Competition, Customer Choice and Convergence (4 July 1995)



We either can position ourselves on the leading edge of this new wave of change, and benefit from it, or be engulfed in its backwash. Ontario Hydro has determined that its responsibility as stewards of the immense investment Ontarians have in the existing electric power industry has a responsibility to lead.

"Competition, customer choice, and convergence: a new structure for Ontario' electricity industry"

Speech by Maurice Strong, Chairman, Ontario Hydro to the Canadian Electrical Association, at the Deerhust Resort, Huntsville, Ontario, on 4 July 1995.


I appreciate the opportunity of being with you today. Indeed, I really had no option. When my good friend and colleague, Dane MacCarthy, in his new role as your Chairman, told me I must be here, I simply could not say no, despite the fact that I had planned to be on vacation. For Dane has been one of my most valued and effective partners in the process of major change we have been effecting at Ontario Hydro. And there could be no more appropriate forum in which to discuss the nature and importance of these changes and the directions to which they point for the future of the electricity industry in Ontario and the role in it of Ontario Hydro.

The views I am expressing are my own. Although they generally reflect the views of the management of Ontario Hydro, our Board of Directors has not taken a position on the issues related to restructuring of the industry and Ontario Hydro's future role in it. It is not necessary to criticize the industry structure that has served Ontario well in the past to affirm that this structure is not capable of meeting the much different needs and demands of the future. Let me be clear - the present system is obsolete and must be replaced if we are to have an electric power industry in Ontario that will be a primary contributor to revitalizing the Ontario economy to make it more competitive and sustainable in terms of the environmental, social and quality of life values which Ontario cherishes.



Unique factors

 

There are a number of historical and other factors which are unique to Ontario and affect both the present character and future direction of the industry in the Province. But there are other powerful industry and international factors which are driving a process of fundamental change to which Ontario and, indeed, all participants in Canada's electric power industry will need to respond. Each will respond in its own way. But respond we must. The status quo is not an option. And I am convinced that the benefits of change will accrue to those who lead it and that those who lag will pay a heavy cost. Clearly, Ontario must lead. And the changes we have initiated at Ontario Hydro have placed Ontario in a position to lead.

The next steps can only be taken through the political process. The people of Ontario have just elected a new government under Premier Mike Harris which is committed to change. In the election campaign, Premier Harris indicated that his government would consider major changes in Ontario Hydro, including at least some degree of privatization. We welcome - and we need - his leadership in effecting these changes. Ontario Hydro is ready.

This will come as no surprise to those of you who are aware of what has been going on at Ontario Hydro over the past 2-1/2 years. Two years ago, we initiated round table discussions with people throughout the Province on future options for Ontario Hydro around the theme "Hydro 21 - Preparing Hydro for the competitive world of the 21st century".

We raised the possibility of three kinds of structural change in the electricity industry: first, changes in industry structure, including the introduction of competition and ending the integrated Hydro monopoly; second, changes in regulatory structure, including the trade-offs between market-based versus regulated planning and rate setting; and third, changes in flnanclal structure, and the possibility of different ownerships including full and partial privatization.

Hydro's preparations for change went further. We have engaged in extensive consultations with our partners and principal customers, the Municipal Electric Utilities, and other key stakeholders. Over the past few months a financial restructuring group, external advisors to Hydro, has worked with us on identifying a number of financial options including the infusion of private equity and the sale of assets.

Concurrently, a Hydro team has analyzed a number of regulatory options, and the impacts of different industry structures on the regulation of Ontario Hydro and others in the industry.

Our conclusion is that Ontario's electricity power sector cannot sustain its current structure. This begs the question, "What is the new structure, and how soon will it be in place?" It is the people of Ontario and their provincial government who must decide - and the decision must be made soon, with the mandate of this government - or events will decide the issues of us.

 

Evolving change

 

One might well ask, "Is it not possible to evolve change, gradually and incrementally? Can the current integrated monopoly structure not be modified and 'fixed' to cope with problems that affect the competitiveness of Ontario?"

Let's explore that for a minute, and keep in mind that the solutions we're looking for should target the people of Ontario as the primary beneficiaries.

The current structure has allowed us to accomplish a lot already. By late 1992, Hydro had fallen into a state of deep and acute crisis. Demand was falling, costs were escalating, debt was mounting, customers were angry at the cumulative 40% rate increase over the previous four years, and we had $60 billion in planned capital expenditures on the books.

In early '93, we quickly adopted two objectives to overcome this crisis. First, massive and deep cost reductions to halt spiralling rate increases and to reduce Hydro's indebtedness. Second, a fundamental restructuring of Hydro's organization to make it more business-like, more open, more flexible and responsive to customer needs.

We made deep and extensive cost reductions. We committed to a no real rate increase ceiling for the balance of the decade, reduced staff by more than 30% and OM&' A costs by $600 million, and slashed capital spending by $13 billion over 10 years. We have written off "soft" assets and cleaned up the balance sheet.

These measures have enabled us to embark on a long term program of debt reduction. Even with very slow load growth and our self-imposed rate cap, we expect to be able to reduce our 35 billion dollar debt by 9 billion dollars over the next ten years. And after experiencing our largest loss ever, over 3-1/2 billion dollars for 1993, we achieved our largest profit ever in 1994 with a net income of over 800 million dollars before restructuring costs, while effecting a small reduction in rates for the first time in over 30 years. Although our rates are still higher than those of most other Canadian utilities, our variable costs are near the lowest amongst the closest thirty inter-connected US utilities in the northeast.

At the same time, we effected a major internal restructuring, organizing the corporation into autonomous, strategic business units and separating the transmission and distribution sides of the business. Within the new structure we have created an electricity exchange and developed transfer pricing amongst our business units to replicate and prepare us for, competitive conditions as much as possible in an internal setting. We are also embarking on an hourly spot market experiment to get external experience with competition amongst other Ontario generators.

There have been people changes as well, reflective of a more commercial orientation. We now have a business-oriented board of directors, and a senior management team with new people, several with private sector experience.

We have done other things to prepare for an increasingly competitive world and create a performance oriented culture within the Corporation. We have examined our core competencies, assessed our competitive position in relation to an open market, and analyzed our vulnerability to stranding assets under competition.

We have instituted corporate performance measures and put executive compensation on a performance basis. We have established Ontario Hydro International and Ontario Hydro Technologies as subsidiaries to pursue offshore and domestic markets for non-electricity services.

All of these changes were focussed around a strategy for sustainable development based on greater efficiency, both for the corporation and its customers, in the production, transmission and use of energy and in the prevention, reduction and recycling of wastes. This, we are convinced, will put us in the best position to meet the needs of our customers and serve the interest of the Province as we move into the 21st century. This is reflected in a new statement of corporate goals "To make Ontario Hydro a leader in energy efficiency and sustainable development, and to provide its customers with safe and reliable energy services at competitive prices".

We can and must continue to improve and build on the changes we have already made. But we have gone about as far as we can go within our existing legislative authorities and constraints. The process of change must now move into the political arena. Only through major legislative changes can the areas to the kind of fundamental changes we envisage be removed and a new framework established which will enable the electric power industry in Ontario to make its indispensable contribution to revitalizing Ontario's economy on a sound, sustainable and competitive basis.



Cosmetic changes

 

The status quo or mere cosmetic changes within or to the current structure just won't do the job.

To sum up, we have accomplished a lot in establishing Hydro as a more competitive company. Moodys Investor Services identifies nine major steps that successfully positioned utilities have to take to position themselves for competition. Of these steps, Hydro has, or is in the process of: reducing controllable costs; reorganizing for efficiency and accountability; restructuring along business unit lines; encouraging internal competition through transfer pricing; removing cross subsidies and making cost more transparent; written off "soft" assets to put the financial books on a more commercial footing; committed to no real rate increases, and recognized the need for cultural change and a new kind of leadership.

The ninth preparation step, developing customized rate options in response to customer needs, we are attempting to do within the constraints of our present legislation. However, we are limited by the power at cost and rate allocation stipulations in the Power Corporation Act. More on that later.

At the outset, I mentioned three types of structural change - industrial structure, regulatory structure, and financial or ownership structure. I will talk first about industrial structure because that's the cornerstone of change as you move to introduce competition.

Keep in mind that you can privatize without introducing competition. Nova Scotia did that. And you can look to restructure industries which are already under private ownership. California and other US states are doing that, as is Alberta. You can privatize and introduce competition simultaneously, as the UK did.

Also, you cannot effectively design a regulatory structure without first defining what the shape of the industry will be -which parts will be open to competition and which will still be monopolies.

Similarly, divesting public assets to investors when there are plans afoot to change the shape of the industry requires that the industry structure and the way it will be regulated be clearly defined.



For whose benefit?

 

So I start with industry structure, and I say that restructuring is inevitable. Two fundamental questions come to mind - "Why?" and "for whose benefit?" would you restructure an industry which, until relatively recently, has worked very well.

The answer to "for whose benefit?" is for our customers and the Province of Ontario. We feel that the most appropriate approach to creating a provincial benefit in today's environment is to work from the bottom up --to increase Ontario's competitiveness by fostering a more commercially-based and customer-oriented industry which increases the value of electricity to Ontario's homes and businesses.

The answer to "Why?" is complex but compelling. Massive structural change in our industry is inevitable. Much better to lead a process of managed change than to wait until it is imposed by crisis. For there are too many pressures pushing for change, and too many opportunities which will require it.

First is the increasing pressure for customer choice. Customers will increasingly expect the right to pick their supplier of electricity in Ontario, just as they now can in natural gas and telecommunications services, sectors which a few years ago were monopolies.

Second is the recognition by consumers that the incentives of an open competitive market unleash innovation and make companies more customer-responsive. The result -better service and lower prices.

This is particularly crucial when we consider the competitive global pressures that our businesses face. Ontario's industrial customers have over the last few years seen their province's competitive edge in electricity prices evaporate. A significant part of Ontario's industrial base (pulp and paper, mining, chemicals, and steel) is highly electricity-intensive. Even those industries for which electricity is not a large percentage of their costs must increase their competitiveness by reducing all their input costs. Electricity cannot be the only one of their major cost inputs that is isolated from the disciplines of competition and customer choice.

Then there are technological changes coupled with the increasing realization around the world that most monopolies have outlived their usefulness.
Technological change is making reasonably priced electricity available to thousands of new entrants. Generation is no longer a natural monopoly. But what about the wires business?

Clearly it will continue to be desirable to have only one province-wide transmission grid and one set of distribution wires to homes an businesses. But metering, energy audits, and even maintaining and operating the wires businesses are activities that anyone of a number of companies could do. Why then not make all these activities open to competition?

In fact, we think Ontario should ultimately do exactly that. Hydro believes that direct retail access is the ultimate end-state for our industry. Consumers have it in other fixed-link services such as natural gas and telecom. Why should electricity be the only remaining service that can't be competitively sourced?



Made-in-Ontario

 

Such a structure would be built on competition and a market in electricity. Itis not a wholesale access model, as has been declared by the Federal Energy Regulatory Commission - FERC - in the US. But we believe a made-in-Ontario solution is best.

The FERC model does not fit Ontario. Most large US utilities sell all the way down to the end-use customer, and sales to wholesalers are only a small portion of their base. But 89 % of Ontario Hydro's sales are not to electricity consumers but to utilities which resell power.

It does not strike Hydro as any more reasonable to allow our municipal utilities to maintain monopoly power over their customers than it does for Hydro to maintain monopoly power over the municipal distributors. The natural flow of a marketplace starts with the retail customer. As Jessie Knight points out in his California PUC recommendation, "Most industries start with retail competition, transactions between individuals. Over time, as people trade with one another, they realize that there may be economies of scale that they can realize by purchasing in bulk. Hence a wholesale market develops. While competition in the wholesale market is vital to lowering wholesale prices, still greater benefits can be created for retail consumers through retail competition. "

Why not introduce retail access in phases, first to large industrial users, then to smaller businesses, and finally to residential customers?

A structure that phases in retail access over time has been proposed in some jurisdictions. We didn't think that different legal rights for different classes of customers would be acceptable to most Ontarians because it would be at odds with long-held Ontario values about equatability. When customers were given the right to directly purchase natural gas, it was given to all users -big and small -without discrimination.

Furthermore, giving large customers first choice could allow them to "cherry pick" the most attractive supplies. If there is some urgency for some industrial customers to have lower rates, we believe that this should be made possible through flexible rate and pricing offerings or for publicly reviewed discounts to customers in distress.

The structure we have in mind would create a real market in electricity where all customers could make purchasing agreements with generators, and/or from an electricity spot market. It would be based on customer choice -that is, the users would be the choosers.

That's a fairly elementary, and necessary, concept of the marketplace, but the only one I believe that will put electricity customers - whether a large industry, commercial business, farmer, or home owner - in the driver's seat for shaping further change. And I believe, as developments in telecommunications are now showing, that Canadians are becoming less and less satisfied to have governments and authorities at whatever level dictate what's good for them and what's in their best interests.



New structures

 

What other features would the new structure have?

Aggregators and brokers would be licensed to be able to act on behalf of smaller customers who would like to buy direct but lack the time or expertise to do so.
It offers choice of a different path for those electricity customers who do not want to go the open market route. They could elect to continue to have their electricity supplied and priced by means of a not-for-profit Ontario power pool which could be administered by Ontario Hydro much as it is now.

In the new structure, Ontario Hydro would no longer have the obligation to serve those customers who choose direct access.

There would be a competitive retail power sector, where, as much as possible, decision-making would be put into the hands of end-use customers. The owners of the local wires (municipal councils) could put out for competition the right to operate, maintain, and upgrade facilities within a franchise area.

Structuring for a competitive market would require further disaggregation of the parts of Ontario Hydro. We foresee Hydro as a holding company with separate subsidiaries -generating companies configured to compete with one another and with other generators in Ontario and outside the Province. Separate subs for the Exchange, Transmission Grid, a Price Averaging Pool, and Hydro-owned retail utilities. This in addition to our current subsidiaries - Ontario Hydro International and Ontario Hydro Technologies.

One of the decisions the new government will need to take is the role of Ontario Hydro International in repect of which the Ontario Energy Board has recently issued its report. At this time of surplus capacity in Ontario, there is a very attractive market for Ontario Hydro's expertise and we believe that it is important for our customers, and for the Province's economy, that we actively pursue these opportunities. In many cases they require an investment component which could, in largle part, be provided by private capital.

The technological expertise and research and development capacity of Ontario Hydro Technology represents an extremely important asset to the corporation and
the Province. Any restructuring must ensure continuity of its fuding, and this is another area in which private capital could be utilized. For as technology is a primary driver of change in our industry, we must continue to look to Ontario Hydro Technology to keep us on the leading edge of technological change.



Flexible structures

 

There would be freedom for any of Ontario Hydro's current generators to sell to any buyer inside or outside of Ontario.

There would be a flexible and minimal regulatory structure that could accommodate increasing degrees of convergence between traditionally separate industries.

Putting decision-making into the hands of customers in a competitive market is, I believe both inevitable and best. It will profoundly change our industry and ways of doing business. It will spawn more innovation and incentives for change. No longer will large centralized generating stations necessarily be dominant. One can foresee municipalities, and shopping malls, and residential co-ops installing local distributed generation as a complement to, and maybe even an alternative to, buying power produced two hundred miles away and transmitted across the Province.

Let me say a few words about convergence. One inevitable aspect of convergence is the increasing symmetry and substitutability between natural gas and electricity - sometimes called the "gas by wire/power by pipe" phenomenon.

End-use consumers are interested in the services energy provides, not in the raw state of the energy itself; so, whether large industries or homes, the idea of dual energy systems that can use both gas and electricity, or convert gas into electricity, will be increasingly available and appealing to consumers. The storability of gas makes it the perfect complement to the provider of electricity. Gas pipelines to a small jet turbine are an innovative way to avoid electricity transmission blocks.

In the regulatory sense, gas in Ontario is already to a high degree "de-regulated" and retail access is a fact(?) - therefore the gas industry provides a ready model for us. This will inevitably lead to a need for regulatory symmetry between our industries, and with other fixed-link services like telecom. When new generation is required, we believe it will be distributed, local, located near to the customer -and most probably, gas-fired. That's why Hydro could be interested in the idea of purchasing gas in the ground as a first step. Vulnerability to major increases in gas prices would be the only 'major barrier in this scenario, and if Hydro had a stake in gas futures, we would have an important hedge against that vulnerability.

Similarly, a partnership with other members of the gas industry - pipelines, storage, local distribution companies - would be very attractive to power utilities such as Hydro. We foresee a growing convergence of interests between our industries in the very near future. Hydro Quebec already has a strategic alliance with Consolidated Natural Gas of Pittsburgh. We should expect many more similar developments soon.



Radical changes

 

This is my broad overview of the industry structure I believe will best serve Ontario. It represents some radical changes from our current structure - one which has served Ontario well in the past but now threatens to throttle our future. It starts by re-thinking the fundamental assumptions of a monopoly utility structure. An obligation to serve both implies and requires an associated obligation to buy. But in our industry, technology has changed all that. The monopoly was based on the premise that huge capital investments and economies of scale were required to make and distribute electricity.

Because of innovations in technology, our customers - particularly our large industrial customers - have attractive alternatives to being captive to the monopoly supplier. It is important for them and for Ontario's economy that they be competitive and this means that they must be able to meet their energy needs on a competitive basis, so our monopoly - which has been the cornerstone of Ontario's electric power utility structure for almost 100 years - is not only obsolete, but is increasingly becoming an obstacle to ensuring that the economy of our Province remains healthy and competitive. We must sweep this monopoly away and with it the obligation to serve, and let the market work. That's why Ontario's Power Corporation Act must change. New legislation should require, and enable, Ontario Hydro or its successors to compete effectively. We are ready to compete - and to thrive on it!

Let me now tum to the realm of regulatory change. Where possible, the new structure would substitute competition for compulsion. The major role of the regulator would be to ensure fair competition and provide incentives for efficiency and sustainability.

At present Ontario Hydro is self-regulating with its rates subject to review by the Ontario Energy Board. It is also responsible for regulating Municipal Electric Utilities and private utilities, but has not exercised these functions aggressively. Hydro's main legislation, the Power Corporation Act, defines what Hydro can and must do, so although free of formal rate regulation, we do not have the commercial freedoms of other businesses. If we move into a competitive situation as I am suggesting, then we will need the rights and freedoms of a commercial enterprise, and be subject to the same regulation and obligations.

For example, both transmission and distribution tariffs would be regulated. There are efficiency gains to be made in both the transmission and distribution systems, and we believe that some form of incentive regulation would be the appropriate approach in both instances. Elsewhere, as I mentioned, we believe that customer benefits would best be achieved through relying on competition and the discipline of the marketplace.

Some regulation would undoubtedly be required, at least initially, to provide incentives to meet environmental and sustainable development goals. Incentives which harness the competitive marketplace to drive environmental performance will, over time, be more effective than the traditional command-and-control approach. Shifting the regulatory responsibility to an independent regulartory body will require substantive strengthening of and changes in existing regulatory regime - centering around the Ontario Energy Board.

There would also be regulatory concerns around the integrated structure of the industry, particularly if Hydro were to continue to own generation, transmission, the power pool and system exchange that operates it, as well as some of the retail distribution businesses.

A holding company model, with arms-length relationships and separate governance for each subsidiary, would help reduce these concerns. So would full separation of the transmission grid, the exchange, and the generating and retail distribution businesses.

Another concern in keeping Ontario Hydro intact would be its market power. Ourgeneratingstationstodayproduceabout91 %oftheelectricitysuppliedinthe province. The question is the degree to which new entrants could make headway in the Ontario market under these conditions.



Expanding the market

 

There are a couple of ways of addressing this concern. One would be to expand the market beyond the borders of Ontario. If we include the neighbouring utilities with which Hydro interconnects, then we are by no means the dominant player. The development of a regional transmission group for competition would however depend on the position of jurisdictions beyond Ontario.

A second approach would be to take steps to ensure that generators in Ontario are effectively competing with each other. The issue of market power brings us squarely into the third realm of restructuring - of ownership.

Ontario Hydro is well positioned as a low cost producer from the standpoint of marginal costs of production. But this is only half the truth. For Hydro has the competitive disadvantage of having very high fixed costs, mostly attributable to servicing its debt. It is, therefore, highly vulnerable to changes in interest rates.

If open access were declared in Ontario tomorrow, Hydro would also be vulnerable to a few low-cost US utilities dumping their surplus power at just above their marginal costs into Ontario. Because Hydro rates reflect system average costs, these utilities could selectively undercut Hydro rates and for some customers even if our average costs are lower than theirs.

There are other vulnerabilities. Customers which are particularly vulnerable to electricity prices could either move production out of the Province to where it is cheaper, or could generate power themselves at a cost below that of Hydro's system average costs. The effect of customers vacating the system would be to reduce Hydro revenues, and force increases among the remaining customers on the system which would only feed back more incentive to leave. The net effect would be a stranding of Hydro's costs which, because Hydros's debt is guaranteed by government, would put the taxpayer at risk.

There are several ways this vulnerability may be addressed. One would be to have pricing flexibility to discount rates to customers who are being courted by other suppliers. Another would be to defer for four or five years introduction of open access until Hydro's debt and fixed costs can be reduced. A third would be to pay down debt by the infusion of equity. There are, in my view, strong and compelling reasons to do this.

In addition to reinforcing the corporation's capacity to deal with these vulnerabilities, an equity infusion which brought Ontario Hydro's debt down to a level of some 60-65% and enabled it to meet the requirements for borrowing on its own credit, would enable it to phase out, or defease, the provincial government's guarantee of its debt. Itwould be fully in keeping with the character of the new Ontario Hydro as a competitive, market-oriented business for it to be financed on a stand-alone basis, which it certainly can do. At the same time, it offers the Province the opportunity to reduce its aggregate debt by something like a third, a prospect I think would be especially attractive under current conditions. To attain the maximum degree of debt reduction from the removal of its guarantee of Ontario Hydro's debt, the equity infusion to Ontario Hydro would need to come from private investors. But even if the government were to provide this equity, it could still reduce the overall provincial debt by some 25-27 billion dollars.

One of the most cost-effective sources of new equity would be to effect a financial combination or merger between the Municipal Electric Utilities and Ontario Hydro. There is some billion dollars of equity in the municipal utilities, and virtually no debt. This equity has been contributed by the same end-use consumers who bear the costs of Ontario Hydro's debt. The principle of such a consolidation was recognized in the recent study "give name of study" by the Municipal Electric Association, even though the end result they proposed was somewhat different from that which I envisaged. Nevertheless, such a combination would also resolve the long-standing contention of the Municipal Electric Utilities that they own Ontario Hydro by giving them Ontario Hydro shares in return for their assets. The ownership of the new entity would then be shared between the municipalities and the Province. The combination would make an attractive starting point for further financial restructuring and equity infusion.



Employee ownership

 

Another essential consideration in respect of ownership is the desirability of employee ownership. In the final analysis, our future depends on our employees and they should have a vested interest in the Corporation. The employees should be given a preferred opportunity to acquire shares in it. They could also be offered shares as an incentive to move from their current union contracts to contracts which provide for performance-based remuneration and benefits. Our current union contracts are outmoded and constitute a major obstacle to the kind of changes we envisage. Our employees are our most important allies in effecting the kind of changes required and they must be major beneficiaries of these changes.

In referring to the financial advantages of the consolidation of Ontario Hydro with the Municipal Electric Utilities, I mention that this in itself did not require changes in the existing operating and management structure of the MEUs. But this structure needs to be changed for other reasons.

There is no reason why these retail utilities could not also be privately owned, either as cooperatives by the consumers themselves or by private investors, or by a mix of private and public sector ownership.

In any restructuring of Ontario Hydro, the manner in which the nuclear generating plants are dealt with will be a major issue. The nuclear generating plants of Ontario Hydro nuclear now account for some 57% of our base load generating capacity. They also account for some 27 billion dollars of our debt. Our financial advisors indicate that our nuclear plants could be included in a private financing of our generating assets, but that they would have to be written down to a present value of some 15 billion dollars which would involve us taking a whopping haircut of some 12 billion dollars. The good news is that this could be entirely offset by increases in present value over book value of other assets, notably our hydro-electric plants, so that the entire nuclear write-off could be absorbed by the corporation without recourse to government.

The issue of the role of nuclear power in the future mix of electricity supply options for Ontario, which has been somewhat quiescent recently, is bound to re-emerge as we are confronted with decisions on the major new capital investments that will be required to extend the life of existing nuclear plants. But whatever decisions may be taken in this respect, it seems likely that the principal markets for new CANDU reactors in the forseeable future will be outside of Canada. In principle, there would seem to me to be no reason why the processes of consolidation and rationalization which are essential to the future of the remainder of the electric power industry should not also apply to its important nuclear component. Thus, it would make sense to consider a merger of Atomic Energy of Canada with Ontario Hydro Nuclear, to include if they wish to join the nuclear components of New Brunswick Power and Hydro Quebec into a new "Nuclear Canada". It would be in a much better position to compete internationally and maintain the integrity and viability of the industry in Canada, combining in one major organization research, design operation and marketing expertise.

The potential convergence of the electric utility with other industries such as natural gas, telecom, and cable will likely require flexible ownership structures enhanced by the holding company model -that encompass various degrees and forms of partnership, disaggregation, and reintegration of elements of our industry.

A report we commissioned from independent financial advisors and the advice of our investment bankers make it clear that, with the changes we have already made and those now being proposed, a re-structured Ontario Hydro can be financed, with private capital. Our financial advisors prefer a model which would separate generation, into one or more corporations, from the transmission grid and the retail distribution business. The grid would remain in a single corporation but the retail business could, after financial consolidation with the municipal electric utilities, be divided into up to separate corporations. And the electricity exchange would also function as a separate entity.

Restructuring of the industry on this basis would clearly mean a high degree of privatization. But as I said at the beginning of my remarks, the primary purpose of these changes is to provide real benefits to the customers and the Province. For the customers, these must be measured in terms of rates, service and reliability of supply. The benefits for the Province will arise from a more efficient, sustainable and competitive energy industry, from a major reduction in the Province's debt, increased income through taxes and dividends and from the establishment of an asset in terms of its equity interest in Ontario Hydro, which does not now appear on its books, worth at least several billion dollars which could be realized if it wished to sell all or a portion of its equity.
But an important issue that will need to be resolved before these benefits can be fully evaluated is the tax status of a new private, privatized Ontario Hydro.

In principle, a privatized Hydro would be subject to normal commercial taxes at the municipal, provincial and federal levels. Over time, the privatized company or companies should be expected to pay normal taxes, but it would probably be necessary, and certainly desirable, to negotiate special taxation arrangements for at least a certain period of time, particularly as the new taxes to which privatization would give rise, would represent substantial additional sources of tax revenue for each of the jurisdictions concerned. And while the operating efficiencies which privatized companies are normally expected to achieve should eventually offset the taxes that would have to be paid, this will take time, in the case of Hydro as it has already undertaken the kind of large scale cost-cutting measures that would normally only be effected after privatization. This will, in the case of Ontario Hydro, reduce the immediate benefits to be achieved by privatization. While this in itself may be seen as weakening the case for privatization, that case rests largely on the other factors I have mentioned as well.

So there you have it. The steps that Hydro has already taken, and the structure that I am proposing, disaggregates the components of our industry and positions customer choice and competitive performance as the drivers of change. I believe that this framework, once in place, facilitates a number of full or partial privatization variants. That's why I can say to the Premier, "Should you decide to pursue any of a number of restructuring options, Ontario Hydro is ready. "
Hydro has done much of what it can do for itself. It is now up to the new Ontario Government to determine what actions it will undertake with respect to the Province's electricity services sector.

In the next couple of years, our industry world-wide will undergo the most radical transformation since its inception 100 years ago. Ontario will not be immune to those changes. We cannot escape them. The status quo is not an option.

We either can position ourselves on the leading edge of this new wave of change, and benefit from it, or be engulfed in its backwash. Ontario Hydro has determined that its responsibility as stewards of the immense investment Ontarians have in the existing electric power industry has a responsibility to lead - by putting its own house in order as we have been trying to do, and by serving, advising and supporting the government in defining the strategies and making decisions which only it can do. For I am firmly convinced that what we do, or fail to do, within the term of this government will determine decisively whether Ontario is to be the beneficiary or the victim of the processes of change that I have tried to describe. I hope in doing so, I may also have stimulated your own thinking on these issues in which in your own companies and sectors you are also prime actors.