How Would the Privatization of Hydro-Québec Make Quebecers Richer?
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Chairman of the Board: Hélène Desmarais President: Michel Kelly-Gagnon Vice president and chief economist: Marcel Boyer The Montreal Economic Institute (MEI) is an independent, non- profit, non-partisan research and educational organization. It Web site: www.iedm.org endeavours to promote an economic approach to the study of public policy issues. The product of a collaborative effort between entrepreneurs, academics and economists, it does not accept any public funding. The opinions expressed in this study do not necessarily represent those of the Montreal Economic Institute or of the members of its board of directors. The publication of this study in no way implies that the Montreal Economic Institute or the members of its board of directors are in favour or oppose the passage of any bill. Reproduction is authorized for non-commercial educational purposes provided the source is mentioned. Graphic Design: Valna Graphisme & Impression © 2009 Montreal Economic Institute ISBN 2-922687-25-2 Legal deposit: 1st quarter 2009 Bibliothèque et Archives nationales du Québec Library and Archives Canada Printed in Canada Claude Garcia How would the privatization of Hydro-Québec make Quebecers richer? Montreal Economic Institute Research Paper • February 2009 How would the privatization of Hydro-Québec make Quebecers richer? Table of contents LIST OF TABLES . .4 LIST OF ABBREVIATIONS . .5 EXECUTIVE SUMMARY . .7 FOREWORD . .9 CHAPTER 1: THE ORIGINS OF HYDRO-QUÉBEC . .11 CHAPTER 2: LIBERALIZATION OF THE NORTH AMERICAN MARKET . .18 CHAPTER 3: OPERATIONAL EFFICIENCY . .21 CHAPTER 4: USE OF CAPITAL . .27 CHAPTER 5: THE EXPERIENCE OF THE UNITED KINGDOM . .40 CHAPTER 6: THE RISE IN ELECTRICITY RATES . .43 CHAPTER 7: A STRATEGY FOR PRIVATIZATION . .47 CHAPTER 8: THE PUBLIC OFFERING . .54 CHAPTER 9: PROTECTING QUEBEC ELECTRICITY CONSUMERS . .57 CHAPTER 10: THE ROLE OF THE QUEBEC GOVERNMENT . .61 CHAPTER 11: THE ROLE OF HYDRO-QUÉBEC . .67 CHAPTER 12: THE “SOCIAL CONTRACT” . .70 CHAPTER 13: ELECTRICITY EXPORTS . .72 CHAPTER 14: ELECTRICITY AND ALUMINUM SMELTERS . .75 CONCLUSION . .80 APPENDIX 1: A BRIEF DESCRIPTION OF COMPANIES FROM THE COMPARISON GROUP . .82 APPENDIX 2: STANDARD LIFE, AN EXAMPLE OF DEMUTUALIZATION . .84 ABOUT THE AUTHOR . .85 Montreal Economic Institute 3 How would the privatization of Hydro-Québec make Quebecers richer? List of tables Table 3.1: Sources of energy used . .21 Table 3.2: Number of customers per employee . .22 Table 3.3: Operating expenses per customer for transmission and distribution . .23 Table 3.4: Length of transmission and distribution network . .24 Table 3.5: Operating expenses per customer . .25 Table 4.1: Construction cost of power plants per MW by developer . .28 Table 4.2: Cost of electricity by developer . .30 Table 4.3: Analysis of proposed budgets for Hydro-Québec construction projects relative to final costs . .31 Table 4.4: Installed power utilization factor . .32 Table 4.5: Peak consumption relative to average consumption . .33 Table 4.6: The seasonal nature of electricity consumption . .34 Table 4.7: Investments in transmission . .37 Table 6.1: Evolution of royalties during the transition period . .46 Table 7.1: Income statement for the transition period . .48 Table 7.2: Average electricity rate . .52 Table 7.3: Financial ratios for the comparison group . .53 Table 8.1: Amount of taxable dividends for Quebecers with declared income of $50,000 or more . .55 Table 9.1: Impact of the rate hike and the dividend on low income customers . .57 Table 9.2: Impact of taxes on the dividends and on the sale of shares . .58 Table 9.3: Average consumption per use for households . .59 Table 10.1: Government revenue following the sale of its shares . .62 Table 11.1: Financial ratios during the transition period . .68 Figure 13.1: Electricity exports . .72 Table 14.1: Unemployment rate by administrative region . .76 4 Montreal Economic Institute How would the privatization of Hydro-Québec make Quebecers richer? List of abbreviations kW : Kilowatt MW : Megawatt (1 thousand kilowatts) kWh : Kilowatt-hour MWh : Megawatt-hour (1 thousand kilowatt-hours) GWh : Gigawatt-hour (1 million kilowatt-hours) TWh : Terawatt-hour (1 billion kilowatt-hours) km : Kilometre Montreal Economic Institute 5 How would the privatization of Hydro-Québec make Quebecers richer? Executive Summary The study begins with the Moreover, we show that Hydro- early days of electricity in Quebec Québec’s annual profit would shrink and outlines the reasons that led from $2,882 million to $709 million Quebec to nationalize the produc- if it had to pay the market price for tion and distribution of electricity the electricity it obtains from and to entrust its management to Churchill Falls. Is it reasonable to be Hydro-Québec. A summary is also content with such a trifling contri- presented of the developments undertaken to bution from our principal collective resource? enable Hydro-Québec to boost substantially its Why such limited profits from the exploitation of exports to the United States following liberaliza- such a large hydroelectric development? This tion of the American market toward the end of figure alone supports our position that Hydro- the 20th century. Québec’s annual profit would surpass $5 billion if it made better use of the capital entrusted to it, To analyze Hydro-Québec’s performance and if it were as productive as the most efficient from various standpoints, we create a compari- businesses in exploiting it. son group of U.S. companies involved in the production, transmission and distribution of There are many similarities between the electricity. We show using several measures that British experience before privatization and the Hydro-Québec achieves a lower operational effi- picture of Hydro-Québec we have sketched in ciency level than comparable businesses. It could this study: overabundance of personnel; save at least $1 billion a year if it reduced its unnecessarily high cost structure; unnecessarily operating expenses to bring them in line with large investments; and lack of competition. those of the most efficient private businesses. Privatization enabled the United Kingdom to enjoy renewed profits despite a rate drop of over Hydro-Québec has not shown great 30% from 1990 to 2005 (after taking inflation financial discipline when building power stations into account). If it was successful, though, it is over the years, since the cost price of the electri- because privatization was accompanied by a two- city it will produce with some of those power part reform in the industry’s governance. First of plants is more than double the cost price of all, the regulatory model was modified to electricity produced by small private sector encourage market participants to increase their power plants. The construction cost of a Hydro- efficiency. In addition, competition was freed up Québec power plant surpasses its projected as much as possible, notably by allowing all budget by 26% per project, on average. These British consumers to choose their electricity noted shortcomings in the management of large provider. investment projects are not limited to the Production division, as we have revealed similar In addition to taking necessary measures to shortcomings in the firm’s other divisions. Better improve Hydro-Québec’s efficiency for the management of investment projects would benefit of all Quebecers, we also propose enable Hydro-Québec to cut, over time, more modifying our aluminum industry strategy. than $1 billion from its annual spending on debt Increasing Quebec’s aluminum production servicing and amortization of fixed assets. capacity—90% of which is exported to the Montreal Economic Institute 7 How would the privatization of Hydro-Québec make Quebecers richer? United States—coincided with a reduction in electricity rates be paid to the Quebec govern- production capacity for this metal south of the ment in the form of annual royalties. The border. Meanwhile, the deregulation of the government will receive $8 billion a year in American energy market has increased the value royalties once rates have risen to market levels, of electricity produced in Quebec by a and will collect $24.7 billion from the progressive considerable amount. Unlike the situation that sale of its Hydro-Québec stock. Privatization will prevailed in the 1980s during which we had a also enable true market prices to play their full surplus of electricity for which there were no role. In the future, if the Quebec government takers, the American market is now thirsty for wants to subsidize the aluminum sector, it will energy and ready to pay a lot more for it. We have to do so explicitly by soliciting funds from estimate that Quebec deprives itself on average of the National Assembly rather than by ordering at least $2 billion a year by continuing to Hydro-Québec to do it. subsidize electricity supplied to aluminum smelters. If we add this $2 billion in lost profits to It is clear that Quebec consumers will have the $5 billion of potential profits if Hydro- to pay more for their electricity if this proposal is Québec had better financial results, this means accepted. Electricity consumers will react and that Hydro-Québec’s profits could reach $7 quickly adapt to the proposed rate hike by billion without raising Quebec’s current low reducing their consumption and by choosing electricity rates. other forms of energy better suited to their needs. We propose to compensate, in full or in part, all It is time to modify our strategy and obtain residential Hydro-Québec customers by granting returns from Hydro-Québec worthy of the best them free Hydro-Québec shares at the time of its Quebec businesses. As one government after initial public offering.1 another since 1944 has been either unwilling or unable to obtain acceptable financial results from Failing to adopt the set of measures we Hydro-Québec, we must take inspiration from propose here, Quebecers leave over $10 billion on the British example and privatize Hydro-Québec.