Ontario's electricity grid has been in the news again lately. It seems some folks are confused about what, exactly, goes into their power bill and why they are paying 12 cents per kilowatt hour when the "market rate" is supposedly 3 cents.

I can't say I blame them- we have an alphabet soup of agencies in on this, and the electricity "market" is anything but. Let's try to clarify.

History

Before Mike Harris, we had Ontario Hydro and the local utilities and... well, that was about all that mattered. In 1998-99, the Harris Conservatives thought it would be a good idea to split up Hydro into smaller components that could more easily be sold off, and that would encourage private competition. So, in addition to the dozens of local distribution utilities, we get our first two provincial agencies:

• OPG (Ontario Power Generation), which owns and runs most of Ontario's major power plants.
• Hydro One, which owns and runs the inter-city transmission grid.

If you completely deregulate an electricity system, though, you end up like California at the turn of the century: the wrong infrastructure in the wrong places, with frequent and extended blackouts and skyrocketing prices as the main results. So Ontario had to keep the planning and management roles of the old Ontario Hydro under publc control, separate from the two big infrastructure corporations (which were expected to be sold off). Hence, more alphabet soup came out of the breakup:

• IESO (Independent Electricity System Operator, formerly Independent Market Operator), which runs something resembling a commodities trading floor for the purposes of determining the current "spot price" and therefore which generators are in use at any given time.
• OEFC (Ontario Electricity Financial Corporation), which holds and slowly pays off the debts of the old Ontario Hydro that were racked up when it tried to keep the price of power too low to support the construction of the province's nuclear stations. Had OPG held on to these debts, it would have been impossible to sell it.
• ESA (Electrical Safety Authority), which- as its name suggests- documents and enforces safety standards.

We've also ended up with two planning and regulatory bureaus controlled by the provincial government:

• OPA (Ontario Power Authority), tasked with long-term strategic planning and public outreach.
• OEB (Ontario Energy Board) which sets the rates paid by consumers, and issues licences to companies wishing to participate in energy markets. Its main function is to protect consumers, along with other players in the market, from unscrupulous outfits such as sketchy door-to-door salespeople.

The "Market"

In theory, the electricity market (run by the IESO) matches the province's supply of electricity to its demand. If demand increases, the price increases, and more generators come online to take advantage of the high price. If demand falls, the price falls, and the most expensive generators shut down, leaving the cheaper ones to handle the remaining demand.

Such a market relies on several assumptions:

• Electricity is fungible, i.e. electricity from any one supplier is equivalent to electricity from any other supplier.
• Generators can be quickly started up or shut down in response to changes in demand.

Unfortunately, neither of these assumptions are true:

• Electricity is not quite fungible. The system works much more efficiently when power is generated close to where it is used, and some generators- the coal station at Nanticoke, for example- have enormous pollution and public health externalities that the market doesn't account for.
• Ontario relies heavily on nuclear reactors, which throttle up and down on the scale of days, not minutes. Our least polluting sources- wind and solar- produce energy whenever the weather feels like it, with no regard for demand or the market. Only a handful of fossil fuel plants, and some of our hydro dams, have rapid startup and shutdown capability.

Furthermore, many generating facilities have contracts that stipulate they're guaranteed a certain rate for their power, regardless of the "market" rate. Renewables under the FIT programs are the best known of these, but they're a pretty small component of the overall mix, and quite a few fossil-fuel generators have similar guarantees. So do the hydro dams and the nuclear plants.

The Global Adjustment

The average Ontario consumer pays a fixed, regulated rate per kilowatt hour. The rate varies by time of day, and there are other complications such as fixed minimum fees, but the rates are regulated and known in advance.

Plenty of electricity resellers, many of which are run as sketchy pyramid schemes or door-to-door sales operations, promise a much lower rate- often close to the "market" rate.

What they don't usually tell you is that, unlike customers who pay the regulated rates to a traditional utility, contract customers get a separate line on the bill for the "Global Adjustment". Business customers who pay the spot market price also get this charge. The global adjustment covers the spread betwen the floating "market" price and the price paid to the generators, most of whom- as mentioned earlier- get regulated or contractually fixed rates. At the moment, the GA is actually larger than the market price.

Our market, then, is not really a market. Many consumers pay a fixed, regulated rate and most of the producers are paid at fixed minimum rates. The "market" is little more than an artificial illusion; indeed, there have been cases where the spot price goes negative and yet almost everyone still pays or gets paid as usual. Only a handful of large players notice, or benefit from, price swings in the market.

Could it really be otherwise?

Why, then, do generators get paid these fixed rates? Can't they just accept the market rate and shut down if the price goes too low?

From a business perspective, betting your generation company's fortunes on the market just doesn't work. A power plant's main costs are capital; the things cost a flippin' fortune to build. Fuel is a substantial cost for fossil-fuel plants, a tiny and output-independent cost for nuclear plants, and free for hydro dams, wind turbines and solar farms. The only generators who have a strong incentive to adjust their output according to market forces, then, are the coal and natural gas facilities- the latter of which are only cost-competitive when overall demand is very high, leaving an expensive asset sitting idle on most days.

If the cost of production is more or less fixed, but the market price is highly variable, there's not much incentive to invest in generation: You can't bet, with any reasonable degree of certainty, that the price you'll be paid is enough to cover your capital investment- particularly since the addition of your new power to the market will force the price down. With no-one (including the government) willing to take such a risk, contracts that guarantee a certain minimum price are essential to convince those who control the money to invest it in new generators.

We could let the market have its way, with no interference, and we just wouldn't see any new generators built if the prices didn't justify it. Markets, though, operate on time scales three or four orders of magnitude faster than power plant construction. That would leave multi-year gaps, filled with blackouts and skyrocketing electric bills, between a systematic market trend suggesting a lack of supply and the required new generation actually being brought online. We have a lot of old, failing infrastructure that needs to be replaced, and relying on the open market to make it happen just won't work.Making it happen is supposed to be the OPA's job; whether they're doing it well is another matter.

So, in conclusion:

• The system's a bureaucratic mess of alphabet soup.
• You pay the rates you do because, if you paid less, no-one would be able to afford to run, fix or build a power plant and we'd be stuck with the dirty, deadly, falling-apart coal stations.
• We can certainly do better, and we should be taking advantage of the recession- which is keeping province-wide power demand unusually low- to fix up what we have and replace what we need to before the economy picks up again, which would set off an increase in the demand for electricity.
• Unless you have a mathematically sound case to justify doing otherwise, your best bet as an individual or small business consumer is to deal directly with your local utility. You'll get the predictable, regulated rates and you won't have an extra party inserting their profit margin on top of all the actual costs.