A Spoonful of Rebates Won't Make Electricity Costs Any More Palatable
A NETWIT special report
It's apparent what "spin" the Ontario Tories are going to try in order to explain away the large electricity bills that will have annoyed most Ontarians before they vote on Ontario's next government, almost certainly in the Spring or early Summer. "Not our fault," they will say, "it was the weather." If it works, you deserve them for another four years.
We refer readers to earlier articles to understand why this is a load of piffle. We also have a post in preparation that examines all of the costs that have been added to the Ontario electricity system. In this piece we discuss another dollop of drivel that is being presented by the various spokespeople for the industry as a partial cure for the ills of the deregulation fiasco. This concerns an arcane bit of business called the Market Power Mitigation Framework Agreement (MPMFA) and a customer rebate that figures prominently in it. Taking a leaf from Mary Poppins, the Tories are hoping the rebate will be the spoonful of sugar that helps the medicine of a screwed-up electricity system go down with the voters.
Everything we've read, from official sources and pundits alike, about the MPMFA is wrong. So, as a continuing public service, we're here to try to explain what is really going on and what you might expect.
The MPMFA is a series of legal provisions that were imposed on Ontario Power Generation (OPG) by the Ontario government to give the impression that OPG does not completely dominate the so-called Ontario "wholesale" electricity market. In reality OPG is only held in check from unlimited price gouging by political considerations. The executives know that if they run amok now they'll never get any government to let them go private when they can really coin it in.
Be that as it may, the centrepiece of the MPMFA is a price cap and rebate mechanism. There are also a number of ludicrous "decontrol" provisions which require OPG to sell, lease or otherwise "decontrol" various amounts of capacity by certain target dates. We will discuss these in another post.
Regrettably, the only way to grasp the rebate provisions is to understand what a weighted average is [Editor's note: or rather what the OPG considers a weighted average to be – the OPG's definition is different from the definition commonly used in statistics]. Those who ploughed through of our earlier articles will find a discussion of the concept there but we repeat it here because of its centrality to understanding the issues.
Consider your local Bay Street drug pusher. The same analysis works for stocks, too. She has three bags of cocaine, priced at $200, $300 and $400; two of cannabis, at $100 and $200; and, three of Viagra, at $500, $400 and $400. The average price of her drugs is $2500/8 = $312.50 per bag.
Another way of doing the same calculation is as a weighted average, where the "weights" are the contributions of each type of drug, i.e. the number of bags. The weighted average is $300 X (3/8)+$150 X (2/8)+$433 X (3/8), where $300(=900/3) is the average price of a bag of cocaine, $150 (=300/2) is the average price of a bag of cannabis and $433 (=1300/3) the average price of a bag of Viagra, and 3/8, 2/8 and 3/8 are the number of bags of each over the total bags. This is $112.50+ $37.50+$162.50 = $312.50, as before. Finally, we could compute the average as the weighted average of each bag, i.e. = 1/8 X $200 + 1/8 X $300 +1/8 X $400+etc.. We hope it's obvious that this is the same as $2500/8. [Further editor's note: The OPG-style weighted average is simply the mean price per bag, as Dr. LaPaunche notes. By the way, how much Viagra do you get in a bag?]
What makes the new Ontario electricity price difficult to calculate is the sheer number of "bags". Since the system now produces an hourly price, our "bags" are the quantities of electricity produced or consumed in each hour in whatever period we are interested in. In a standard year there are 8,760 hours, so the weighted average price for Ontario for a year will only be known by April 30, 2003, since the new "market" began May 1, 2002, and the price will be each hourly price weighted by the load for that hour divided by the total annual load as the denominator.
The MPMFA specifies the hourly weights for the years 2000 to 2004 that will be used to determine if OPG will have to pay a rebate and, if so, how much. The first two years are, of course, irrelevant, only serving to remind us that the original target date for the "market" was January 1, 2000!
Technically, the total output from OPG for 2002, for example, is called the Contract Required Quantity (CRQ) and the hourly outputs are specified "crqs" for each OPG unit. The CRQ is set to be about 90% of OPG's expected total output. OPG is required to rebate any amounts over an average price "cap" for the Contract Required Quantity of $38/MWh.
The first misconception to clear is that an average price for the whole Ontario market of over $38 will trigger a rebate. This is wrong. In our example this mistakes the average price of cocaine for the average price of all of the drugs. Suppose the mafia told the pusher that any average price she got for cannabis in excess of $140 per bag had to be rebated to their local enforcer. The pusher would owe $20 (+$(150-140) X 2 bags) not $1380 (i.e. $(312.50-140) X 8 bags.
However, unlike our drug example, there is a relationship between the average price of the Contract Required Quantity and overall price. To make our analogy more precise, it would be as if the drug kingpin – let's call him Mr. Baillie – set daily price for bags of drugs irrespective of the content of the bags. To figure out the average value of a bag of Viagra you would have to know the number of bags sold each day and the corresponding daily price.
Some of you may be aware that the Ontario Energy Board (OEB) has set a "reference price" of $43/MWh. In effect, this is an estimate of the maximum overall total Ontario average price that would result in no rebate, i.e. the MPMFA price would be $38.
The second misconception is that the average Ontario price is what individual consumers should expect to pay. This has arisen because the OEB and the government have made no effort to explain what the reference price really represents (assuming they know). We'll go further. Both the government's literature and the minimal explanation given by the OEB leads people to think that $43 is the average they should expect to pay. What they've not explained is that the price you pay depends upon how much you consume in which hours, not the overall revenue received by the generators.
If you and your neighbour each consume three bags of drugs, in calculating your average cost of drugs it matters whether you consume straight Viagra or a mixture of Viagra and cocaine. Residential consumers have this determined for them by something called the Net System Load Shape, which is different for each distributor. However, since the Net System Load Shape is obtained by subtracting the industrial and streetlighting loads from the amounts each distributor buys from the Independent Market Operator, it's a pretty fair bet that residences will pay more than the average. As a rough rule of thumb you can add 20% to the Ontario average, although we caution this varies widely from service area to service area.
Finally, the rebate has couple of ugly correction terms that reduce its value. The more important of the two is the "Price Spike Adjustment," which means that any prices above $125 multiplied by the load in that hour get subtracted from the rebate. In effect, this limits OPG's responsibility for high prices to $125.
The second is a "Force Majeure" adjustment whereby capacity claimed under this category in any hour gets deducted from the rebate. The bad news is that in the North American electricity industry, Force Majeure tends to mean whatever the generator says is means. The good news is that OPG is only allowed to deduct actual costs for the amounts of power it claims are eligible, which effectively limits the average per MWh deduction to around $40.
Let's try to make all of this more concrete by using the available data for the first five months of the "market". The monthly load-weighted average prices (per MWh) for electric power, rounded to the nearest 10 cents, were; May- $30.1, June $37.1, July $61.9, August $69.3 and September $83.0. The cumulative load-weighted price is $57.0. The corresponding cumulative price for the purpose of the MPMFA rebate is $54.7, for an unadjusted OPG rebate of $16.7 (i.e. $54.70 - $38). To get the customer rebate this must be scaled to the full load (65 million MWh for the five months versus 40 million MWh Contract Required Quantity), yielding a rebate of about $10.4 (i.e.(40 X $16.7)/65). Our estimate of the Price Spike Adjustment is $2.8 so, if the rebate were calculated over these months (which it isn't) it would be $7.6 or less, depending on the Force Majeure adjustments. We don't know what residential prices were because we can't get hold of any utility Net System Load Shapes.
We hear that the Tories are under pressure to force OPG to pay rebates right away. This would require a change to the MPMFA since the $38 cap depends on the calculation being done over a twelve-month period. You can see from the prices above that there's a large seasonal variation in prices/costs. However, if OPG were pressured into this, what would it mean?
Leaving aside the fixed costs on your electricity bills (for transmission, distribution, the Independent Market Operator and the new Debt Reduction Charge) the average residence, using one MWh per month, would owe about $350 (5 times $70, our guess of the translation of a $57 IMO price to residences by application of the Net System Load Shape) and get a rebate of $35, rounding the $7.6 down to allow for Force Majeure. Most utilities have put their Standard Service Supply customers on "equal billing" so most Ontario households are already in the process of being billed for close to this amount. Not so Torontonians, whose utility, Toronto Hydro, decided to go with the Standard Service Supply "reference" price of $43, set by the OEB. We now hear that Toronto Hydro has applied to the OEB to change to an "equal biiling" scheme. As an illustration, if this were to have been made effective immediately, the net impact would be $100 extra on your bill ($350 - ($43 X 5) - ($7 X 5)).
So what is the likely consequence for the Ontario consumer if the rebate is paid according to the existing MPMFA? Since OPG's execs must still be hoping that the Eves government or a Liberal successor would still be bamboozled into giving them a licence to print money by taking OPG private, they will likely manipulate prices to generate a small rebate which will likely appear on bills in the Spring. If the Ontario Winter is relatively normal our (per MWh) predictions are: a weighted average total Ontario IMO price of $49 - $51 (compared to $57 for the first 5 months): an average Standard Service Supply price of $55-62 (our guess of the effect of the Net System Load Shape); an MPMFA price of $46 - 48 (compared to $54.70, above) and a rebate of $4 - 5, after PSA adjustment. The average household (one MWh per month), after shelling out about $200 - 300 more (in total, not just for power – in another post we'll explain all of the costs) than they would have done for the same level of annual consumption four years ago, would get a whole $40-50 rebate.
Just in time to re-elect the ferret! Don't spend it all at once!
A Spoonful of Rebates Won't Make Electricity Costs Any More Palatable
© Coolth, 2002
