Ontario Electricity IX: The Elephant in the Room
This is my first blog on this new website. Most of my previous electricity-related research is at the Progressive Economics Forum (PEF), and I encourage readers to review that work for context and previous research. Over the years I had written eight blogs about the Ontario, Canada electricity sector at the PEF. This would have been my ninth, which is why I’ve chosen to continue with the Roman numeral count on this new website. All money amounts, unless otherwise indicated, are in Canadian dollars.
In July I described how GHG emissions are expected to increase in Ontario by about 8.3 MT as a result of Ontario Power Generation (OPG) (the State-owned Enterprise - “Crown Corporation” in anglophone Canada) deciding not to refurbish its Pickering Nuclear Generating Station (PNGS) and to shutter it in 2024-25. To “keep the lights on”, Ontario’s Independent Electricity System Operator (IESO) forecasts that gas generation will need to increase from the current 10 TWh to about 32 TWh by 2030 to make up for the lost 22 TWh from PNGS. I argued that the carbon tax, as currently designed in Ontario, is not likely to significantly mitigate the emissions increase.
In parallel, over the last year, some two-dozen Ontario municipalities have voted on and issued non-binding resolutions to go even further, calling on the Province to fully phase out gas generation by 2030. The Province did not originally react to these resolutions. Instead, IESO initiated and concluded a public consultation process by issuing a Study last month on the feasibility, reliability and affordability of shutting down gas generation by 2030. There is lots to review in the IESO Study; in this post I focus on the costs of implementing such a policy and develop one lower-cost alternative.
IESO Study’s Replacement Scenario
The core of the IESO Study is a costed scenario that replaces the current 11 GW of gas capacity with a series of zero-emission assets. It is important to note that IESO warns that even this scenario is likely not implementable (due to the relatively short time frame to 2030), and even if it were, it would not be reliable.
The replacement portfolio includes new wind and solar assets, a nuclear small modular reactor (SMR), grid-scale storage (greater than any existing storage facility in the world), totalling $17 billion in capital expenditures (capex), plus $10 billion capex for new transmission, for a total of $27 billion. The debt and operating expenses of these new assets and other new annual costs, including “firm” (guaranteed) imports from Quebec, would result in $5.7 billion in annual costs. IESO does not provide the parameters of how it calculated this annual cost or a breakdown of its elements. To put this annual cost in perspective, annual total system costs in Ontario are currently about $21-23 billion.
Carbon Abatement Costs
From a cost/benefit perspective, IESO calculates the carbon abatement costs of the replacement scenario at $469 per tonne (T) of avoided GHG emissions, based on forecast 2030 emissions of 12.2 MT ($5.7 billion / 12.2 MT = $469/T) and argues that it is “a steep price compared to other carbon abatement efforts”. I agree. In principle. In practice I have misgivings about how IESO defines the “baseline” against which it compares its replacement scenario (more below).
Economists have developed a series of tools to help analyse climate change and weigh the costs and benefits of different policy options. William Nordhaus, the Nobel Laureate, developed the social cost of carbon (SCC) which is the discounted rate of future costs and benefits related to climate change. The USA has recently calculated the SCC at US$51/T; under this framework, measures that cost less than $51 to avoid or reduce a tonne of carbon are cost-beneficial, while those above are not. The SCC, for example, can be used to set the level of a carbon tax. More generally, carbon abatement costs can be used to compare different policy measures, as I do below.
Compensation to Gas Generators
While the IESO Study includes “hard” capex and opex costs and “soft” carbon abatement costs, it warns that it has not included a number of “unknown” costs, for example “compensation to asset owners” if gas plants are legally prohibited from operating from 2030 onward. There are two compensation elements that would arise from such a prohibition.
The first element is the cancellation of the power purchase agreements (PPAs) signed by the gas generators with IESO. These are mostly in the form of capacity-like Net Revenue Requirement (NRR) provisions. Scott Luft has calculated the NPV of these contracts from 2030 to 2040 (when the last one expires) at $2.0 billion.
The second element would result from the legal prohibition from operating gas plants, regardless of whether gas operators have a contract. Recall that the original vision of the reformed Ontario sector from 2002 was that most new generation would be “merchant” – that is, operating in the market without having a State-guaranteed contract. Indeed, this is how “energy-only” markets operate in Alberta, Texas and other liberalized markets around the world. Absent contracts, gas plants in Ontario would be free to continue to operate either on a merchant basis or via newly-signed public or private PPAs (e.g. local distribution companies (LDCs), or large industrial/commercial users). To prohibit this operation, the Province would have to pass new legislation, which would presumably also involve compensation, as has been done for the coal prohibitions in Alberta and Nova Scotia. I calculate the one-time compensation costs of legally prohibiting the operation of all gas plants at about $6 billion. In theory, the costs would be calculated as the difference between the “as is” and post-prohibition (residual) values of the assets (taking into account financial obligations) plus the NPV of forgone profits. For simplicity, I use IESO forecast gas generation of 400 TWh over the 2030-2040 period multiplied by a residual asset value and forgone profit that I estimate at about $15/MWh. Compensation from both elements totals about $8 billion.
Of course, in practice, the actual compensation would depend on legal strategies, bargaining power with the private gas generators and the extent to which the Province compensates OPG. Recall that OPG owns nearly half of the of 11 GW of installed gas capacity, and that it was not compensated by the Province to prematurely shut down all of its coal generation as part of Ontario’s coal phase from 2005 to 2014.
Scenario Analysis – Replacement Scenario #A
Here I discuss the IESO replacement and other scenarios, which I summarize in Table 1.
Scenario #A is the IESO replacement scenario with capex of $27 billion and annual costs of $5.7 billion. Using a borrowing rate of 3.5% and a series of amortization periods I disaggregate the $5.7 billion into debt costs ($1.4 billion) and opex ($4.3 billion). IESO states that capacity for this scenario is 17.4 GW, which works to $1.6 million/MW. IESO does not provide generation estimates, which I estimate at around 32.0 TWh (rounded up from the 31.3 TWh forecast IESO’s 2030 forecast of gas generation to match the other scenarios), meaning annual costs of $179/MWh. For comparison, current system-wide costs, including generation, transmission are around ($22 billion / 147 TWh=) $150/MWh.
Scenario #D: IESO Baseline
As noted above, IESO calculates the carbon abatement cost of Scenario #A at ($5.7 billion / 12.2 MT =) $469/T, as presented in Table 1. I do not consider the “zero cost”, “zero emission” baseline against which IESO compares their Scenario #A realistic. IESO does not provide an explanation of this baseline or any other detail. The way I interpret is that we could eliminate gas at zero cost, and not replace it with anything and hence live with reduced generation of 20%. In spite of my misgivings, but for completeness, I present this IESO-defined baseline as Scenario #D in Table 1.
Scenario #E: Reference Scenario
As an alternative, Scenario #D is my “reference”, which is that the required 32 TWh in 2030 is provided by gas generation. I calculate annual costs at $2.2 billion, based on total NRR and fuel costs equivalent to about $70/MWh. Based on my July post, I estimate minimal carbon costs because upwards of 93% of emissions would be exempt under the current large emitter program. Relative to this more realistic baseline, the Scenario #A abatement cost declines to $286/T (($5.7 - $2.2 billion)/12.2T).
Scenario #B: IESO Replacement Scenario + Compensation
Above I calculate the total compensation costs of $8 billion. Using the same financial parameters that I used to allocate the IESO capex into opex, I calculate that the annual costs of this compensation are $0.57 billion, or about 10% of the Scenario #A costs. I add this amount to Scenario #A, so that total annual costs are $6.3 billion. Based on this higher number the abatement costs for Scenario #B are $515/T and $332/T relative to Scenarios #D and #E respectively.
Scenario #E: Alternative Replacement
IESO did not model what I consider the most obvious replacement scenario; to refurbish PNGS and avoid the increased gas emissions in the first place! There are three cost elements to this “business as usual” scenario, that essentially projects today’s generation forward to 2030.
Element III is gas generation, which I calculate at $1.5 billion annually (with minimal carbon costs), based on current average gas generation of about 10 TWh.
Element I relates to the refurbishment of the four B units at PNGS. In total, these are likely to be between $8 to $10 billion in capex. In 2009 OPG estimated $2.0 billion/unit. In its 2017 report on nuclear refurbishment programme, the Financial Accountability Office of Ontario (FAO) estimated refurbishment costs of $2.5 billion per unit for the Darlington and Bruce units actually being refurbished. It also noted that actual refurbishment costs for Point Lepreau and earlier Bruce units was $2.4 billionunit. To be conservative, I use $2.5 billion/unit, for a total capex of $10 billion. Applying the same financial parameters as above, that capex translates to annual debt cost of $0.5 billion. To that I add $0.9 billion in opex annual costs, for a total annual costs of $1.4 billion, which based on 14.7 TWh of output is equivalent to $95/MWh (higher end of FAO estimates).
Element II relates to the continuation of the two operational PNGS A units that would otherwise be closed down if the four PNGS B units are not refurbished. Based on the mid-range of FAO post-refurbished costs of $85/MWh, and based on 7.3 TWh of output, annual costs are $0.6 billion.
The sum of these three elements is $3.5 billion of annual costs at $111/MWh based on 32 TWh. The corresponding abatement costs are $422/T and $156/T relative to Scenarios #D and #E. That compares to abatement costs of $515/T and $332/T for IESO’s replacement scenario when financial compensation to gas generators is included, and $469/T and $286/T when it is excluded, respectively.
Discussion & Concluding Thoughts
Ontario already has a very low emission electricity sector. The relatively high carbon abatement costs calculated in this post reflect this achievement and suggest that emission reductions in Ontario should be focussed on other sectors (transportation, etc.). But it is another question when bad policy will result in increasing electricity emissions….
My preferred least-cost option would be to maintain the status quo generation assets. But this is not OPG’s preferred option, and its 100% owner, the Province of Ontario, has not directed it to refurbish PNGS. Once it goes off-line the “do nothing” scenario of having gas generation make up the lost 22 TWh to “keep the lights on” is not acceptable to me and to many others. The replacement scenario, the only one modelled in the IESO Study, is relatively very expensive and unreliable.
The PNGS refurbishment option is preferable to the IESO replacement scenario. It has proven to be reliable, as current experience shows. It is also much less expensive because it is based on the refurbishment (nuclear) and continued use (gas) of existing assets, rather than new generation, and because it does not involve financial compensation to gas generators. The refurbishment option does not increase current emissions and has much lower carbon abatement costs than the IESO replacement scenario.