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Posted in: Utility Mergers

Feb 1, 2016

Will Toronto Hydro be "Ubered"? Disruptive Technologies and Electric Utilities

By Ron W. Clark

Recently, reports of behind-the-scenes consideration of the sale of a minority stake in city-owned Toronto Hydro have surfaced. Some (including Mayor Tory himself) have criticized any such potential deal as a "fire sale." Others cite the need for new sources of revenue to fund needed infrastructure. Whether Toronto Hydro remains wholly owned by the city or not, current or future owners should not expect that the heavily regulated monopoly will continue to churn out dividends the way it always has. Disruptive technologies may leave owners with a very different type of company in a very few years.

A sale of part of Toronto Hydro, while unprecedented in the corporation's history, would be unsurprising given the industry's current climate. The province is selling a minority stake in Hydro One, its electricity transmitter and distributor, as part of a public offering. This past fall, the shareholders of Enersource (Mississauga), Horizon Utilities (Hamilton and St. Catharines) and PowerStream (Markham, Richmond Hill, Vaughan, Barrie and others) approved a proposal to merge the three companies and purchase Hydro One Brampton. Energy Minister Bob Chiarelli has encouraged and applauded these transactions as ways to increase efficiencies and "bend the cost curve."

Just as consumers empowered by technology are choosing Uber over traditional taxis, electricity distribution customers are being empowered in ways that threaten the utilities' traditional revenue model.

The current grid was developed to accommodate the one-way travel of electricity, from large central generation plants (think Niagara Falls and nuclear power plants) to consumer. However, the declining cost of "distributed" small scale renewable and other generation, electricity storage, private "micro-grids," and "demand response" (shifting consumption from expensive peak times) means that the grid must become "smart" and be able to accommodate electricity flow in different directions. These trends also mean that consumers at some point may have the option of "cutting the cord" to the distributor and relying on their own resources. In Germany, one in six companies now generates its own electricity, a year on year increase of 50%.

Once a customer disconnects from the distribution system, costs increase for the remaining customers (who need to make up the lost revenue). Increasing costs for the remaining customers means greater incentives for them to disconnect. And so on. When enough customers have disconnected, there is not enough revenue to maintain and operate the network. This has been described as the utility "death spiral." Exaggerated? Probably. Cause for concern? Definitely.

The industry is responding. Ontario has made a massive investment in smart meters and the smart grid. The Ontario Energy Board has adopted a rate design that "decouples" electricity consumed by customers and the revenue received by distributors. And many utilities, including Toronto Hydro, have begun to sell products and services related to (i) reducing consumption through increased efficiency, (ii) reducing emissions through the use of renewable sources, (iii) increasing grid efficiency through a two-way, networked smart grid, and (iv) increasing grid flexibility to integrate distributed generators.

Crucially, these activities are outside of the traditional regulated-monopoly distribution business. Utilities will need to compete with generators, energy services companies and technology and telecom companies.

These competitive service offerings represent a business model some are calling "Utility 2.0." While challenging, the Utility 2.0 model would provide tremendous new opportunities for incumbents, if they recognize and respond to them.

It took Uber only three years to disrupt the taxi industry. They did so by servicing customers outside of the regulated industry who then became a political constituency. Regulation is now scrambling to catch up.

The pace of change in the electricity sector is unlikely to match that of Uber. Opportunities and challenges may arise over the next five years or over the next couple of decades. In any case, existing and future owners of Toronto Hydro will be making a bet on the speed and direction of these changes, whether they know it or not.

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