Far from being anomalous, monopoly utility systems like Ontario's have been the norm throughout the world until very recently. It was only a little over a decade ago that competition was first introduced into the electricity supply business in Margaret Thatcher's United Kingdom. Others eventually followed, most notably the U.S., Australia and Western Europe. One of the more recent entrants to competitive electricity markets is the Philippines, where an Electricity Reform Act to privatize the heavily indebted National Power Corp. and unbundle electricity generation from electricity transmission was introduced in the National House of Representatives last April. The Senate must now pass its version of the Bill, provided the process survives allegations of massive bribery.
For economic, political, and other reasons (see Ontario Hydro: The Dismemberment of A Crown Jewel Sidebar which accompanies this article), it was only a matter of time before Canada's most industrialized province, whose economy throughout most of the twentieth century had been built on relatively cheap power, joined the new mainstream and opened up its electricity marketplace to competition. Other Canadian jurisdictions, such as Alberta, B.C., Manitoba, and Quebec, have opened their electricity markets to varying degrees of competition. However, while market developments across Canada are important and will be examined in the second and third parts of this three-part article (i.e., in the June and July/August issues of Lexpert), there is no question that Ontario's initiative is the most comprehensive and fundamental proposed restructuring of the electricity industry in Canada to date.
So, as of November of this year, if all goes according to plan, the simplicity of Ontario's power monopoly will be replaced by a purportedly more efficient but indisputably far more complex marketplace. The stable, no-surprise, no-choice, one-stop shopping system ruled with benign absolutism by a publicly-owned monopoly will be replaced by a clamorous swarm of service suppliers and marketers, a dense thicket of regulatory codes and licensing requirements, and an eye-glazing encyclopedia of market rules, all of which must be managed by buyers and sellers alike as they wend their way through an uncharted commercial jungle filled with unfamiliar and significant risks.
The stakes are enormous. This is a $10 billion market (in annual sales) up for grabs, with billions more in infrastructure. Such UK and US heavy-hitters as British Energy, Pec Energy, American Electric Power, GPU Service and Enron have all indicated that they are interested in expanding into Canada. Yet there is a dearth of information as to how the new market will work. For those lawyers and law firms who have the requisite skill set and the ability to move quickly, there exists a window of opportunity to get in on the ground floor of a major new practice area. There are two key words here: "skill" and "speed".
Knowledge Is Power
In describing the opportunities that Ontario's new electricity marketplace presents to lawyers, it is difficult to imagine an aphorism more accurate, and in this instance apt, than the simple truth that: knowledge is power. The pivotal importance that knowledge of the industry and the unfolding regulatory labyrinth will have is dealt with at length later in this article. There is no better illustration of the opportunities at hand than the meteoric growth of Toronto-based Power Budd LLP and the leverage this firm has enjoyed as a result of its association with Cameron McKenna, a UK legal giant with a world-class energy practice.
Like the industry it serves, Power Budd is in a hurry. It is no surprise that it is the "express zone" elevator which whisks you to the firm's office on the 72nd and top floor of Toronto's First Canadian Place. Things happen fast at Power Budd which, after all, did not even exist a year ago. But since the firm's establishment in April of 1999, founders Robert Power, Martine Band, and Peter Budd have parlayed their expertise and connections into a 15-lawyer firm of "cherry-picked" specialists in energy law, environmental law, regulated industries and government relations. All three founding partners have extensive backgrounds in the electricity or related-energy sectors. All three are expatriates from well-known firms, i.e., Robert Power from Outerbridge, Miller, Sefton, Willms & Shier; Martine Band from Stikeman Elliott; and Peter Budd from Bennett Jones.
The restructuring of Ontario's electricity industry is Power Budd's immediate raison d'être. Currently growing at more than a lawyer a month, the firm anticipates between $4 million and $5 million in first year billings. Clients include major energy industry companies such as Trans Canada pipelines, Pan Canadian Energy, Tractebel, U.S.-based General Public Utilities, Hydro Mississauga and Detroit Edison. The firm expects to approximate its current rate of expansion for at least five years, at which time Peter Budd predicts the firm will support 60 to 70 lawyers as it broadens its scope in regulatory areas.
Add to this impressive growth the firm's exclusive affiliation with Cameron McKenna (a major London, England-based international law firm with offices throughout Europe, the former Soviet Union, as well as in the U.S. and Asia-Pacific), and there's a ring of truth to Robert Power's claim that entrance of Power Budd/Cameron McKenna to the Canadian legal market poses a "significant competitive threat" to the country's big firms for electricity restructuring work. The leverage that Cameron McKenna brings to Power Budd by way of its electricity sector deregulation knowledge base is formidable indeed. The UK firm has played an important role in utility deregulation in England and Wales, Northern Ireland, Argentina, Portugal, the Czech Republic, Hungary, India, Pakistan, Taiwan, and Australia. A noteworthy coup was landing the implementation of arguably the world's most complex utility deregulation in what is undeniably one of the world's most lawyered jurisdictions: California. These are people you want in your corner.
From start-up to 15 lawyers in 12 months with your principal competitors being many of the largest and most prestigious law firms in Canada, by any account, is impressive. It is a perfect example of the opportunities present in the new marketplace. When you're hot, you're hot.
A Reconstituted Ontario Energy Board
"Energy is very hot right now," says Jennifer Lea, counsel for the Ontario Energy Board (OEB). "It's a great area to be in because there's a lot going on, a lot of demand for legal advice. Everybody in Ontario is having to grapple with the new legislation and the new responsibilities of marketplace participants."
Many, if not most, of those new responsibilities are within the jurisdiction of the OEB, which was granted considerably expanded regulatory powers by the Energy Competition Act, 1998 (Bill 35). Prior to enactment of Bill 35, the OEB could conduct hearings and make recommendations on rates and other electricity system issues, but final authority always rested with Ontario Hydro's Board of Directors.
David McFadden of Smith Lyons is Co-Chair of the Electricity Transition Committee, a multi-stake-holder group set up in early 1998 to advise the Minister of Energy, Science and Technology on how the province can most smoothly move from monopoly to marketplace. A frequent speaker at electricity industry conferences, McFadden is also Chairman of the Stakeholder Alliance for Electricity Competition and Customer Choice, one of the moving forces behind electricity reform. He underlines the new role of the OEB (and the new opportunities for the legal profession) by pointing out that the word "deregulation" is a misnomer. "We haven't had deregulation, we've had reregulation. Ontario Hydro ran the electricity industry in the past, but now the Ontario Energy Board is the effective regulator. This means, among many other things, that electricity generators have to be licensed, electricity distributors have to be licensed, electricity retailers have to be licensed, and indeed, virtually anybody involved in the industry has to have a license. So this creates significant opportunities for lawyers; it creates a demand for their services in licensing applications, hearings, interpretation and so on. There's a growing need within the industry for legal assistance at the OEB."
The most crowded area of regulatory activity at the OEB these days involves municipal electric utilities (MEUs)-the local hydro commissions. Nearly all of Ontario's approximately 250 MEUs are owned by the municipalities they serve and have been historically governed by appointed commissioners. Bill 35 now requires all MEUs to become Ontario business corporations by November 7th. "It's a very significant change from being a public utility that is owned and operated by the local municipality, to being a corporation which involves having directors and officers and treasurers and possibly even shareholders, depending on the way it is structured," notes the OEB's Jennifer Lea, who goes on to add: "There has to be asset valuations and asset transfers: A lot of MEUs are merging, amalgamating or selling. So there is just a huge amount of corporate related-legal work in that regard."
Mark Rodger, counsel at Borden Ladner Gervais LLP, has spent his entire career involved in energy law, both in electricity and natural gas. He knows the workings of the OEB well, having participated at practically every electricity-related proceeding before the Board since 1988. He's also "seen the other side of the tracks" having served as counsel to OEB staff on natural gas regulation. Now Rodger is co-chair of his firm's Energy Markets Group and leads a team of about 25 lawyers, economists and electricity rate-design specialists whose focus is preparing firm clients for the new Ontario energy market. According to Rodger, Borden Ladner is heavily involved in most aspects of the industry restructuring and a team approach is critical for success. "We act for some 50 plus municipalities/MEUs located across the province. We have had to take each of these and restructure them into at least one, often three or more, Ontario Business Corporation Act companies. Sometimes amalgamations or joint-ventures with other MEUs are involved, others involve outright divestitures, such as our recent sale of Thorold Hydro to Ontario Hydro Services Company. These MEU restructurings typically involve a broad range of issues. There are corporate governance and shareholder agreement matters, recapitalization and other corporate finance issues, and allocation of assets and employee placement considerations. Each of these new companies is also required to file rate applications with the OEB under a new Performance Based Regulation regime. Accordingly, you need a dedicated team with a wide range of skill sets to bring it all together-corporate, regulatory, finance, real estate, labour, tax, telecommunications, municipal-to name a few."
A Learning Curve? Try a Bullet Train Without Tracks
Is expertise in the energy industry per se necessary for lawyers and municipalities getting involved in MEU restructuring? According to former Ontario NDP Treasurer Floyd Laughren who now chairs the OEB, the answer is "Yes, but...". According to Laughren, lawyers of course "need to know the legislation, which is relatively new, and I think they also need to know our system of codes and licensing. If they did not, they would really be starting from a disadvantage. I am not sure they have to be steeped in the energy industry, but they have to at least know these basics." "Or get up to speed," adds Jennifer Lea. "One hopes that lawyers can take on new fields and learn new legislation. For example, a lawyer who's only done consumer protection work previously might be the best person to understand our marketers and retailers licensing regime, which deals a lot with consumer protection, as do our codes of conduct. So obviously you need lots of skills, but lawyers from various areas could make themselves aware of energy issues that are relevant to their existing expertise."
Others are not so sure. Blake, Cassels & Graydon LLP has historically had a close relationship with the principal players in Ontario's electricity industry. Recent involvement includes acting as counsel to Ontario Power Generation Inc. (OPG), the successor power-generating corporation of Ontario Hydro, in its $8.5 billion acquisition of the electricity generating business from Ontario Hydro. However, "municipal restructuring did not turn out to be as hot as we thought it would be," says partner Peter Gilchrist, long-time counsel to various public utilities. Gilchrist, who has a significant national and international track record in natural gas co-generation and district heating developments, is not sanguine about what lies around the corner. "Once you put aside the sophisticated utilities like Toronto, Mississauga, and maybe three or four others, then there is almost a free fall in the capability of local utilities to bring a meaningful analysis to bear on restructuring. I think the regime asks more of those municipalities than they are capable of doing. Many are frozen like deer in the headlights. Fortunately, I think if you don't know what you're doing, and you have some time, the best thing to do is nothing, and that is what most of the municipalities have done."
Echoing Gilchrist at Blakes, Robert Power of Power Budd similarly does not mince words. Power is an environmental and energy law specialist. His involvement in the industry began with a two and a half year-long hearing into Ontario Hydro's 25-year demand supply plan back in 1989. His firm now advises a significant number of municipal utilities, major project developers and other electricity industry players. His partner, Peter Budd, was a member of the Ontario Market Design Committee, which crafted the framework for the market rules and Power himself served as Special Counsel to the 1997 Ontario Legislative Committee investigating Ontario Hydro's troubled nuclear program. Like Gilchrist, Power has his own graphic description of the legal challenges facing the stakeholders in Ontario's new electricity industry: "The fascinating thing about this new game is that the participants feel they are in the equivalent of a high speed Bullet Train, rocketing towards the destination of market opening, and the rest of the track between here and the destination is literally being built in nanoseconds, just ahead of the train. It's a mad scramble."
The train track Power is referring to is the massive set of rules being established by Ontario's Independent Electricity Market Operator (IMO), the entity that will govern the wholesale marketplace, along with the documentation requirements that accompany these rules. Whether you are a generator, a marketer, a retailer, or a wholesale customer, you will be bound by a 700-page compendium called the Market Rules (which can be viewed at the IMO's website at www.iemo.com). "There's going to be a whole range of documents, companion agreements and other secondary and third level instruments relating to these rules. It's either going to be a lawyer's dream or a lawyer's nightmare, depending upon your perspective", says Power, who goes on to add that: "The difficult issue for practitioners is going to be ensuring they understand the unfolding commercial realities of the marketplace and twin that knowledge with the market rules. Further, as the rules will be drafted in advance of the commercial market place, there will be many unforeseen issues still to be resolved."
Mark Rodger at Borden Ladner agrees that just knowing the Market Rules will not be enough, adding somewhat wryly that even that part alone represents "a very challenging and on-going learning curve." Rodger is blunt about who will be the winners and losers in the restructuring of Ontario's electricity marketplace: "I don't believe too many clients will be interested in paying for your education about the new market. Clients expect that you are up to speed on all the latest developments. The real value will be the ability to predict and then seize upon the emerging opportunities as the Rules change to accommodate the inevitable transition and evolution in the market. It is particularly important to have a good understanding of the big picture and how the individual pieces go together to make up that picture. This could be a very daunting task for people just coming in. If someone is interested in becoming involved in this area they should be prepared to make a significant commitment."
Martine Band, a partner at Power Budd, is the principal draughtsman of the Market Rules and it is a safe bet that she is one of a small group of lawyers who have a "big picture" mastery of how the new regime will (should?) perform. After working on electricity restructuring in Hungary for two years and a large oil pipeline transaction in western Africa, Band returned to Canada and was seconded as in-house legal counsel to the Ontario Market Design Committee, where she met future law partner Peter Budd. She thinks that the rules are "predominately quite clear as to what they mean," but concedes that each page has the potential to raise questions of interpretation adding, in brilliant deadpan fashion: "It seems almost inevitable in a document that size."
Band explains that "anyone who wants to participate in the markets has to sign what is referred to in the Rules as a Participation Agreement. They also have to sign a Credit Support Agreement relating to their prudential requirements (security for financial obligations). Anyone who wants to be a metering service provider also has to sign an agreement with the IMO, in accordance with the Rules. People have to understand what being a market participant means in terms of their obligations, which will depend in part upon whether or not their facilities are required to be registered facilities and whether they'll be dispatched or dispatchable, as well as on what class of participant they are."
There are rules for generators, rules for transmitters, rules for customers, and so on. But it does not stop there. There are different rules for different markets. If you are in the "real time" energy markets, for example, you'll have significant prudential support obligations, whereas these are very limited in the financial transmission rights market. "Although some of these obligations are technical," Band says, "all are legal obligations, one way or the other. I'd be hard pressed to see how somebody could really adequately advise a prospective market participant without having a fairly good knowledge of what's in the Market Rules."
The encyclopedic knowledge required to competently advise electricity marketplace participants suggests a secure and busy future for those prepared to take up the challenge. According to Robert Power a "cornucopia of opportunity" awaits the right people. "If I were an ambitious young lawyer, I would jump into this practice area. You can leapfrog your seniors at the bar; they're too busy doing other things. There are great opportunities for the next generation of lawyers. There will be multiple specialties coming out of this."
A Legal Cornucopia Awaits
A broad area of emergent legal specialties involves the related businesses of electricity production and trading in competitive markets. On the horizon are: acquiring, building and operating power plants; securing the rights to transmit power over common carrier networks; physical bilateral supply contracts; financial contracts for differences; and inter-jurisdictional energy commodity trade issues, to name just the major categories where cutting-edge legal expertise will become increasingly in demand.
According to David McFadden at Smith Lyons, the generation side of the business is now replacing municipal utility restructuring as the main focus of electricity industry legal practice. The "decontrol" (i.e. privatization) of several Ontario Power Generation facilities, required by the 1998 Market Power Mitigation Agreement between OPG and the provincial government, will open the floodgates of legal work in the competitive power production marketplace. "There is going to be all kinds of new work for law firms in terms of the acquisition of those assets, working for all the various companies that end up owning them-big opportunities that did not exist before. There is going to be an expansion in a whole range of fields: regulatory, corporate, financing, and more. And all this will continue to expand as new players come into the marketplace."
Adèle Malo's description of the legal workload at Ontario Power Generation appears to confirm McFadden's reading of the marketplace. Malo has been Vice President-Law & General Counsel for Ontario Power Generation (OPG) for eight months now, bringing to OPG her experience with energy deregulation at Union Gas. The natural gas industry, parenthetically, began the kind of restructuring now underway in the electricity business back in 1985. "In terms of OPG's legal load right now, it's fairly heavy. We've got several large transactions on the go right now. We've got the Bruce Nuclear Power Station transaction, which is very large. We've got the decontrol of Lakeview and Lennox. There is complex nuclear and environmental legislation to understand and interpret. We're looking seriously at selling our IT assets and purchasing these services from an outside party. We're negotiating a semi-outsourcing of some of our research and developmment functions. There is a great deal of legal work right now. The heat is really turned up."
Malo heads a legal department of 16 lawyers, including herself, with ten support staff. It may seem like a large in-house department, she allows, but the size and the nature of the company warrant it. "People are working very hard; they are having brand new demands placed on them by people who want to know immediately what to do about trading, or how does an interconnected marketplace work in an environment where there are differing regulatory requirements? All this in addition to the transaction work. Everybody is very busy."
Malo gets help for her team from the broader legal community, particularly for transaction work. "We bring in outside counsel, we have relationships with several firms in the city. I think the size and the nature of the transactions would dictate that this is the prudent way to go. This has not traditionally been a transaction-oriented legal department. We also use US counsel where inter-jurisdictional issues bump up against each other. That's too thorny a neighbourhood to be in alone."
David McFadden is not alone among lawyers at Toronto's major firms in his hope that the use of US lawyers will decline in the near future. "I notice that a lot of American lawyers try to advise their clients on Canadian matters and use Canadian lawyers as back-up. OPG actually brought in a lawyer from California to work with them on transmission rates; he was actually at meetings representing OPG. We do have a North American market here so obviously there's a lot of cross-border work and we work closely with a number of US firms and have very good relationships with them. But we do notice that at times US attorneys are inclined to follow their clients here and use Canadians in an advisory role. Part of the reason is you do not have Canadians who have the experience. I would hope that as things develop more Canadian firms will feel they have enough experience to be able to advise Canadians and be lead counsel, rather than following along in the footsteps of US counsel. I'm hoping Canadian firms will secure the kind of expertise which will enable them to get out in the world market."
A New Skill Set: Knowing The Rules Is Not Enough
George Vegh at the Toronto offices of Donahue Ernst & Young LLP knows something about inter-jurisdictional trading issues. He came to the practice of energy law via constitutional law. After working on the Charlottetown Accord and other high-profile constitutional files, Vegh took a year off to get a Masters degree studying trade issues within the context of constitutional and international law. "It was really my interest in trade issues that transitioned to energy. The area of energy that we particularly work on here is the trade area. We work with power marketers, both gas and electricity." Vegh emphasizes that the electricity market is really just part of a broader energy marketplace. "Power brokers do not just sell the electricity commodity. Their business is to hedge and trade electricity using other kinds of energy products such as transportation capacity or natural gas. These other products are as important a part of the power broker's portfolio as the electricity itself."
Donahue Ernst & Young is affiliated with the global accountancy and professional services giant Ernst & Young, a multidisciplinary relationship which Vegh says adds value to both the business and the legal advice given to the firm's electricity industry clients. "Clients need education and advice on rules as they develop; they need advocacy, someone helping them shape the rules; and they need analysis of the financial implications of the rules. That's another area where we work closely with the E&Y people because they have that kind of expertise that lawyers don't. Very often when a rule is being developed, the big question is 'So what? How does this impact me?' As a lawyer you are not always in a position to answer that. You know if something is going to make their lives more cumbersome. But in terms of orders of magnitude, you're not really in a position to quantify it for them, while the financial advisers, either in corporate finance or in risk management, can do that. From the client's perspective, whether a rule is a financial rule or a regulatory rule or a market rule or an OEB license requirement, they just need to know at the end of the day how it affects them."
Peter Budd at Power Budd agrees. "We're dealing in a sector that is broader than traditional energy and environmental practice," he says. "Our expertise is also in the policy, strategy and economics of production, emissions, dumping, pollution and global warming. It's an area that, from a holistic perspective, is not being properly served in the Ontario market."
Mark Rodger at Borden Ladner Gervais LLP also attaches great importance on how energy-related legal, business and political issues are intertwined. He finds the complexity "always interesting and often unpredictable." "I suppose that practising in this industry is somewhat different. My own practice over the past decade has essentially been one-third law, i.e., negotiation of commercial agreements, regulatory hearings, etc.; one-third business, i.e., helping to establish a business case for a new generator or for acquiring a distribution utility; and one-third government relations. Frankly, that is what I've always enjoyed about the industry. You could be involved in an Energy Board hearing one week, negotiating a power purchase agreement the next, or participating in a lobbying initiative at Queens Park. I see this kind of flexibility as becoming increasingly important to clients."
And this is exactly what Bryson Stokes at Blakes is doing. Stokes has been working on energy projects for a number of years. He started working on gas supply agreements, gaining experience "that sort of flowed into a number of co-generation projects." He is currently assisting clients determine whether or not it makes sense to get into the electricity production business in Ontario. According to Stokes, the first step is to look at the economics. "Before they even start exploring the regulatory regime, it is important for them to figure out if they actually want to be a generator. A lot of people are looking at how they can further develop their existing facilities and/or build new plants to get involved in the market. We have been trying to help them come to grips with all the unknowns that are out there. They have to decide whether it's worth making the investment now and have the advantage of being one of the first in, or whether they should wait until the rules are more clearly defined. That means looking carefully at OEB licensing requirements and the IMO rules, and a lot of this is still in development. It's not an easy decision."
Corporate Counsel: Make Haste Up The Curve!
In selling the idea of electricity industry competition, advocates of deregulation typically cited the price impacts in the telecommunications sector, particularly plummeting long-distance telephone rates, as evidence that ditching the monopoly would be good for all users including heavy corporate consumers. Hopefully, this will be the case. On the other hand, if experience in the U.S. and elsewhere is indicative of the shape of things to come, corporate consumers in the new wholesale electricity market may be in for a rough ride.
Industries and companies with large commercial usage will be placed in the electricity "spot market", unless they choose to contract with an energy provider for fixed rates of various terms. This is analogous to assuming a mortgage or loan for a period of time, rather than accepting the daily fluctuation in interest rates, with one big exception. Robert Power at Power Budd explains: "electricity is the most volatile commodity in the world-prices in other markets can spike 50 fold or more during peak demands. The unbudgeted cost implications of the spot market for major industry and commercial consumers is very serious. Many industry estimates envision 20-50 per cent spot market increases, and possibly higher in the early stages of the new Ontario market, unless alternative contracts are entered into." In short, we may be deluding ourselves by counting on a repeat of the telecom deregulation experience. This is why so many knowledgeable industry players, like Robert Power, are urging corporate counsel to get up the curve, quickly.
David W. Drinkwater knows all about telecom deregulation. He is worth listening to. A partner at Osler, Hoskin & Harcourt LLP for over twenty years, he left Oslers in 1996 for Bell Canada Enterprises to fulfill an ambition to combine law and business. When Ron Osborne, Bell's President and CEO, moved to Ontario Hydro and ultimately became head of Ontario Power Generation, he invited Drinkwater to join as Executive Vice President-Law and Corporate Development. Given his background, the relevant experience and skills which Drinkwater brings to OPG are obvious to all.
Drinkwater says the broad area of "risk management" for new commercial enterprises in a new market is OPG's major legal concern right now. But he has important advice for corporate counsel, particularly in companies where electricity is a significant input cost. "As a general statement (and there are exceptions), I think the degree of sophistication and understanding in the province of generally what's coming in the way of the new electricity market is way too low. That's in all aspects. I don't think most people have any idea what's in front of them. Having said that, some of our customers are industrial users that we sell to directly and some of them are very sophisticated in power. My recommendation to corporate counsel would be to make sure, if they aren't already, that their business people understand what's coming and get ready for it, because it's going to be potentially much more significant than most have anticipated. We've had a freeze on electricity prices in the province for seven years and therefore things have been kind of static. A spot market means prices will move up and down and although there is a form of price cap for a few years, this is going to be a market for which people must develop an understanding. And so I think people need to get up the curve. I don't think enough people are sufficiently up the curve yet."
Drinkwater joins others in seeing a bright future for law firms that carve out a niche in the new marketplace. But he cautions that the newness of it all means few people have the requisite experience, one exception being those who have worked in the natural gas industry. "Many of the lessons learned in the gas industry in Ontario will be applicable; experience with the OEB on gas will be helpful with the OEB on electricity. But there aren't really any bilateral contracts out there on electricity; they aren't buying and selling on the new basis yet. No one has bought or sold a large generating station yet. In any event, however, I think that the people who have an energy practice are making a good decision because it's going to be a big opportunity... It's a good investment."
Bill Reno is a Toronto-based writer and communications consultant to the energy industry. He is President of Reno Associates Inc. and can be reached at bill@reno-associates.com. Contact from law firms and corporate counsel on the subject of electricity is encouraged for future articles in this series.
Next month: The New Deregulated Regulatory Labyrinth