Accounting ploys kept rates down, government revenue up — but at big future costs.
Storm clouds over the W.A.C. Bennett dam — and BC Hydro. Photo by Tad McIlwraith, from Your BC: The Tyee’s Photo Pool.
The Liberal government in Ontario is facing a major political crisis due to opposition to the rapid increase in electricity prices, which have jumped by about 70 per cent for peak consumption in the last five years.
The rising price of electricity in Ontario has been attributed to growth in fixed costs, longer-term lucrative contracts for private power suppliers, the cost of major capital expenditures, the move to green power generation and falling demand for electricity. Public concern about growing electricity rates forced the government to announce this month it would cut bills by an average of 17 per cent. Borrowing the money to cover the lost revenue will saddle taxpayers with $1.4 billion in interest payments annually.
In British Columbia, BC Hydro is facing similar pressures on its costs and relatively flat demand, but the five-year cumulative increase in rates has been “only” about 27 per cent. How has the public electricity utility in B.C. managed to keep the price increases at a more moderate level compared with Ontario’s?
The answer lies in the fact that the B.C. government has deliberately directed the formerly independent regulator of BC Hydro to approve rate increases at levels below what is actually required to produce the electricity.
Through the aggressive use of an accounting device called deferral accounts, the annual shortfall in operating revenue has been added to BC Hydro’s rapidly growing debt burden.
At the same time the government has created a unique accounting standard for BC Hydro that allows the financial manipulation to occur in the absence of an independent regulator.
Regulated electricity rates
The major power utilities in Canada are regulated by independent third-party commissions. They set the rates charged for electricity using a “cost of service” model: it incorporates all prudently incurred costs and a fair return on equity. The power corporations must manage costs to ensure that profit targets set by the regulators are achieved.
The independent regulators have a dual role. They must ensure that the rates are high enough that the power corporations remain financially viable, and at the same time they must protect the public from excessive profits that can result when big power utilities are monopolies or near-monopolies.
Regulated power utilities use a special accounting standard that allows them to defer certain costs that exceed the planned costs. This way, some unplanned costs get incorporated into future rates. This practice ensures that the utility will eventually have its costs covered, but the rate increase will be spread over a longer period to protect the consumers from short-term rate shock.
These “deferral accounts” (also called regulatory accounts) are especially useful for moderating the rates for hydro power, because water flows are dependent on the weather and hard to predict, and for major capital or other one-time expenditures.
The large publicly owned power utilities in Quebec (Hydro-Québec) and Ontario (Hydro One and Ontario Power Generation) are regulated by independent bodies using the cost of service model and deferral accounting.
In theory, BC Hydro is also regulated by an independent utilities commission and also uses deferral accounting. However, while the regulators in Quebec and Ontario have been relatively free from direct political control, the BC Utilities Commission has had its authority limited to the point where it has become little more than an agent of the provincial cabinet.
The BC model
The BC Liberal government stripped the BCUC of its rate-setting authority in 2012, after the commission indicated that the planned rate increase for that year was too low. This dramatic action came about even though from 2009 to 2011 the BCUC had agreed to hold down projected rate increases by allowing a major increase in the number of deferral accounts and the costs shifted into them.
The government ordered the BCUC to approve a low rate increase for April 2013, one month before the provincial election.
In November 2013, the re-elected BC Liberal government responded to criticism from the provincial auditor general by announcing a 10-year financial plan that set the rate increases for the next two years and capped the rate growth for 2016-2018. The next month, the government approved BC Hydro’s controversial $8.8-billion Site C dam project.
Normally, such a major capital project would have required the review and approval of the regulator, but again the government was not prepared to be second-guessed, as Energy Minister Bill Bennett said, by “a group of unelected bureaucrats and lawyers.”
The new rate plan was included in a detailed March 2014 cabinet directive to the BCUC that took all discretion away from the regulator.
The directive also created a new “rate smoothing” deferral account that allowed BC Hydro to record revenues that it may collect in future years. This dubious accounting device allowed the government to claim that BC Hydro was still profitable. It recorded additional revenue on its books for 2014/15 and 2015/16, and it sent $590 million in dividends to the government that would not have been paid out under normal circumstances.
Because BC Hydro did not actually receive the revenue, it had to increase its borrowing requirements by an equivalent amount to pay the dividend. Bennett acknowledged that without the deferrals, the necessary rate increase would have had “a horrible impact on ratepayers.”
A 2014 independent review of the BCUC recommended that the government reinstate its authority and provide it with more resources. The report included a review by Rowland Harrison, an authority on regulatory independence, who concluded that the BCUC was essentially an agent of the government.
But the government has ignored the report. In fact, in July 2016 the cabinet ordered BC Hydro to use the recording and deferral of future revenue to achieve set profit levels for the next three years. Rather than the net income being a variable, set according to each year’s circumstances, it was now fixed in advance, thus demonstrating that the cost of service model had become a thing of the past.
BC Hydro’s growing debt
By March 2016, the net balance in BC Hydro’s deferred assets — the total of the expenses pushed into future years and future revenues already counted — had reached $5.9 billion, against total year-end shareholder’s equity of $4.5 billion. The net deferred assets to equity ratio was 131 per cent. This compares with a 58 per cent ratio of net deferrals to equity at Ontario Power Generation, about 30 per cent at Hydro One and only about 19 per cent at Hydro-Québec.
In the past five years, BC Hydro’s long-term debt, including the deferrals, has grown from $12.8 billion to $18 billion, an increase of approximately 40 per cent. BC Hydro forecasts approximately $2.5 billion in additional annual capital expenditures for the foreseeable future. BC Hydro’s debt-to-capitalization ratio is far higher than those of its peers in Ontario and Quebec, which helps explain why Moody’s Investors Service says it has the worst financial metrics of all public power utilities in Canada.
The government has been able to shield today’s BC Hydro customers from the full impact of the cost increases through the enthusiastic use of deferral accounts and by recording hypothetical future revenue to inflate the bottom line. While the other provincial power utility regulators have remained relatively free from political direction, in B.C. the government has retained the facade of regulation while making all the key financial decisions concerning BC Hydro.
The conversion of debt to equity through the deferral accounts would not be permitted under the generally accepted regulatory accounting rules. Generally accepted accounting standards permit a power utility to use regulatory (or deferral) accounting to smooth annual rate changes, but only if the deferrals and the rates are approved by an independent third-party regulator. The government exempted BC Hydro from the need for an independent regulator in 2011, and stripped the BCUC of its rate setting authority the following year. The accounting standard used at BC Hydro is unique in North America.
So, while the Ontario government subsidizes electricity rates by using taxpayer money, the B.C. government has found a way to manipulate the accounting rules to hide the true cost of electricity from the public and load the difference onto the debt burden faced by future generations of customers.
In effect, the government has decided that winning the May 2017 election is more important than providing an honest accounting of the financial situation at the public electric utility.
