace.
• Owners have an opportunity to earn greater profits if they become more efficient.

• Generatorsí costs (as determined by the Independent Assessment Team).
• The values that marketers place on the output of those plants, as revealed through a competitive bidding process for the power purchase agreements.

Why was a 20-year contract period chosen?

The 20-year term of the power purchase arrangements provides a fair balance between the interests of customers and stakeholders. The 20-year term is designed to provide a long transition period during which consumers receive the residual value associated with power plants in existence in 1995.

Keeping the contracts in place longer would not serve the best interests of Albertans, and could be expected to lead to inefficient investment decisions in the generation market, as well as higher prices.

Utilities may not make efficient investments in life extension of their plants if they have to give up earnings associated with these investments. They will invest elsewhere or hold off investing in their current plants until the long-term contracts are no longer in place.

The Alberta government cannot perpetually extract earnings from life-extension investments and pass them on to customers without affecting the incentives of generators to invest efficiently.

Efficient investment in these plants is important to ensure that future electricity prices stay as low as possible. By ending the contracts in 2020, the government is creating the right incentives for investment and for enhancing the Alberta Advantage.

Customer Choice

Customer choice means that Albertans can select any retail service provider they wish. Customer choice will be introduced over time, starting in 1999 with major electrical consumers. Small and residential consumers will have access to choice starting in 2001.

These changes are expected to result in savings to consumers as electric industry firms adopt new technologies, processes and pricing arrangements so they can stay competitive. At the same time, retailers and other industry participants will be licensed and subject to standards and certification. For a five-year period starting in 2001, small and residential consumers will have the option of:

• Continuing with their current service provider and receiving a guaranteed stable rate, or
  
  
• Making new arrangements with a service provider.

How does the system work today?

Today, each Alberta electric power customer "belongs" to a particular utility based on where he or she lives. If you live in a town or city with a municipal utility, your power bill comes from that utility. Rural users are billed either by Alberta Power, TransAlta Utilities or their Rural Electrification Association. City councils regulate the rates charged by the municipal utilities. The Alberta Energy and Utilities Board (EUB) regulates the rates charged by Alberta Power and TransAlta Utilities.

Distribution utilities currently build and maintain the local wires that connect customers to the power system, install and read the meters, pay for the power used by all their customers and the charges for delivery of that power on the transmission system. They also design rate packages for customers and collect money from them based on the rate package.

What would change?

Only the building and maintenance of the transmission and distribution wires needs to be regulated. The other services can be provided by any firm, to any customer. Alberta proposes to allow independent, non-utility firms to compete to offer all other services to consumers. These retailers would likely offer consumers a variety of rate and service options. Consumers can then choose which retailer and which rate and service options best suits their particular needs. The pace at which customer choice is introduced will depend on technology, such as the customerís meter type.

What kind of choices will customers have?

Some may want "life as usual" and stay with their traditional utility retailer. Others may want to go with a different retailer who offers a better rate or a different mix of services. Companies with facilities that consume large amounts of power may prefer to make their own arrangements for the services they require.

How will customers benefit from the changes?

• Competition for metering and billing services will likely result in savings to consumers as firms are forced to become more cost-effective.
• Firms will develop new types of services and rate packages designed to fit individual needs and preferences.
• Some customers would like to see more of Albertaís power produced from non-fossil fuel sources such as wind power. Independent retailers will be able to contract with alternative energy producers to pass these costs along to consumers who want a green-power rate.

How will consumers be protected?

Retailers will be licensed by the Alberta Energy and Utilities Board (EUB). Strict rules governing their relationship with customers and their access to private information will be put in place. The relationship between a retail affiliate and an existing distributor will be monitored carefully to ensure that the affiliate has no unfair advantage over other retailers. Customers will be fully informed about the changes and their new options and how to take advantage of them before customer choice is introduced.

Why is a level playing field important?

Customers are best served when the forces of competition work to put downward pressure on rates, increase efficiency and provide a wide range of effective services. If a firm has too much market power, it can take advantage of its customers by charging high prices without fear of losing market share to a competitor.

What steps has the government taken to insure that there is a level playing field?

• Last fall, the Department of Energy commissioned a study of potential abuse of market power in Alberta. The study was performed by London Economics, a world-class firm acknowledged by stakeholders as an independent and export source of advice. The government is pursuing the resulting recommendations in several areas, most notably deregulation and the choice of long-term power purchase contracts to replace legislated hedges.
• The government is changing the way the Power Pool is governed to ensure that the Pool is operated in the public interest and that all market participants are treated fairly. Only independent individuals with no material interest in the industry will be appointed to the Power Pool Council.
• The position of Market Surveillance Administrator has been created and a broader mandate given to the Power Pool Council to ensure that all aspects of the market are working fairly.
• An independent Transmission Administrator has been appointed to ensure non-discriminatory access to the market by all suppliers of power and system services.
• Competition is being opened up on the retail side to ensure that existing generators cannot take unfair advantage of having protected monopolies in distribution of electricity.
• Codes of conduct will be put into place to ensure that retailers affiliated with regulated distribution utilities do not have unfair advantage over independent retailers.
• Mechanisms are being put in place to remove any unfair tax advantages that municipal entities have over private companies in either generation or retail services.

Who is responsible for making sure that the market is fair and competitive?

The independent Transmission Administrator will ensure that all sellers have fair and non-discriminatory access to the market. The independent Power Pool Council, representing all market participants, is responsible for making sure that the Pool is operated as a fair, open and efficient market for power.

The Act calls for appointment of a Market Surveillance Administrator, who will be appointed under the Power Pool Council to monitor the effectiveness of the market on an ongoing basis. The administrator will be a member of the Power Pool Council.

The Alberta government has ultimate responsibility for ensuring that the market is working. The government will monitor the effectiveness of the market on an ongoing basis.

What actions can be taken to ensure that the market is working properly?

Elements of the Act include processes to ensure that:

• There is confidence in the fairness of market outcomes.
• There is a level playing field among all market participants.
• Market participants abide by all appropriate rules, performance standards and licensing requirements
• Rules and sanctions are in place to discourage anti-competitive behaviours and practices.
• All complaints and disputes are dealt with in the proper forum.

What duties and powers will the Power Pool Council have in this area?

The Council will be responsible for:

• Determining and imposing sanctions on market participants found to be in violation of rules or engaging in anti-competitive practices, even if those practices are not specifically prohibited in existing rules, laws, or regulations. This level of responsibility is necessary to ensure full protection of consumers in a new system in which prohibitions against certain practices are not necessarily entrenched in laws or regulations.
• Setting up a binding dispute resolution process.
• Reporting infractions of rules, laws or regulations to the appropriate authority, if it is unable to deal with the matter itself.
• Making recommendations regarding changes to rules, laws or regulations to the appropriate authority, where such changes would serve to increase the efficiency and fairness of the markets.

What duties and powers will the Market Surveillance Administrator have in this area?

The Market Surveillance Administrator (who will be a member of the Power Pool Council) will:

• Perform on-going monitoring of electricity markets to ensure efficient and fair operation of the markets and compliance with all rules, laws and regulations governing the behaviour of participants in those markets.
• Investigate complaints by market participants.
• Make recommendations to the Power Pool Council regarding the disposition of complaints and improvements that could be made to rules and procedures.

What duties and powers will the Transmission Administrator have in this area?

The transmission administrator plays a crucial role in creating a competitive generation market. By law, all electric energy entering Albertaís system must be bought and sold through the Power Pool. To access the pool, all market participants must have a system access agreement with the Transmission Administrator. The Transmission Administrator ensures that this access is provided in a fair, open, transparent and non-discriminatory manner and that the system itself is reliable. Open access means that the transmission system is available to all power producers on the same terms, ensuring that owners of the transmission system cannot put competitors at a disadvantage.

The government has appointed a new, independent transmission administrator, ESBI Alberta Ltd. This company will take over as transmission administrator on June 1, 1998 in place of the Grid Company of Alberta which that is owned by the four major wire owners in the province. The Transmission Administrator is regulated by the Alberta Energy and Utilities Board (EUB).

Rates

Increased competition, incentive regulation and lower regulatory costs are expected to put downward pressure on rates. Although it is impossible to say exactly what rates will be in the future, with or without restructuring, there is already evidence that the new structure is working to the advantage of consumers.

Rates declined substantially in 1997 and will decline further in 1998. This is due to many factors, including lower interest rates. However, the electric industry restructuring in 1996 also made an important contribution by increasing Albertaís ability to obtain lower-cost imports from British Columbia, thus putting pressure on Alberta utilities to cut their costs.

What will happen to the rates paid by small and residential customers?

Small and residential customers will have a guaranteed stable rate option for a five-year period starting in 2001. This ensures that these customers do not have to worry during the transition to a competitive retail market.

Under this option, small and residential customers may choose to stay with their original distribution utility.

Alternatively, small and residential customers may choose to go with another retailer who offers a different package of rates and services that better suits their needs and preferences.

Will the new structure lead to rate disparities across different service areas?

Rates will be determined through a competitive retail market. A customerís rate will depend on the retailer they choose, not the service area they happen to live in. In addition, when the balancing pool is in place, the benefits from low-cost power will go directly to customers, rather than to customers through a fixed share allocated to their distribution utility. This means that customers across Alberta will share residual benefits equally.

Regulation

The physical transmission and distribution of electric energy are natural monopolies. Building competing sets of wires across the province would result in unnecessary and expensive duplication. The Alberta Energy and Utilities Board (EUB) will continue to regulate transmission and distribution to protect consumers from monopoly power. The EUB will be responsible for approving the system access tariffs of the Transmission Administrator and the distribution tariffs of investor-owned distribution utilities. These tariffs cover the cost of providing the high-voltage transmission system and the cost of taking the electricity down to the customer level on the low-voltage distribution system.

Who will regulate municipal utilities?

The distribution tariffs should be set on a consistent basis to ensure fair competition for retail services across the province. The EUB will provide guidelines and principles to municipalities on how distribution tariffs should be determined. Municipalities will not have to file these tariffs with the EUB if:

• The municipalities decide not to compete in the retail services market.
• They have successfully negotiated with customers the rate that will be charged for distributing power.

When are retail services going to be deregulated?

Some retail services such as rate design and billing will be deregulated starting in 2001. Metering and the information systems that maintain customersí records will be deregulated in 2006 after the five-year transition period. Experience in other jurisdictions has shown that it is prudent to allow sufficient time to deregulate these areas.

Further Information

copyright 2000 Government of Alberta