Thursday, March 26, 2015

In a commentary in the National Post, Prof. Michael Trebilcock and JD student Duncan Melville identify flaws in the Ontario government's proposal to sell a 10-15% stake in the provincially-owned utility Hydro One via an initial public offering (IPO) ("Ontario’s bizarre ‘privatization’ plan for Hydro One," March 25, 2015).

Read the full commentary on the National Post website, or below.


Ontario’s bizarre ‘privatization’ plan for Hydro One

By Michael Trebilcock and Duncan Melville

March 25, 2015

The Ontario government’s plan to partially privatize Hydro One, the provincial electricity transmission and distribution utility, is misguided. The sale of a 10-15% stake via an initial public offering (IPO) is motivated by short-term fiscal considerations rather than a long-term overhaul of what has become one of the highest cost electricity systems in North America. The sale is unlikely to trigger any innovation or efficiencies within Hydro One, and, perhaps most worryingly, the value of revenues the province will be losing will exceed the proceeds it stands to generate from the sale.

No Efficiency Gains

Most other privatization efforts have resulted in governments selling either the whole company or a majority stake. This is typically motivated by the competition and ownership effects that are widely believed to lead to greater operational efficiencies and innovation than under public ownership.

Hydro One’s main business areas, electrical transmission and distribution, are natural monopolies in the province, and thus the stimulation of competition in these sectors is implausible. Instead, the provincial government may be looking at the ownership effect of financially motivated private investors to generate improvements in the business. This, too, seems unlikely under the proposed plan. With the province retaining 85-90% ownership in Hydro One, having the ability to elect board members, steer corporate strategy and retain control of the company, it is unclear why management would have different incentives than under full public ownership.

Discounted Valuation

The province is selling an interest in a business that has historically been used as a policy tool. For example, over the past few years the province has passed resolutions restricting Hydro One’s ability to hire foreign consultants and redeem costs associated with connecting renewable power projects to the grid. These resolutions were consistent with the political objectives at the time, namely job creation and renewable-energy investment. However, an inevitable outcome of Hydro One’s close history with provincial politics will be investor wariness, which will likely manifest itself in a lower valuation of the company.

Further, with only a 10-15% position, minority investors will have no ability to block future resolutions proposed by the province. While this may not prevent the sale of a minority interest it will likely lead to investors applying a “minority discount” to the purchase price.

Forgone Provincial Revenue

In lieu of its exemption from federal and provincial corporate income tax, Hydro One currently makes payments to the Ontario Electricity Financial Corporation (OEFC), the organization responsible for the $38-billion debt load inherited from Ontario Hydro. However, by selling a stake greater than 10%, the province will be altering the tax status of Hydro One. Last year Hydro One made payments to OEFC totalling $86 million. Following the proposed sale most of this amount would be redirected toward the federal purse. In effect, the proposed sale would act as a wealth transfer from the province to the federal government.

It is difficult to foresee any of the operational benefits typical with privatization coming from the sale of a minority stake in Hydro One. Moreover, although the proceeds from a sale will improve this year’s provincial budget, the resulting drop in provincial revenue will make it more challenging to meet budgets in future years. These forgone revenues, combined with the dividends associated with the sold shares, would be more valuable to the province on a present-value basis than the proceeds it is forecasting from the IPO.