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Insights at UBC Sauder

Werner’s Blog: Who will be the economic winners and losers when B.C.’s Bill 17 drops electricity self-sufficiency

Image of a hydro dam.
Posted 2020-07-20
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In this excerpt from his latest blog post, Werner Antweiler, Associate Professor & Chair, Strategy and Business Economics Division at UBC Sauder, discusses who is set to gain and who is set to lose out from the notable changes that Bill 17 will make to B.C.’s Clean Energy Act, and lays out some possible solutions.

During COVID-19, energy topics have receded somewhat into the background. Thus, it is not surprising that British Columbia's Bill 17 that amends the province's Clean Energy Act from 2010 has not received a lot of public attention. But perhaps it should have, as the forthcoming changes are quite fundamental. They also make economic sense, although the changes will not be popular with independent power producers in the province.

In February 2019, a report commissioned by the provincial government came to some rather unpleasant conclusions about the consequences of entering into power purchasing agreement (PPAs) with independent power producers (IPPs)—wind farms and run-of-the-river hydro installations. The report, authored by Ken Davidson, found that BC Hydro:

  1. bought too much energy (8,500 GWh)
  2. bought energy with the wrong seasonal profile
  3. paid too much for the energy it bought ($16.2 billion over 20 years)

The Clean Energy Act and its self-sufficiency mandate shackled BC Hydro and its trading arm, Powerex. B.C.'s hydro power resources allow the province to engage in a profitable seasonal trading pattern, and the requirements to buy power from IPPs limited Powerex's ability to engage in optimal seasonal trading.

The trouble with self-sufficiency is its creation of artificial demand of 5,500 GWh per year for local IPPs, rather than relying on the market to deliver it. On top of that is another 3,000 GWh per year "insurance capacity" above the self-sufficiency level. Combined, this created an artificial 8,500 GWh electricity deficit. The PPAs stipulate guaranteed delivery at a fixed rate, which makes electricity from PPAs more expensive than from BC Hydro's portfolio of its own generation and electricity trades.

Bill 17 drops the self-sufficiency mandate from the Clean Energy Act, allowing BC Hydro and Powerex to return to a more efficient level of operation. The winners are B.C. rate payers, who won't see their electricity rates go up more and more. The losers are IPPs in B.C. who will likely not see most of their PPAs renewed, and instead may have to face market rates. This is a highly welcomed move from an economic point of view. Fixed feed-in tariffs for renewable energy are no longer needed as a form of subsidy. Wind farms in particular have come of age and can compete on market terms. Given that B.C. has cheap hydro and a brand-new hydro dam under construction, only cost-effective new wind farms that can make a profit on market terms will have a future in this province.

As with any policy change, not everyone is better off. Existing IPPs are obviously unhappy.

The thorny question is what to do with the existing IPP projects? A recent article by Brent Jang in the Globe and Mail pointed to the adverse effect on several Indigenous communities in B.C. who have invested in clean power projects. Some of their contracts expire as early as 2025. From an economic point of view, power projects that have fully amortized after 20 years should simply receive market rates. The correct electricity price is the locational marginal price (LMP), something that is not yet widely used. The marginal cost for run-of-the-river hydro projects is quite low, and certainly below the feed-in tariff of the original power purchasing agreement. Yet, the LMP is what electricity generators should be paid. Some communities, as those mentioned in Brent Jang's article, count on the income. What can be done about it?

Communities that have invested in power projects may have hoped to receive income in perpetuity at levels of the feed-in tariff set out in the original PPA. However, the contracts are only for 20 years, not perpetuity. The initial high rates are meant to help amortize the project and pay off the fixed costs of building the generators. Beyond that, economic circumstances change and market forces apply.

Existing IPPs will continue to operate, but less profitably. IPPs in B.C. will still be able to sell their electricity, but it will have to be at market rates rather than inflated feed-in tariffs, and that means less income. If there is excess supply, BC Hydro needs to have the ability to curtail purchases. IPP investors, whether they are communities or corporations, will not be happy. However, PPAs should not become vehicles for subsidizing communities by exempting them from market forces. One might argue that other sectors are subsidized—the agricultural sector has several examples—so why not subsidize power projects? That is a faulty argument. The correct course of action is to get rid of existing market distortions, not to create new ones.

Going forward, some Indigenous communities may well receive extensions if they can demonstrate that their projects haven't fully amortized in the first 20 years. BC Hydro may find ways of easing the pain for community-owned projects, although these cases will need to remain exemptions and demonstrate a trajectory to full market pricing eventually. It is not BC Hydro's mandate to subsidize communities. If communities need economic assistance and opportunities, there are better pathways for provincial governments to provide these rather than using inflated PPAs.

But what about the benefits of getting rid of self-sufficiency?

British Columbia's electricity trade is mostly with the United States, particularly California. When we analyze monthly exports and imports, we find a pattern of two-way trade even within the same months. Electricity is moving back and forth across the border to balance loads efficiently. But when we analyze net exports, it becomes readily apparent that there is a seasonal pattern to it. British Columbia is a winter-peaking jurisdiction where demand is highest when the weather is cold. Many homes in B.C. heat with electricity rather than natural gas. In California, on the other hand, power demand tends to peak in the summer when temperatures are hot and people run their air conditioners. California is a summer-peaking jurisdiction. It is easy to see that this creates another trading opportunity. B.C. sells power in the summer and imports power in the winter. Both sides gain.

Local IPPs had hoped for continuing profits after their projects amortized during their initial PPA. They will likely face a reality where their revenues will be low—in line with the low marginal cost of these generators. But this is as it should be. Overly generous PPAs are unsustainable, as the former Ontario government learned, but not before encountering significant backlash. With Bill 17, B.C.'s provincial government is putting a lid on this before the issue becomes a political football. Minister of Energy Bruce Ralston has taken the Davidson report to heart and acted swiftly. As we are moving into a future where our electricity consumption will increase as we move away from powering our cars with gasoline, keeping our electricity rates low will be of great benefit to all of us. And if electricity demand grows faster than expected, IPPs in B.C. stand to benefit again from higher market prices for electricity.