In April, 2016, Enersource Hydro Mississauga Inc. (“Enersource”), Horizon Utilities Corporation (“Horizon”), and PowerStream Inc. (“PowerStream”), three of the largest municipally owned local electricity distribution companies (“LDCs”) in Ontario, applied to the Ontario Energy Board requesting approval to amalgamate to form a new utility, now named Alectra.
Approval was also sought to purchase and amalgamate with Hydro One Brampton Networks Inc. (“Hydro One Brampton”), owned by the Province of Ontario1, under section 86 of the Ontario Energy Board Act, 1998 (the “OEB Act”).2
On December 8, 2016, after written interrogatories, a technical conference, a five-day hearing and written argument, the OEB issued its Decision approving the consolidation.
The consolidation will create the largest municipally-owned LDC in Ontario and second-largest in North America, by customer numbers, second only to the Los Angeles Department of Water and Power in California. The new company will serve almost one million customers with a total rate base of $2.5 billion.
The purchase of Hydro One Brampton, for a price of $607 million is the largest electricity distributor acquisition in Ontario to date. The application was the first involving multiple distributors and the first merger application since the release of the OEB’s Handbook to Electricity Distributor and Transmitter Consolidation in January 2016.3
Jurisdiction over Electricity Distributor Share Purchases and Amalgamations
In the late 1990s, the Ontario Government undertook a fundamental restructuring of the Province’s electricity sector. This included the breakup of Ontario Hydro into (among others) a wires company (Hydro One) and a generation company (Ontario Power Generation), and a requirement that the 300+ local hydro commissions be incorporated under the Ontario Business Corporations Act (“OBCA”).4 The municipalities in which those commissions operated would become their initial shareholders.
Section 86 of the Ontario Energy Board Act, 1998 provides (in part) that OEB approval is required prior to the sale, lease or disposition of a distribution system as an entirety or substantially as an entirety; the amalgamation of a distributor with any other corporation; the acquisition of shares of a distributor such that the purchaser and its affiliates/associates will hold more than 10% distributor’s voting shares; and/or the acquisition of control of any corporation that holds, directly or indirectly, more than 10 per cent of the distributor’s voting securities if such voting securities constitute a significant asset of that corporation.
Key Aspects of the Decision — the “No Harm Test”
a) OEB Principles in Consolidation Applications from 2005 to the Present
The OEB’s policies on merger, acquisition, amalgamation and divestiture (MAADs) applications, and more particularly its use of the “no harm test” in considering those applications, were established in the OEB’s 2005 decision in a Combined Proceeding in which the OEB considered the principles to be applied to MAADs applications.5 In its decision in the Combined Proceeding, the Board established several principles that would be considered in determining applications of this kind. Among them:
- The Board determined that the “no harm” test is the appropriate test. “The Board is of the view that its mandate in these matters is to consider whether the transaction that has been placed before it will have an adverse effect relative to the status quo in terms of the Board’s statutory objectives. It is not to determine whether another transaction, whether real or potential, can have a more positive effect than the one that has been negotiated to completion by the parties. In that sense, in section 86 applications of this nature the Board equates ‘protecting the interests of consumers’ with ensuring that there is ‘no harm to consumers’”.
- The selling price of a utility is relevant only if the price paid is so high as to create a financial burden on the acquiring company which adversely affects economic viability as any premium paid in excess of the book value of assets is not normally recoverable through rates. The fact that the seller could have received a higher price for the utility, even if true, would not lead to an adverse impact in the context of the objectives set out in section 1 of the OEB Act.
- As a general matter, the conduct of the seller generally, including the extent of its due diligence or the degree of public consultation in relation to the transaction, would not be issues for the Board on share acquisition or amalgamation applications under section 86 of the OEB Act. Based on the “no harm” test, the question for the Board is neither the why nor the how of the proposed transaction. Rather, the Board’s concern is limited to the effect of the transaction when considered in light of the Board’s objectives as identified in section 1 of the OEB Act.
- With respect to the claim that ratepayers have a right to “an open and transparent process” for the sale of the shares or the assets of an electricity distributor, the Board observed that the OBCA contains provisions governing procedures and rights associated with, among other things, amalgamations and other significant corporate activities. “The Board does not believe it is appropriate to add an additional layer of corporate review by vesting process rights (again, in the sense of rights associated with the process leading up to the conclusion of a transaction) within customers of distribution companies. The content of such rights and the process by which they may be exercised is beyond the Board’s objectives or role within the energy sector.”6
Since its decision in the Combined Proceeding, the OEB has set out and refined its policies on rate-making associated with consolidation in 2007 and 2015 reports (the Reports) entitled Rate-making Associated with Distributor Consolidation.7 The OEB’s January 19, 2016 Handbook provides guidance on the process for the review of an application, the information the OEB expects to receive in support of an application, and the approach it will take in assessing whether the transaction is in the public interest. The Handbook also includes Filing Requirements for the consolidation applications. With the LDC Co Decision, the OEB reinforced these long-standing principles.
b) MAADs Principles Applied to the Application
In its Decision, the OEB reaffirmed its application of a no harm test in consolidation proceedings. If the proposed transaction has a positive or neutral effect on the attainment of the objectives set out in section 1 of the OEB Act, the OEB will approve the application. In applying the no harm test, the OEB’s review primarily focuses on the impacts of the proposed transaction on price and quality of service to customers, and the cost effectiveness, economic efficiency and financial viability of the consolidating utilities. In this case, the OEB found that it “has considered the specific facts in this application and is of the view that the features of this transaction are anticipated within the framework of the OEB’s policy and the outcomes are aligned with the articulated policy objective of improving the efficiency of electricity distribution. The OEB finds that the scale enhancements of service delivery embedded in this transaction can be expected to result in long term benefits to customers.” Having determined that the proposed consolidation meets the no harm test, the OEB approved the transaction, the LDC Co Licence application and the transfer of the rate orders for each of the applicants and Hydro One Brampton to LDC Co.
Price, Cost Effectiveness, Economic Efficiency and the Rebasing Period
The 2015 Report established a policy under which a consolidating distributor may choose to defer its next rebasing application (in which the distributor’s rate base and costs of providing distribution services are updated) for up to 10 years (previously, the limit had been five years). The deferral period allows for recovery of costs related to the consolidation and creates an incentive for consolidation. Savings during the deferral period will flow to the consolidated utility’s shareholders, but earnings in years 6-10 that are greater than 300 basis points above the applicable OEB-approved rate of return are to be shared on a 50/50 basis with customers.
The intervenors in the proceeding generally did not oppose the consolidation. Instead, their submissions included arguments that:
- The projected net synergies over the first 10 years were based on high level estimates and there was no credible evidence that savings realized in the deferral period would be sustainable in perpetuity;
- The projected savings (the applicants estimated $429 million in savings over the 10-year deferral period) were understated, and there were many potential synergies/savings that had not been counted or quantified (this was used in support of the argument that the 10 year deferral period should be reduced because the significant anticipated savings that would flow to the utility’s shareholders during the deferral period were excessive and should be transferred to customers sooner); and
- The applicants suggested that rates would be lower under the consolidated scenario than under the status quo because in the absence of the consolidation and rebasing deferral, each of the individual utilities would have been rebasing at least once during the 10-year period. Intervenors argued that the gap between the status quo and consolidated scenarios was overstated, as (in their submission) the applicants had overstated the annual rate increases that would be approved by the OEB during the deferral period.
In rejecting the intervenor submissions, the OEB observed:
“The Handbook states that to demonstrate no harm, applicants must show that there is a reasonable expectation based on underlying cost structures that the costs to serve customers following a consolidation will be no higher than they would otherwise have been. The Handbook also states that the impact the proposed transaction will have on economic efficiency and cost effectiveness will be assessed based on an applicant’s identification of the various aspects of utility operations where it expects sustained operational efficiencies, both quantitative and qualitative.
In this case, the applicants submit that the effect of the consolidation on underlying cost structures will be positive, that costs to serve customers will not be higher as a result of the consolidation and that the consolidation will have a positive effect on economic efficiency and cost effectiveness.”8
In its Decision, the OEB advised that its “incentive framework is intended to provide sufficient financial gains over and above the status quo to incent utilities to seek out merger or acquisition efficiency gains opportunities. The incentive framework is also intended to have customers share in large savings through earnings sharing beyond the 5 year deferred rebasing period.”
The applicants selected a 10 year deferral period, and submitted that customers were expected to benefit from the consolidation with regard to the price for distribution service, in that revenues would be lower during the 10 year deferral period relative to the status quo, in which the individual utilities would be rebasing sooner.
The OEB agreed, and found that “customers will be not be harmed by the proposed transaction in the short term, and will, in fact, be better off and will likely benefit from the enduring benefits of scale in the long term.” Hydro One Brampton was identified as being the lowest cost entity involved in this transaction, but in response to intervenor concerns about potential impacts of the transaction on that utility’s customers, the OEB noted that “Hydro One Brampton will have additional scale available to it in the long term and its existing cost structures are embedded in its rates for the next 10 years.”
The OEB will consider the matter of its rates and the impact of rate harmonization in the context of a rate application. In the OEB’s view, there will be no net negative impact on Hydro One Brampton’s customers in the long term in comparison to the status quo.”9
Reliability and Quality of Electricity Service
The OEB stated that:
“The Handbook sets out that under the OEB’s regulatory framework, consolidating utilities are expected to deliver continuous improvement for both reliability and quality of service performance to benefit customers. The applicants submit that they are committed to maintaining the quality, reliability, and adequacy of electricity service for customers, stating that they currently have a total of six service centres across their service areas which will continue to be used for decentralized functions such as construction and maintenance, trouble response, logistics, fleet services, and metering, such that the adequacy, reliability, and quality of electricity service will be maintained. The applicants further expect LDC Co to maintain and improve upon the five-year average reliability indices and the OEB customer service standard metrics for its customers.”10
The OEB concluded that no issues of concern were raised by the intervenors regarding the transaction resulting in a potential deterioration of overall reliability. The OEB noted that it “has the ability to monitor the reliability performance of licensed entities on an ongoing basis and also has the authority to intervene and impose corrective action where a licensed entity does not meet established performance expectations.” 11
Financial Viability
The Handbook sets out two primary considerations in this regard — the effect of the purchase price, including any premium paid above the historic (book) value of the assets involved; and the financing of incremental costs (transaction and integration costs) to implement the consolidation transaction. In this case, as is common in MAADs transactions, a premium is being paid for the shares of Hydro One Brampton, and the OEB’s policy is that any premium is not recoverable through rates.
A combination of debt financing and shareholder contributions is being used to fund the purchase. The OEB was satisfied that “the evidence relating to the proposed financing of the Hydro One Brampton acquisition and the premium to be paid will not impact the applicants’ financial viability and finds that the proposed transaction therefore meets the no harm test with respect to financial viability.”12
The Distributor Licence and the transfer of Rate Orders
The OEB approved the issuance of the new Distributor Licence to the new company and the transfer of the existing rate orders. The Licence will be effective when the company is incorporated, and the transfer of the rate orders will take place after notice of the completion of the consolidation has been given to the OEB.
Conclusion
This case represents a landmark decision by the OEB in the largest amalgamation the regulator has reviewed to date. The Boards decision clearly set out The Boards approach to the no harm test and again recognized that LDC consolidations will likely benefit rate payers and shareholders alike.
In April, 2016, Enersource Hydro Mississauga Inc. (“Enersource”), Horizon Utilities Corporation (“Horizon”), and PowerStream Inc. (“PowerStream”), three of the largest municipally owned local electricity distribution companies (“LDCs”) in Ontario, applied to the Ontario Energy Board requesting approval to amalgamate to form a new utility, now named Alectra.
Approval was also sought to purchase and amalgamate with Hydro One Brampton Networks Inc. (“Hydro One Brampton”), owned by the Province of Ontario1, under section 86 of the Ontario Energy Board Act, 1998 (the “OEB Act”).2
On December 8, 2016, after written interrogatories, a technical conference, a five-day hearing and written argument, the OEB issued its Decision approving the consolidation.
The consolidation will create the largest municipally-owned LDC in Ontario and second-largest in North America, by customer numbers, second only to the Los Angeles Department of Water and Power in California. The new company will serve almost one million customers with a total rate base of $2.5 billion.
The purchase of Hydro One Brampton, for a price of $607 million is the largest electricity distributor acquisition in Ontario to date. The application was the first involving multiple distributors and the first merger application since the release of the OEB’s Handbook to Electricity Distributor and Transmitter Consolidation in January 2016.3
Jurisdiction over Electricity Distributor Share Purchases and Amalgamations
In the late 1990s, the Ontario Government undertook a fundamental restructuring of the Province’s electricity sector. This included the breakup of Ontario Hydro into (among others) a wires company (Hydro One) and a generation company (Ontario Power Generation), and a requirement that the 300+ local hydro commissions be incorporated under the Ontario Business Corporations Act (“OBCA”).4 The municipalities in which those commissions operated would become their initial shareholders.
Section 86 of the Ontario Energy Board Act, 1998 provides (in part) that OEB approval is required prior to the sale, lease or disposition of a distribution system as an entirety or substantially as an entirety; the amalgamation of a distributor with any other corporation; the acquisition of shares of a distributor such that the purchaser and its affiliates/associates will hold more than 10% distributor’s voting shares; and/or the acquisition of control of any corporation that holds, directly or indirectly, more than 10 per cent of the distributor’s voting securities if such voting securities constitute a significant asset of that corporation.
Key Aspects of the Decision — the “No Harm Test”
a) OEB Principles in Consolidation Applications from 2005 to the Present
The OEB’s policies on merger, acquisition, amalgamation and divestiture (MAADs) applications, and more particularly its use of the “no harm test” in considering those applications, were established in the OEB’s 2005 decision in a Combined Proceeding in which the OEB considered the principles to be applied to MAADs applications.5 In its decision in the Combined Proceeding, the Board established several principles that would be considered in determining applications of this kind. Among them:
Since its decision in the Combined Proceeding, the OEB has set out and refined its policies on rate-making associated with consolidation in 2007 and 2015 reports (the Reports) entitled Rate-making Associated with Distributor Consolidation.7 The OEB’s January 19, 2016 Handbook provides guidance on the process for the review of an application, the information the OEB expects to receive in support of an application, and the approach it will take in assessing whether the transaction is in the public interest. The Handbook also includes Filing Requirements for the consolidation applications. With the LDC Co Decision, the OEB reinforced these long-standing principles.
b) MAADs Principles Applied to the Application
In its Decision, the OEB reaffirmed its application of a no harm test in consolidation proceedings. If the proposed transaction has a positive or neutral effect on the attainment of the objectives set out in section 1 of the OEB Act, the OEB will approve the application. In applying the no harm test, the OEB’s review primarily focuses on the impacts of the proposed transaction on price and quality of service to customers, and the cost effectiveness, economic efficiency and financial viability of the consolidating utilities. In this case, the OEB found that it “has considered the specific facts in this application and is of the view that the features of this transaction are anticipated within the framework of the OEB’s policy and the outcomes are aligned with the articulated policy objective of improving the efficiency of electricity distribution. The OEB finds that the scale enhancements of service delivery embedded in this transaction can be expected to result in long term benefits to customers.” Having determined that the proposed consolidation meets the no harm test, the OEB approved the transaction, the LDC Co Licence application and the transfer of the rate orders for each of the applicants and Hydro One Brampton to LDC Co.
Price, Cost Effectiveness, Economic Efficiency and the Rebasing Period
The 2015 Report established a policy under which a consolidating distributor may choose to defer its next rebasing application (in which the distributor’s rate base and costs of providing distribution services are updated) for up to 10 years (previously, the limit had been five years). The deferral period allows for recovery of costs related to the consolidation and creates an incentive for consolidation. Savings during the deferral period will flow to the consolidated utility’s shareholders, but earnings in years 6-10 that are greater than 300 basis points above the applicable OEB-approved rate of return are to be shared on a 50/50 basis with customers.
The intervenors in the proceeding generally did not oppose the consolidation. Instead, their submissions included arguments that:
In rejecting the intervenor submissions, the OEB observed:
“The Handbook states that to demonstrate no harm, applicants must show that there is a reasonable expectation based on underlying cost structures that the costs to serve customers following a consolidation will be no higher than they would otherwise have been. The Handbook also states that the impact the proposed transaction will have on economic efficiency and cost effectiveness will be assessed based on an applicant’s identification of the various aspects of utility operations where it expects sustained operational efficiencies, both quantitative and qualitative.
In this case, the applicants submit that the effect of the consolidation on underlying cost structures will be positive, that costs to serve customers will not be higher as a result of the consolidation and that the consolidation will have a positive effect on economic efficiency and cost effectiveness.”8
In its Decision, the OEB advised that its “incentive framework is intended to provide sufficient financial gains over and above the status quo to incent utilities to seek out merger or acquisition efficiency gains opportunities. The incentive framework is also intended to have customers share in large savings through earnings sharing beyond the 5 year deferred rebasing period.”
The applicants selected a 10 year deferral period, and submitted that customers were expected to benefit from the consolidation with regard to the price for distribution service, in that revenues would be lower during the 10 year deferral period relative to the status quo, in which the individual utilities would be rebasing sooner.
The OEB agreed, and found that “customers will be not be harmed by the proposed transaction in the short term, and will, in fact, be better off and will likely benefit from the enduring benefits of scale in the long term.” Hydro One Brampton was identified as being the lowest cost entity involved in this transaction, but in response to intervenor concerns about potential impacts of the transaction on that utility’s customers, the OEB noted that “Hydro One Brampton will have additional scale available to it in the long term and its existing cost structures are embedded in its rates for the next 10 years.”
The OEB will consider the matter of its rates and the impact of rate harmonization in the context of a rate application. In the OEB’s view, there will be no net negative impact on Hydro One Brampton’s customers in the long term in comparison to the status quo.”9
Reliability and Quality of Electricity Service
The OEB stated that:
“The Handbook sets out that under the OEB’s regulatory framework, consolidating utilities are expected to deliver continuous improvement for both reliability and quality of service performance to benefit customers. The applicants submit that they are committed to maintaining the quality, reliability, and adequacy of electricity service for customers, stating that they currently have a total of six service centres across their service areas which will continue to be used for decentralized functions such as construction and maintenance, trouble response, logistics, fleet services, and metering, such that the adequacy, reliability, and quality of electricity service will be maintained. The applicants further expect LDC Co to maintain and improve upon the five-year average reliability indices and the OEB customer service standard metrics for its customers.”10
The OEB concluded that no issues of concern were raised by the intervenors regarding the transaction resulting in a potential deterioration of overall reliability. The OEB noted that it “has the ability to monitor the reliability performance of licensed entities on an ongoing basis and also has the authority to intervene and impose corrective action where a licensed entity does not meet established performance expectations.” 11
Financial Viability
The Handbook sets out two primary considerations in this regard — the effect of the purchase price, including any premium paid above the historic (book) value of the assets involved; and the financing of incremental costs (transaction and integration costs) to implement the consolidation transaction. In this case, as is common in MAADs transactions, a premium is being paid for the shares of Hydro One Brampton, and the OEB’s policy is that any premium is not recoverable through rates.
A combination of debt financing and shareholder contributions is being used to fund the purchase. The OEB was satisfied that “the evidence relating to the proposed financing of the Hydro One Brampton acquisition and the premium to be paid will not impact the applicants’ financial viability and finds that the proposed transaction therefore meets the no harm test with respect to financial viability.”12
The Distributor Licence and the transfer of Rate Orders
The OEB approved the issuance of the new Distributor Licence to the new company and the transfer of the existing rate orders. The Licence will be effective when the company is incorporated, and the transfer of the rate orders will take place after notice of the completion of the consolidation has been given to the OEB.
Conclusion
This case represents a landmark decision by the OEB in the largest amalgamation the regulator has reviewed to date. The Boards decision clearly set out The Boards approach to the no harm test and again recognized that LDC consolidations will likely benefit rate payers and shareholders alike.
* Mark J. Rodger is a senior partner with Borden Ladner Gervais LLP in Toronto. His firm acted for the applicant in this matter.- Enersource Hydro Mississauga Inc, Horizon Utilities Corporation & Powerstream Inc: Application for approval to amalgamate to form LDC Co and for LDC Co to purchase and amalgamate with Hydro One Brampton Networks Inc, (8 December 2016), EB-2016-0025, online: OEB <http://www.rds.ontarioenergyboard.ca/webdrawer/webdrawer.dll/webdrawer/rec/554096/view/licence_dec_order_ed_LDC%20Co_20161208.PDF> [LDC Co Decision].
- Ontario Energy Board Act, SO 1998, c 15, Schedule B.
- Ontario Energy Board, Handbook to Electricity Distributor and Transmitter Consolidation (Toronto: 19 January 2016).
- See section 142 of the Electricity Act,1998, SO 1998, c 15, which provides, in part, that “…every municipal corporation that generates, transmits, distributes or retails electricity, directly or indirectly, shall cause a corporation to be incorporated under subsection (1) for the purpose of carrying on those activities”; Business Corporations Act, RSO 1990, c B.16.
- OEB File Nos RP-2005-0018/EB-2005-0234/0254/0257, online: OEB <http://ontarioenergyboard.ca/documents/cases/RP-2005-0018/decision_310805.pdf>. The OEB’s section 1 objectives in electricity-related matters, and which the OEB focuses on in MAADs proceedings, include the protection of the interests of consumers with respect to prices and the adequacy, reliability and quality of electricity service, and the promotion of economic efficiency and cost effectiveness in the generation, transmission, distribution, sale and demand management of electricity and the facilitation of the maintenance of a financially viable electricity industry. Other section 1 objectives are addressed through other OEB policies and reporting requirements.
- Ibid at pp 7-9.
- Ontario Energy Board, Report of the Board: Rate-making Associated with Distributor Consolidation (26 March 2015), EB-2014-0138.
- LDC Co Decision, supra note 1 at p 8.
- LDC Co Decision, supra note 1 at p 12.
- Ibid at p 13.
- Ibid at p 14.
- Ibid at p 16.