OEA Releases Discussion Paper on Load Serving Entities

Introduction

On September 13, 2018, the Ontario Energy Association released “Policy Case: Recommendations for an Ontario Load-Serving Entity Model.” The Discussion Paper was written by Power Advisory LLC and Aird & Berlis LLP. In the paper, the authors make the case for allowing local electricity distribution companies (LDCs) to act as Load Serving Entities (LSEs) and procure electricity generation and other resources, instead of acting as mere pass-through entities for resources procured by the Independent Electricity System Operator (IESO) (Ontario’s de facto LSE).

Consistent with the Changing Role of the LDC, Rise of DERs

These additional LSE responsibilities would be consistent with the changing role of the LDC generally in an environment where customers, large and small, are becoming more empowered through distributed energy resources. In such a market, LDCs are expected to become distribution system operators, coordinating, connecting and integrating such distributed resources.

New Functions and Skills

LDCs (voluntarily) choosing to take on the new role of an LSE will need to make changes to their organization and structure. These changes will include increasing power system planning requirements, developing procurement plans, implementing procurements and managing contracts, including exposure, credit and default risk. These new responsibilities will require an increase in regulatory, planning, procurement, legal and risk management functions. However, as regulated activities (see below re: development of an LSE Code by the Ontario Energy Board (OEB)), LDCs would be entitled to a rate of return on LSE activities. It may be the case that a limited number of Ontario LDCs will wish to take on these challenges. At the same time, given consolidation in the electricity distribution sector, four to six LSEs would service most Ontario electricity consumers.

An Incremental Approach

The authors of the Discussion Paper recognize that for LDCs taking on the LSE function, the process will be gradual (over time) and incremental (in terms of procured resources). It is recognized that much of Ontario’s resource requirements are already contracted for by the IESO or regulated by the OEB. Therefore, for a number of years, LSEs will only be required to procure resources that complement and fill the need not met by such already-committed capacity. As the need for additional resource procurement grows over time, LSE procurement would increase to fill the gap. During this period, it is expected that LDCs would develop skills, experience and sophistication, either internally or on an outsourced basis, to grow their portfolio.

Benefits of the LSE Model

Benefits of the LSE model would include:

• Improved Resource Investment Decisions: An LSE model will improve planning by more closely integrating distribution system plans and other LDC plans through integrated planning for reliability and resource adequacy, distribution system needs and customer preferences.
• Improved Price Signals: As LSEs will have obligations to supply their customers, wholesale electricity market prices should provide pricing benchmarks to value resources to be procured.
• More Efficient Risk Allocation: The present planning and procurement framework, depending on the IESO as the single buyer, results in customers bearing most, if not all, of the risks (whether as consumers or taxpayers). An effective LSE planning and procurement framework should result in more appropriate risk allocation between third-party resource providers, LSEs and customers.
• Enhanced Buy-Side Participation: Finally, an LSE can help the IESO meet the objectives of its market renewal initiative through increased competition by developing the ‘buy-side’ of the market. It is notable that generally U.S. wholesale electricity markets are underpinned by LSE buy-side participation, which helps generators and other suppliers manage investment risks.

Risk Mitigation

Risk mitigation for LDCs and customers is an important concern in the Discussion Paper. LDCs taking on the LSE function would be governed by an “LSE Code,” to be developed by the OEB, and would be licensed as LSEs by the OEB. The Code and license would provide regulatory oversight, limitation of costs to customers, prudent resource investment decisions, and power system resource adequacy and reliability requirements. The Code would require procurement through competitive mechanisms to maintain downward pressure on costs. Standardized contracts would limit execution risk. Finally, either the IESO or another Ontario government agency, such as the Ontario Electricity Financial Corporation or Infrastructure Ontario, would financially “back-stop” LSE contracts, at least at the early stages, to protect LDC credit ratings and ensure confidence in the LSE structure.

Ontario as an Outlier on LSEs

In most jurisdictions in North America, utilities (of all sizes) have the responsibility for resource adequacy and to perform the LSE function. In this sense, Ontario is an outlier in having decided to restrict its LDCs from this function and, in effect, relying on electricity retailers and the market to ensure adequacy. The restriction on the ability of LDCs to procure electricity resources was made prior to Ontario’s electricity market opening in the late 1990s. At that time, there were 300 municipally-owned electricity distributors. In 2002, volatile and high wholesale prices created political pressure to take action. Instead of leaving market mechanisms in place and temporarily subsidizing customers, the Ontario government froze default supply prices. This had the effect of spooking investors and development of generation stalled. To kick start investment, the Ontario Power Authority (OPA), was established in 2004 as a “single buyer” to procure generation resources. Thus, the OPA (later merged into the IESO) became Ontario’s de facto LSE. As early as 2005, the then-CEO of the OPA contemplated that its electricity contracts would be transferred eventually to a limited number of LSEs to facilitate a transition to a market-based system. This never happened.

Conclusion

As the IESO focuses on developing an Incremental Capacity Auction and other Market Renewal initiatives, the Discussion Paper shines a spotlight on how LDCs can take on the LSE role as another step toward more efficient electricity markets. Not only would adoption of an LSE model bring Ontario into line with most North American jurisdictions, it would also reflect the original intent of establishing the OPA as a single buyer for only a temporary period to act as a bridge to an LSE market structure.