A Perspective on Ontario’s Cancelled Renewable Energy Contracts

A number of articles have appeared in the media over the last few weeks about the cancellation of 759 renewable energy contracts from 2018. The trigger for the interest has been the revelation that contract cancellation costs are going to be $231 million. The government is reminding us that we are saving $790 million by cancelling the contracts. The media keeps repeating these numbers. Repeating the numbers won’t make them right. They are indeed, both wrong. They are simply placeholders for:

1. A value that has yet to be finalized ($231 million)
2. A number that won’t be measured or ever validated ($790 million)

There is more to this saga than what is being shared by the government and media that would put the story in perspective.

As the situation surrounding the cancellation of renewable energy contracts developed, some important considerations changed. The cancellation costs would make contract termination the worst option from a financial perspective. I’m sure it wouldn’t change hard-line positions of groups that oppose wind farms or object to incremental costs, however the decision to cancel has become a costly one and results in throwing money away. Not just for 20 years, but for the rest of our lives. To make it worse, we get absolutely nothing in return except perhaps a smug feeling of having stuck it to… someone.

At the end of the day, people should understand how this will impact them and how we got to this point. Cancellation doesn’t lower your rates and there is a cost involved regardless of whether the projects were to proceed or be cancelled.

• Cancellation is going to cost hundreds of millions of dollars up front. It will be paid out of your taxes for the remainder of our lifetimes. You aren’t likely to notice the cost but you may feel outraged because of the principals involved.
• Proceeding with the projects would result in an incremental energy cost over the duration of the contracts (20 years for most). You wouldn’t likely notice the cost on your bill, but it may offend those ideologically opposed to what has been happening with renewable energy expansion in Ontario.

Here is a visual representation illustrating the scale of the cancelled energy from 759 projects in 2018

The impact on electricity rates would have gone unnoticed because the amount of energy added and its incremental cost is minuscule at the ratepayer level. The government is not being forthcoming with this information. So much for transparency in the industry. I will lay it out for you as best I can by crunching the actual numbers associated with 759 projects and positioning them against the greater magnitude of energy at the provincial level.

I’m also going to have some fun with the misinformation being put out from some sources. Following that, I’ll do a Frequently Asked Questions (FAQ) section, followed by facts, details and finally the takeaway.

First, some fun…

An article in Huffpost by Emma Paling from November 21, 2019 included a video clip of Doug Ford commenting on the terminated contracts where he said:

“I’m proud we actually saved the taxpayers $790 million when we cancelled those terrible, terrible wind turbines that really for the last 15 years destroyed our energy file.”

The irony of this situation is that building a wind farm poses no burden on taxpayers.

Cancelling them is what impacts taxpayers to the tune of several hundred million dollars that will hang over us for the rest of our lives.

About ‘those terrible, terrible wind turbines’

Wind farms would not pose any additional financial burden on ratepayers. Most of the capacity being provided had a weighted average cost of 8.69 cents/kWh. That’s less than the average cost of electricity in November 2019 which is approximately 12.8 cents/kWh for residential Time of Use (TOU) customers. The White Pines wind farm is the highest profile case which was contracted in the first phase of the Feed in Tariff (FIT) program at 13.5 cents/kWh almost 10 years ago. Considering that cancellation charges apply to these contracts, there is absolutely no business case to stop them. It is being done for other reasons.

Did you know…

• Any form of new generation today will likely cost more than legacy hydro and nuclear since the capital cost of their construction was recovered many years ago
• Cancelling the 758 energy contracts that were never given ‘Notice to Proceed’ doesn’t lower electricity bills. Not one cent.
• Terminating the contracts takes away a steady stream of annual revenue for the government worth tens of millions of dollars.
• The cost associated with wind and solar energy has not historically been paid for by taxes. The cost of energy and its delivery is mostly paid by electricity ratepayers. Some rate-relief programs are funded through taxes. The ‘Clean up the Hydro Mess’ legislation moves some debit onto Provincial ledgers to lower interest charges and shifted conservation programs to the tax base.
• The ‘Clean up the Hydro Mess’ legislation was supposed to make the industry more transparent, however in this case I see the opposite.

FAQs

Are the $231 Million in cancellation cost and $790 million savings legitimate?

The short answer is no.

There is a more detailed explanation to follow, however the numbers are placeholders. The $231 million for cancelled contracts is an estimate. Not all of the contract holders have submitted their claims. In the case of White Pines, the wind turbines are still being dismantled and the full cost has yet to be determined. The estimate for that single project is $100 million.

The $790 million in savings is a fallacy. There aren’t any savings to be had, however there are avoided costs over the next 20 to 40 years. Estimating avoided cost related to energy production and demand over several decades would be based on so many assumptions it will be inaccurate; or if you prefer a more blunt interpretation, it’s wrong.

Renewable energy – how important is it?

It’s very important. We have had renewable energy for over 100 years in the form of hydroelectric. Other forms such as wind and solar historically cost more than hydroelectric. Both wind and solar have dropped in price over the last decade and are now less expensive to build than new fossil fuel. The contract issue is just a trigger for a much larger debate about renewable energy. There will never be consensus about this, however there should be a coherent government strategy, policy and plan in place so that everyone understands the ground rules. I’m going to focus on the technical and financial aspects of the issue in my commentary. The environmental, health and social issues are addressed in my separate articles on wind and solar energy.

Do we really need the energy that would be produced by the 759 contracts?

This question has a two part answer. One part addresses the present and the other, 10 or more years in the future. We do not need the energy now, however we are losing 25% of our generation capacity in the next 10 years and will need some form of additional supply by then. The lead time for procuring generation can easily take 10 years, so the plan should be in place now. It isn’t.

Is cancellation a reasonable option for the 759 projects?

Cancellation is a valid contractual option. Whether or not it is reasonable depends on the consequences and how we view their importance. There are always other options which include

• do nothing – let the contracts run their course – some facilities would not likely be built anyway for various reasons including inability to secure funding
• establish an acceptable cost threshold and cancel only the most expensive contracts
• defer the work to a later date

In this case the critical considerations are cost and future energy needs. There is clearly a significant cost involved in cancellation and there are future energy needs which raise legitimate questions around cancellation. It is a high risk solution from a financial perspective due to the future uncertainty of our energy needs and the true cancellation cost.

If the contracts were left alone, what would the consequences be?

If the renewable generation came on line there would be a cost impact driving electricity rates up. As energy contracts expire and available capacity decreases, rates would decrease. Over 40% of the renewable generation in the 759 projects was cheaper than what our average current rates are.

For some, the fact that we have renewable energy contracts with rates as high as 80 cents per kWh is cause for outrage and no capacity whatsoever should have been on the Ontario grid. The voters in Ontario have had their say on that issue and elected a new government. The question at hand relates to how the new government has responded to 758 projects which haven’t been started yet, and one that was essentially complete. Has the cancellation made the situation better or worse than leaving them alone?

After all of the flapping by our government about energy costs we should expect that the decisions made going forward make things better and not worse – correct?

Guess again.

I’ll show you more about what the rate impact would have been for the ‘do nothing’ alternative in the detailed section. You will probably be surprised.

How much should ratepayers and taxpayers be willing to pay to get out of the energy contracts?

The short answer is… it probably isn’t worth paying any cancellation costs. Any cost is incremental to a debt that will compound over time and… we won’t be paying it off.

There are political, social, health and environmental factors that are difficult to put a price tag on. It is easier to look at the economic aspect of this question. There is a trade-off between borrowing money to pay up-front costs and avoiding future costs. In this case the future costs have a high degree of uncertainty as we are losing energy supply within the next 10 years. Avoided costs will be less in the future as the available supply decreases if we assume demand remains level. Should demand increase in the future, avoided costs will also decrease. These costs will be buried in something called Global Adjustment which is built into our rates.

In situations where avoided cost are uncertain it is not worth paying up-front. You would be ill advised to pay today for any high-risk future benefit – especially when you are short of cash and need to borrow money.

What happens to electricity energy rates as a result of contract cancellation?

Nothing happens to rates. Cancellation costs will be recovered through our taxes. Rates are presently being limited to increases less than or equal to inflation. Since revenues are already insufficient cover the cost of generation it is reasonable to assume that rates will increase, tracking inflation until restrictions are removed.

Who is impacted by the cancellations?

Ratepayers, local communities. Farmers, First Nations, local engineering and design firms, local unskilled and trade labour forces, maintenance firms, local service industries (hotels, restaurants etc.), investors and financial institutions.

Some facts

• There is significant liability due to the large number of contracts and the terms associated with cancellation. The costs are going to be coming in well into 2020 since project cleanup is still underway. Expect the final number to be more than the estimated $231 million. That’s how these things go. According to the government, taxpayers (not ratepayers) will be on the hook for cancellation costs. We may never know the actual final cost – unless there is an audit.
• No reduction in electricity bills will result. There aren’t any ‘savings’ per-se to be had but rather ratepayers (not taxpayers) may benefit from avoided costs. Bills may not rise as much as they would if the projects went to completion.
• kWh is kilo-Watt-hour. there are 1,000 watts in a kWh. It is a unit of energy.
• The average weighted energy rate of the 759 terminated projects was 15.1 cents per kWh.
• As of November 1, 2019 the blended rate for energy on Time of Use is 12.8 cents per kWh
• TWh is Tera-Watt-hour. There are 1,000,000,000 kWh in a TWh. It is a unit of energy.
• The annual energy that would have been produced by the 759 projects is 0.84 TWh
• The energy measured on the Ontario grid in 2018 was 153 TWh
• Wind energy makes up 41% of the cancellations with an 8.69 cent/kWh weighted average cost, significantly less than the 12.8 cents/kWh which we are paying now. If they went forward, it may have lowered our bills.
• If it costs $231 million today to cancel the contracts, it will grow to $478 million in 20 years at the current interest rate on our debt. The cost will continue to accrue interest indefinitely.
• The $790 million avoided cost figure must be riddled with assumptions and therefore, highly speculative. Presumably it is spread over 20 years. There is presently no accepted way to measure this specific avoided cost. It is reasonable to assume that the actual avoided cost will never be known or validated. Not now, or 20 years from now. Speculating today on avoided energy costs 20 years in the future is just not going to be accurate.
• If the contract cancellation costs continue to rise, any justification for cancellation becomes weaker. It is a lousy business case.
• All of the impacts of renewable energy contract cancellation will happen behind the veil of capped rate increases and dwarfed by the $300 billion provincial debt.

Some details

Warning: the details are excruciating and may not be of interest to some readers. If that is the case, you may scroll to the end of the article to ‘The takeaway’ section.

In the sections that follow I’ll break out the mix of energy, contract rates, current annual energy costs, liabilities and energy forecast from sources which include the Ontario Energy Board (OEB) and the Independent Electricity System Operator (IESO).

The cost for contract termination and claim of savings

There was no mention of a $231 million cancellation cost in the lead up to the Ontario election or the pressroom release in July 2018 – possibly because government had intentions of legislating it’s way out of liability for breaching the contracts. The government doesn’t have the money to pay the cancellation fees so it will be added to our debt. We aren’t paying that down any time soon. We currently pay 3.7% interest on debt. If the cancellation costs were $231 million, it would balloon to $478 million in 20 years. The harsh reality is that costs continue to compound indefinitely since we are unlikely to ever pay off the Provincial debt. It certainly won’t be paid off in our lifetimes. Hence, termination costs are not a single, static number. It will continue to grow and cost us long into the future. A calculation of the present value of the cancellation cost would be staggeringly high.

The 2018 announcement indicated that taxpayers should expect $790 million in savings from the cancellations. Presumably those ‘savings’ as stated would be spread out over the 20 to 40 years of the contracts and amount to approximately $40 million annually. While it may just be a play on words, there are no actual savings but there are avoided costs.

To be fair, without specifics about the numbers being claimed, we should treat the $231 million cancellation costs and $790 million in avoided costs as placeholders since neither number would hold up under any degree of scrutiny.

How much generation capacity and energy was cancelled?

The short answers are:

• 462.5MW of capacity in a system that has almost 41,000MW of capacity as of June 2019. That’s roughly 1% of the Ontario grid capacity.
• Approximately 0.84 TWh of energy annually in a system that produced 153 TWh in 2018. That’s roughly 0.6% of the grid energy. It’s the energy quantity which we are billed for.

Don’t worry about what a Mega-Watt (MW) or Tera-Watt-hour (TWh) is. These are units of power and energy which are difficult to comprehend. What is most important is the relative sizes of the numbers. Ontario produced more than 150 times as much energy in 2018 as the total output of the cancelled projects. That’s really small.

As shown previously, the cancelled energy is very small compared to the Provincial-level of production.

Note: The 758 cancelled contracts represent 444MW. The 18.5 MW White Pines Wind Farm was cancelled separately and brings the total to 462.5MW for 759 cancellations. The distinction between the 758 contacts and White Pines is that the former were never issued a Notice to Proceed (or equivalent) by the Independent Electricity System Operator (IESO) and the latter was already built. Different terms apply in the two cases.

Ontario’s energy mix

Renewables in Ontario

There are more than 3,000 contracted suppliers of renewable energy with capacities larger than 10kW on the Ontario grid. An additional 30,200 contracts were executed under the microFIT program for small solar and wind (10kW or less). A total capacity of 11,000 MW are connected to the grid as of the 4^th quarter of 2018. The cancelled contract capacity is a small part of the overall pool of renewable energy capacity – about 4%.

Renewable energy programs and technology impacted

The contracts were from the Feed in Tariff (FIT) and Large Renewable Procurement (LRP) programs offered by the Ontario Government through the Ontario Power Authority and subsequently the Independent Electricity System Operator (IESO). The difference between the two programs are contractual terms, procurement method and the energy compensation rate. The rates in the newer LRP program were substantially lower than FIT due to the procurement process and decreasing cost of materials.

How much cost does the contract cancellation avoid?

Note that I will not consider Aboriginal subsidies, cost escalation, net present value of money or use any sophisticated financial modelling. That won’t be necessary to provide context for what has happened with the cancellation of the 759 projects.

41% of the cancelled contract energy would have been from Wind Farms with a weighted-average cost of 8.69 cents/kWh. That’s 32% less than the current average cost of energy which is 12.8 cents/kWh.

It’s also 26% less than the rate of natural gas generation which is 11.8 cents/kWh in the October 2019 Regulated Price Plan Report.

How ironic.

It is possible to estimate the annual cost of generation from the 759 projects by knowing:

• generator technology i.e. wind, solar, water etc.
• individual project capacity
• capacity factor by technology
• contracted energy rate

All of this information is known but scattered among various websites. I put the numbers together and it comes out to 0.843 TWh of energy with an average weighted cost of 15.1 cents per kWh and $126 million annually when all of the generation is online. That does not mean those are avoided costs! We aren’t done yet…

Let’s provide some context for the $126 million cost. It seems like a big number. The cost of Ontario’s energy in 2018 can be estimated from the Independent Electricity System Operator (IESO) annual financial statements at $14.2 billion (author’s interpretation). The incremental cost increase is 0.89%. That’s actually a small number and does not translate directly to a rate impact.

$126 million represents an annual cost when all of the 759 projects are producing energy. Since only one of the 759 sites were ready for production in 2019, it is safe to assume these costs would take many years (if ever) to materialize.

To estimate the avoided cost for a sample year we would need to know the details about energy supply and demand throughout time. You would need to know if other sources of energy were being dispatched down to accommodate the renewable energy at any given time. Figuring this out would require a team of experts with sophisticated computer modelling tools to run simulations and produce the necessary projections. Presumably, this is what the government has done to arrive at the number of $790 million. I seriously doubt the government went to that amount of trouble to come up with a number, so I’m going to call it out as a guess.

What I can estimate is some costs associated with natural gas generation if it were used to produce the same energy as the renewables. Using data from the Independent Electricity System Operator (IESO) Monthly Market Report and U.S. Energy Information Administration (EIA) statistics for natural gas generation for steam turbines, the following costs can be applied:

Keep in mind that unit price for natural gas fluctuates every year as does the kWh cost.

What is the avoided cost on an average residential ratepayers bill?

Calculating the precise value of avoided costs on a ratepayers bill would be a tedious and time consuming exercise. It wouldn’t be of much value to be precise when the numbers are so insignificant.

The Regulated Price Plan, which residential ratepayers are part of, is $7.4 billion and the total energy cost pool is about double that at $14.2 billion.

One way to look at cost impact is to blend the energy rate of the renewable projects (15.1 cents/kWh) with the present average rate of the Regulated Price Plan (12.8 cents/kWh) to determine the new rate. We know that the renewables would have been 0.843 TWh and the Regulated Price Plan is approximately 75 TWh for 2018. The weighted average rate would be 12.83 cents/kWh, or an increase by about 0.23%. That estimate only takes into account half of the energy in the provincial pool. Considering the entire pool of 150 TWh would reduce the impact even more.

We are looking at less than a dollar a month on an average ratepayers bill if they use 750kWh of energy in a month.

After all of that estimating, it seems like the numbers are so small it is not worth the effort to go any further.

Forget about the exact numbers.

When you put things into perspective, ratepayers wouldn’t have noticed a cost impact from the 759 projects had they been completed.

What ‘avoided costs’ really are…

The numbers that emerge from the fog which are properly termed ‘avoided costs’ deserve a better explanation than simply pinning a dollar value on them. These are actually avoided jobs and economic growth for communities across the province. Our rural, municipal and aboriginal neighbours are being shut out of long term opportunities for economic growth. The terminated projects are not just impacting faceless corporations, they are impacting our people and our communities. The projects represented the most competitive renewable energy rates seen in Ontario. Nobody is profit-taking on them.

The shell-game with costs

There is a shell game happening with the cancellation costs. Associate Energy Minister Bill Walker was quoted as saying taxpayers (not ratepayers) would be on the hook for the cancellation costs. It will make costs less visible if they are blended into taxes and buried in a $300 billion debt. The true cost will accumulate interest over time. It will increase indefinitely through compound interest. The $231 million – isn’t really what it seems. It becomes a legacy that we will pay forever.

The renewable contracts would have lasted 20 years and then be done. Moving the cancellation costs to provincial debt means the costs will go on as long as the debit. That’s more than a lifetime.

Ratepayers and taxpayers – apples and oranges

According to Ontario’s Ministry of Finance the employed labour force was 7.2 million in 2018. These are taxpayers. In addition there are corporate entities, small businesses, and transactional taxes providing revenue to the province. The tax revenue from the Public Accounts 2018-2019 Annual Report was $105.5 billion

According to the Ontario Energy Board’s 2018 Electricity Utility Yearbook there are just over 5.2 million ratepayers. The Independent Electricity System Operator (IESO) reported the cost of Settlement (wholesale transactions) and Global Adjustment for power was $17.3 billion in 2018. The settlement portion of $17.3 billion includes more than just the cost of energy and needs to be adjusted down to better reflect energy cost. In 2018 the average cost of electricity was 26.8% of the Global Adjustment which makes the cost of energy approximately $14.2 billion. I will use this number as a reasonable representation of the annual cost of energy.

The ‘tax base’ of $105.5 billion is 7.4 times larger than the ‘ratepayer base’ of $14.2 billion. Distributing costs over the tax base is less impactive than the smaller ratepayer base and is likely to be of greater benefit to lower income residents.

Historically electricity consumers (ratepayers) have born the cost of electricity generation, delivery and regulatory functions. It is ratepayers that subsidize taxpayers by providing more than a billion dollars annually to the province in the form of general revenues. Even with the 8% PST rebate on bills there are corporate dividends and other layers of taxation that provide revenue of more than $1 billion annually for the provincial government.

At different times some electricity-related costs have been recovered from taxpayers. Most recently the Ford government committed to move the cost of conservation programs from the regulatory charge on utility bills to the tax base as a part of an election promise. The estimated savings on a residential customer’s bill would be about $20 per year.

Ratepayers and taxpayers bear the burden of different costs.

Energy contract liabilities – on the hook for more than $231 million

The terms of cancellation are clearly spelled out in the contractual documents on the Independent Electricity System Operator (IESO) web site. Feed in Tariff (FIT) contract termination guideline are available here. Large Renewable Procurement (LRP) contract termination guidelines are here. Suppliers are entitled to recover costs in accordance with Section 2.4 of their FIT contract or Section 9.6 of their LRP contract. The estimated total liability for the 759 cancellations is $300,599,500 as shown in the following summary table:

The government anticipates the costs will be $231 million. Looking at the liability figures from the contracts and the estimated dismantling cost of White Pines Wind Farm shows the number may be much higher. That will be borrowed money, incremental to the current provincial debt of more than $300 billion dollars. As stated before, a debt of $231 million would balloon to $478 million in 20 years at 3.7% interest on debt (our current rate). If the debt was to be paid off in 20 years it would require annual payments of $16 million at 3.7% interest. Keep in mind that the debt will likely never be paid and the initial amount will grow along with the associated carrying costs.

The carrying cost of the $231 million is $8 million in the first year, ramping up to $17 million in 20 years. It will continue to grow at whatever the interest rate is on the debt.

The provincial debt in Ontario is over $300 billion. Does adding $231 million to it matter? The incremental amount would hardly be noticeable. That doesn’t make it a good choice.

With the pressure to eliminate funding and reduce debt, the addition of hundreds of millions of dollars is a poor choice when the alternative was to spend nothing up front and pay less than 1% more on energy rates. In reality the debt carrying costs over a lifetime are so high, there is no benefit to cancellation.

Ontario’s contracted energy forecast vs demand

According to Peter Gregg, CEO of the Independent Electricity System Operator (IESO), speaking at the Association of Power Producers of Ontario (APPrO) conference November 21, 2019:

“Over the next 10 years, more than 200 contracts totaling more than 11,000 MW will expire. Almost 4,000 MW in contracts are due to expire by 2025. And 75 per cent of the capacity is from 13 large – large meaning greater than 150 MW – facilities. While contracts are expiring, we know that most facilities still have a lot of life in them and can continue to be called on to meet system needs.”

The Independent Electricity System Operator (IESO) prepares 20 year forecasts for long term planning. The forecasts are based on different assumptions and grouped into 4 projections. Three out of four of the projections predict steady or slightly increasing demand over the next 20 years. If we take one of the steady load projections (Outlook B from the OPO report), our summer peak will be over 28,000 MW in 2035. Ontario will be unable to meet demand without procuring new generation, refurbishing existing and renewing contracts.

Expiring natural gas contract capacity is 7,106 MW and renewables are 2,550 MW by 2029. Compare that to the 462.5 MW capacity that would have been coming on line from the renewable projects.

There is no argument to say that the cancelled energy contracts would not be needed over the 20 year forecast period.

The takeaway

The cancellation of the 759 renewable energy contracts had the potential to avoid future energy costs since the capacity is not needed today. Relevant details of cancellation plans show that we will not save anything and over the long-term it is going to cost more money than just proceeding with the projects.

We had a choice of paying hundreds of millions of dollars up-front and a lifetime of carrying costs on debt to get nothing, or paying a minuscule amount annually to create jobs and economic growth for communities across Ontario.

The government, on our behalf has chosen to pay hundreds of millions of dollars to get nothing

Most of the facts and rationale surrounding the cancellation decision have never been shared publicly in spite of a claim that we have transparency in the industry. Transparency seems to only apply when it suits the interest of the government, not taxpayers or ratepayers.

The weighted average cost of the energy was 15.1 cents per kWh while we currently pay 12.8 cents per kWh. The additional amount of energy provided by the projects is so small compared to the overall energy cost, most ratepayers wouldn’t have felt a cost impact. It would be a fraction of 1%.

At the level of the taxpayer and ratepayer, the incremental cost of each option was very small. If this situation wasn’t brought to the public’s attention, the average person wouldn’t be aware of it much less feel an impact because of it. The people that are most impacted are investors and small communities across Ontario. The investors aren’t faceless corporations, they were Farmers, Aboriginals and Municipalities. The projects meant hundreds of jobs and economic growth in our communities for the next 20 years. Instead we will have a few hundred million dollars of debt and a bucket of nothing to show for it.

As it turns out, the cancellation costs make project termination a poor choice. The carrying cost of the debt incurred is greater than the avoided costs but without any tangible benefits like job creation and economic growth for small communities.

It looks like renewable energy decisions are going to continue to haunt our government for the foreseeable future.

Derek

Author: Derek Hughes

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