As we had agreed last week, for the first hour we welcome back to the witness table Eleanor Clitheroe and Malen Ng. We welcome you back for the questioning of the committee. It is my understanding that both in your case, Ms Clitheroe, and the chairman's case there is a wish to have a period of time for presentation and then we will go to the caucuses for the round robin questioning of about five minutes per caucus as we move around. If we exhaust the questions before the hour has been exhausted, then we'll conclude the questioning at that point and give you an opportunity to add any other comments you'd like or the Chair will continue with questioning, depending on how the day goes.
Thank you for giving me the opportunity to make a few opening remarks. I welcome the opportunity as clearly there's been some change in the situation at Ontario Hydro with respect to the white paper coming out and I'd welcome the opportunity to make a few remarks around the impact of the white paper on the issues that we were speaking about before. I'd also like to take a minute to briefly outline for you some of the activities that have taken place on the financial front since we met last.
Clearly, the NAOP puts severe financial pressures on the company at the very time we're experiencing fundamental change in our industry, and we're all concerned about that. There are continued regulatory pressures on the company as well with respect to safety and reliability, first and foremost. If the nuclear recovery could get done for less, we would all be much happier and, to that end, the key financial role is to keep the pressure on through diligent monitoring of costs and results in an ongoing review of alternatives for reviewing costs within the plan.
I might just make a comment; also there is a third quarter financial report that should be out later in the week. I wanted to raise it to your attention because you may wish to have a copy of it when it comes out later this week.
With respect to the business planning, the company is in progress of developing and needs a fully integrated, bottom-up analysis of the NAOP. The Ernst and Young report pointed out particular areas where Ontario Hydro needs to improve either the depth of the analysis, its consistency across the company or both and those areas are being addressed now in the business planning process.
The business units have been instructed to identify the implications of the white paper for their businesses, both from strategic and financial perspectives. December and January will be the key period for this process as the senior managers review those plans and work to integrate the results, make trade-offs and choices for the company.
Now that the government has set out a timetable and a plan for Ontario's move to a competitive marketplace for electricity, providing a specific focus for several issues including how the NAOP stacks up from the market perspective and how we deal with the financial implications and, in particular, the issue of rates.
Starting with the first question, when NAOP came forward, we reviewed the costs of NAOP, and NAOP then assumed existing structure of the industry, including the monopoly and the obligation to serve. We also had assessed the potential impact on stranding and presented those results to the board as well. The latter analysis was consistent with competition in the year 2000.
Looking at Ontario Hydro's cash flows for nuclear on a going-forward basis and using the nuclear team's costs and performance expectations, the additional investments make sense. The risk of course is that costs escalate and then anticipated performance improvements are not achieved. As you know, this has been our experience in earlier nuclear programs over the years.
But we haven't before had the operational focus that the nuclear performance advisory group is now providing. If they are successful, then using the Pickering analysis as an example, the going-forward cost is estimated at 2.6 cents and Ontario Hydro doesn't see a sustained market price below that level.
Looking at it from another perspective, the 2.6-cent figure compares favourably with a new entrant cost for efficient gas generation of 4.3 cents. So if the cost and performance objectives are met, nuclear units will be competitive.
The second question, how best to address the financial implications of NAOP, does have a different character since the release of the white paper. Before the paper came out, the choices available to the board were to add the costs to rates or to exclude them from rates but proceed to finance the effort out of existing revenue, because to do so was prudent from a safety, reliability and asset preservation viewpoint.
With the rate freeze policy in place, the former was and is a difficult option. Without the white paper to settle some of the difficult choices around restructuring, the existing obligations set the parameters for what the choices for the board were, but with the release of the white paper there is now reasonable certainty about the direction of industry restructuring. We know that the monopoly is disappearing and with it will disappear the obligation to serve and the guarantee on the new debt.
As a result, given the rate freeze policy, Ontario Hydro is working with the government to put appropriate financial assurances in place to deal with this issue. This involves ensuring that each of the successor companies mentioned in the white paper is put on an appropriate commercial footing and that the monopoly and the debt guarantee stay in place until that is accomplished and that OH will be sustained in its ability to meet its obligations. From a management and board perspective, it's necessary to the principles of good governance while holding down rates and addressing financial issues as the government moves forward with the restructuring.
Ontario Hydro and the Ministry of Finance share the concerns that Mr Gourley had outlined to me in the letter that he sent me and they are working to ensure that the level of expenditures for NAOP and other programs is prudent and necessary, particularly during the transition period before the obligation to serve disappears.
Ontario Hydro has responded to Mr Gourley's letter of October 28, outlining our approach to the issues raised, and we continue to meet with the Ministry of Finance to determine the most appropriate way of proceeding under the circumstances.
Cheaper NAOP alternatives would be welcome, provided they meet safety and reliability requirements. Within the limits of what is safe and technically feasible, we will be continuing to look for opportunities to mitigate the financial impacts and to ensure that the highest level of prudence and review is exercised as we go forward in implementing this plan.
Mrs Helen Johns (Huron): Good afternoon, Ms Clitheroe. Thank you for being here today. Where I thought I would go with my questioning you've somewhat answered for me, so let me just ask you this question to start with. The NAOP plan was the plan developed when we had a monopolistic Ontario Hydro, and I think you said that the plan you think is the right plan, now that we have a competitive model, is the NAOP plan. Can you reconcile how we've moved from such a monopolistic to competitive market and yet the solution is still the same solution?
Ms Clitheroe: You're correct in saying that when we developed the NAOP model, it was done with the obligation to serve and the monopoly in place. That changes in the year 2000. However, for today we still have to deliver the power under the obligation to serve. There are some changes, however, that result from the introduction of the white paper, and that is the way one would assess the investment with respect to any power or any decisions that are taken to provide power beyond the year 2000.
We would expect that other generators would be coming into the marketplace, so the plan with respect to now and the year 2000 to provide power, to serve is still in effect. Post then, we only need to consider the economic viability of providing that power, and that will cause the board to have some reconsiderations of some parts of the plan.
Mrs Johns: I just want to go back to one of your questions and then I'll try and formulate a question in my mind. You told us that the price of power, if we were to redo Pickering, would be somewhere around 2.3 or 2.6 cents; I can't remember which one of those numbers. Of course, that doesn't take into consideration any of the debt that's outstanding that will be associated with hydro generation.
As you and I both know, having stronger financial backgrounds, we really are comparing apples to oranges when we consider the price of Pickering with just that extra cost, if you will, added to it versus the whole cost of a gas-fired generation, cogeneration plant. That must be a very big concern to you, what the cost of the generation is going to be, so that you can be competitive in the marketplace.
Has there been some analysis of what your all-in cost truly is? We've danced around this for the last 13 weeks here, or however long we've been sitting here. We'd like to know what the all-in cost is for Pickering, Darlington and Bruce so we can try and figure out where we are on this issue. Can you provide us with any more information than what we've got through this last number of weeks?
Ms Clitheroe: The all-in cost is clearly more than just the operating cost. One of the advantages of nuclear is that it has, if it's running well, cheap operating costs because of the fuel. But the flip side of that is that it has very expensive capital costs and initial upfront investment. Do you have, Malen, the actual numbers by station with you?
Ms Malen Ng: I have it by nuclear, fossil and hydro-electric. For example, in the 1996 annual report, if you look at nuclear, if you look at adding up all the variable costs, like OMNA and fuel and then adding in all the interest depreciation, which is a result of the debt, the unit energy cost of nuclear is about 5.5 cents.
Mrs Johns: Okay. We would like to see your response to Gourley's letter. I don't know if you're tabling it or if you have tabled it. I haven't recognized it coming through here yet. Have you tabled that letter?
Mrs Johns: Okay. I just want to clarify for my own sake -- obviously you now know that the province doesn't intend to guarantee the debt after 2000. One of our biggest concerns here is that you're putting this all on the table right now so that the province will guarantee it before the guarantee comes off. How much money does finance believe will have to be guaranteed by the province between now and 2000?
Ms Clitheroe: We currently have just over $30 billion, so we would expect that would all continue to be guaranteed. I would say some of that would come due, it would mature and have to be rolled over, so we would be thinking of that debt that would be rolled over as being guaranteed as well. At this point, we're not anticipating any incremental debt over what we have today plus those rollovers.
If I could make a comment about the legal opinions, what the legal opinions say is that the board, if I can paraphrase it as I understand it, has the obligation to pass all the costs into rates or to exclude costs if it is prudent to do so. Prudence could be safety, it could be all kinds of reasons. So as a basic premise, the board must meet the SDR requirements and it must pass all the costs on into rates.
The only way it doesn't meet the SDR requirements -- because technically it would, but in practice it doesn't, if you think about the cash flows -- is if it decides to exclude some costs so that the SDR is essentially met. To exclude those costs it needs to satisfy itself that it is prudent to exclude those costs. The nature of the discussion we've been having with the Ministry of Finance since the summer is, what is the appropriate way, given the rate freeze, to go ahead and account for these costs?
Mr Conway: Can you tell the committee specifically what those results are going to be? I'd like to do it quickly. If you've got some paper, that would be a useful thing, I think, to share with the committee members.
Ms Clitheroe: The significant part, if you will, is that the outlook presents a 1997 net income projected to be $630 million below the planned $740 million, and that the outlook could be unfavourably affected even further by some write-offs of approximately $475 million. That, said in summary, I think is what you would be interested in hearing.
Mr Conway: Since we last met there have been two reports, one to the committee given last week by Dr John Ahearne, the former chair of the US Nuclear Regulatory Commission. Dr Ahearne basically said to the committee that it is his experience that nuclear reactors that are laid up for anything more than a couple of years are not likely to be coming back into service. The press reports a certain W.F. Farlinger, president and CEO of Ontario Hydro, as having said, I think about a week ago, that it is a real possibility that the seven reactors that are to be laid up as part of NAOP may in fact now not be coming back into service.
Has there been any financial analysis done at Ontario Hydro corporate to assess the impact of a possible situation where none of the seven reactors that are scheduled under NAOP for laying up are in fact ever returned to service? Has there been any impact of what that kind of situation would mean to the finances of Ontario Hydro and particularly to stranded debt and stranded assets?
Ms Clitheroe: Yes, there has been. That information was presented to the board meeting in August. The range of numbers that were disclosed to the press was between $5 billion and $8 billion. The reason there was a range was because of the difference between whether the nuclear reactors did come back or did not come back.
"Based on the memorandum and supporting material, it does not appear that the" Ontario Hydro "board has sufficient information with respect to the costs associated with the proposed_NAOP to determine the rate level which would enable Hydro to meet its statutory debt retirement obligations. This deficiency is exacerbated by the fact that the board has not, to our knowledge, considered alternative courses of action to the proposed plan which might produce sustainably different financial results."
This is the Deputy Minister of Finance basically saying to you, and now to the committee since the letter's been made public, that the guarantor of Hydro debt is not confident that the board, even as of October 28, had looked at in a meaningful way the range of alternatives to NAOP or in fact that the board did not, in his estimation, have sufficiently hard numbers to give finance an adequate, reasonable level of comfort.
Ms Clitheroe: I'd make two comments. One is that there have been a number of additional meetings with audit, finance and among management around alternative options within NAOP. I think one of those documents was tabled with you around other alternatives to nuclear power, around alternatives to a proposed rate increase and around accounting issues, around other means of funding investment in fossil or funding investments in nuclear.
Mr Conway: Can I stop you there. Just back up and very clearly and very slowly, if necessary, repeat what some of those alternatives are. I want to be clear that I understand what you've just said. Did I hear the words "rate increase"?
Ms Clitheroe: The discussion with the Ministry of Finance has been around how to manage the fact that there is a rate freeze policy and how to manage the accounting that would flow from that under the Power Corporation Act.
Ms Clitheroe: The alternatives for the board are a rate increase or to exclude the costs of the NAOP program, either year by year or all in a lump, to be able to meet the SDR requirements or beyond that. Those are the options in front of the board for their consideration as we move out for the next few months.
Mr Conway: Ms Ng, I have your document or the document to which you spoke quite directly on our last visit, Corporate Financial Implications and Issues of NAOP. I'm now looking again at the net income chart on page 11 of that. I'm sure you'll remember the date, if you don't have it with you, but it's the income situation.
Ms Clitheroe has just indicated that third-quarter financials for this year are going to show that Ontario Hydro's income situation has deteriorated somewhat -- I think I'm correct -- deteriorated relative to projections.
I'm looking at those charts again. The charts suggest that in 1998, 1999 and 2000, according to those projections, at Ontario Hydro you'll be looking at annual negative net income of anywhere between $300 million and $400 million for those three years.
We now know that we're going to get competition in the year 2000 and there's going to be some kind of an interim policy between now and the year 2000. Have you done any work, Ms Ng, on trying to re-evaluate these data on the basis of the world of competition which is coming now, we know for sure, within a couple of years and which world has clearly got to be expected to put downward pressure on your revenues?
Ms Ng: We have done it on this basis, which is based on the current regulatory structure. Also, I think we have done some internal analysis in terms of competition. Essentially the 1996 annual report, which quotes a stranded debt estimate of $10 billion to $21 billion, with a reference estimate of $16 billion, came out of the work or the modelling or the internal analysis we did by looking at the projected forward price curve that could be there when competition comes in.
Mr Conway: But I'm looking at the short term. I'm looking really at 1998, 1999, 2000. How are you going to fund, keep your head above water, basically, as you try to do whatever you're going to do with this nuclear recovery plan, and prepare for competition? You've got a rate freeze. How are you going to get through the next couple of years, since we now know what we didn't know two weeks ago, which is that competition's coming and it's coming soon. These numbers, as I look at them, are not good. Ms Clitheroe says that they've slipped somewhat for 1997. What can you share with the committee in terms of any analysis for the years 1997 through 1999 that you may have done on the basis of what you now know as opposed to what you knew two weeks ago?
Ms Ng: As I understand, the white paper states the direction for opening to retail access in the year 2000, which means that really the open competition, the starting point of that is in the year 2000, where the removal of the monopoly would take place. Essentially, in the current period before the open competition starts, what we have assumed in the numbers you've seen is there is a rate freeze, so it's assuming no increase in rates, and also what we have assumed is that during this interim period load will remain the same. So there's no growth even if demand could go up because of the economy growing or whatever.
The position that was taken in this information is assuming that the load will not increase, the price will not increase. Also, in order to ensure that there is some prudence against any potential changes in those assumptions, we have included some contingencies at the corporate level to the tune of about $200 million in 1998 and $300 million each in 1999 and 2000, up to the point in terms of competition.
Mr Wayne Lessard (Windsor-Riverside): Maybe I can just continue from that point. I think I heard you mention, when you were talking about the third-quarter revenue, that revenue is well below planned. When you're talking about revenue, were you talking about net income or were you talking about revenue?
Mr Lessard: Part of the reason you indicated was that the costs of replacement energy were higher than -- well, that was a cost that you didn't expect, I guess, that you were going to have to buy replacement energy.
Mr Lessard: Do you also expect that as a result of competition, the impact on rates would be to cause Ontario Hydro to possibly consider lowering its rates to be competitive? I'm wondering whether you see the costs of the replacement energy that you're having to buy to be significantly higher than the rates you expect in the future when competition comes. You're buying replacement energy. What are the factors that make the cost of that replacement energy higher?
Ms Clitheroe: The replacement energy costs are higher because the cost of running the fossil plants and essentially the purchase of coal is more expensive than the cost of operating the nuclear plants if they are running. That doesn't account for the comment that was made earlier about the fact that it's not covering the original capital costs. In terms of straight operating costs and ongoing expenditures, the cost of running the fossil plant is more than that of running the nuclear plant.
Mr Lessard: Would you expect the hydro that may be available when competition is opened up in the future to come from those fossil fuel plants outside of Ontario or would they be able to compete favourably with Ontario energy prices?
Ms Clitheroe: We would expect that there would be generators in our surrounding territories, primarily the United States, that would want to sell across our wires here in Ontario when it's opened up. The cost of that would depend on how much excess capacity there was in surrounding jurisdictions and how much they could lower their price consequently, but we do think that there will be some of that which is quite competitive with our own fossil plants and will be competition for those fossil plants.
Ms Clitheroe: Again, it would depend on the price of gas and the price of coal, obviously, but there is a school of thought that suggests that, looking forward, gas-fired plants will be a very favourable alternative.
Mr Lessard: You said that you had some legal opinions with respect to some repayments that you feel may not be required to be made and I was wondering whether you could give us some more specifics about what sorts of things may be excluded from those SDR requirements, and why.
Ms Clitheroe: Primarily, we've been considering excluding some of the costs that are associated with the NAOP, which has been the subject of the enquiry here. The reason for excluding some of those costs would be to manage the expenditures of the corporation and stay within the requirements of the act. We've had those discussions with the Ministry of Finance and we've had the discussions with Ernst and Young about what those costs would be. That hasn't been fully determined yet, exactly which costs it will be, but we do have a listing of them tentatively which we could provide if you felt it was appropriate.
Mr Lessard: There was a question earlier on with respect to the all-in-one costs and I guess the response was that the all-in cost isn't broken down on a plant-by-plant basis; it's only broken down according to how the power is generated. Am I right in this?
Mrs Barbara Fisher (Bruce): Coming back to the third-quarter report -- I don't want to dwell on it too much because it's not even a released document yet, I guess, but certainly we have an indication of where things are going -- how do you see Hydro making up that shortfall?
Ms Clitheroe: For 1997, I don't believe we will make up the shortfall. There is an expenditure freeze in place in the company; that is, all expenditures that can be deferred or reduced or eliminated should be done, but I don't believe that we will be able to make up that shortfall this year.
Mrs Fisher: We've just received, as a matter of fact, I guess dated November 20, some information regarding the NAOP plan and it talks about the total cost differences, if you will, between leaving Bruce A down and Pickering coming up, leaving Pickering and Bruce down and then bringing them up in the future, or neither returning. I'm actually quite surprised at the difference. We're talking hundreds of millions here, but I guess when you get to those numbers, everything is relative. I'm actually very surprised that if both are returned, it's a $6.3-billion cost by 2001; and if only Pickering is brought back, it does reduce to it to $5.6 billion. I think that probably happens because there is already $1 billion invested in it that isn't somewhere else. If neither returns, it is, funnily enough, $6 billion again.
I know that you mentioned earlier on about cheaper NAOP proposals being welcome, and I'll come to that in a minute. But taking that comment into consideration, I think we might be wise to revisit that, when you know that your alternates really aren't that far apart. Would you agree?
Ms Clitheroe: Certainly the issue of keeping as many of the nuclear units running as we can through this interim period, from a financial perspective, we will be pushing in the finance department to see that happen. The barriers to doing that are the logistics that Mr Andognini has described in terms of finding appropriate staff and management to run that, and safety issues. From our perspective, from a financial perspective, the longer we can keep the nuclear units running, the financial condition or picture of the company improves quite dramatically.
Mrs Fisher: I don't think you personally have had the opportunity to meet with the people of the community of Bruce yet. It's going to be in the near future that you will have that opportunity, I understand, but I do like the words that cheaper NAOP proposals would be welcome. I want to know what mechanism can be developed to allow outside parties to have more of an influence on those considerations.
I appreciate how it works. I understand that there are many staff within Ontario Hydro who put proposals to yourself and others, and therefore board recommendations happen and the board does what it does with them. I might brag about the community a tad and I'm not ashamed at all to do that, but I think there is a certain intellect within that community that has studied other options and would like to have input that way. How do we get in there?
Ms Clitheroe: Any alternative proposal that came in to the company would be seriously considered. If it came in to the chief executive officer it would be referred to our office for a financial review and so on, and presumably to the chief nuclear officer for technical and safety feasibility and so on. I also believe that if a group has an idea to come forward, requests to come in and have a discussion of that nature, it would be very seriously considered.
Mrs Fisher: I wonder if one of the policy mechanisms could be changed a little bit, if I might just offer some, I hope, constructive input here. I've had dealings with Ontario Hydro for a number of years now and I find that while you appear and you make your presentation, there is usually support. Then you go away and it all gets lost over there somewhere. It's very discouraging for those who actually, for the right reasons, want to help. I'm just wondering, given the serious impact that this type of NAOP proposal would produce upon that community, if we can't find a better way to have continuous input. I understand the right of the board to make a decision, but I think there are many things that are missed just because of, if nothing else, geographic separation, and then for other reasons, other agendas, if you will.
How can we as a community there have more continuous input? I'm thinking more along the line of a working committee where you have the workers represented, where you have the community represented, where you have obviously Hydro represented. I can see some value in trying to come up with other solutions because they out there cannot afford to do what Ontario Hydro does to put these plans together, but there are parts of it that have value. Could you see something like that working over the very near, short term to maybe try and come up with one of these other, cheaper NAOP proposals?
Ms Clitheroe: Yes, I could see something like that. My understanding is that, in the past at least, a lot of the relationship with a particular community like yours has been from the plant manager level to the community and less so from the head office level, if you will, to the community.
Mrs Fisher: I appreciate that, but I see the seriousness here. I think this is the time, if ever, if Ontario Hydro is going to step out and step up in terms of its communications patterns with the community. Now is the time, because it's just, quite frankly, too much for that community to possibly deal with.
Ms Clitheroe: I think the corporation would welcome that kind of input. I am aware of the meeting in December you're referring to of the community representatives coming in to have a discussion at the senior level. I think that's a good step forward and something that we should be considering. I agree with that.
Mr Conway: Ms Clitheroe, I want to come back to the third-quarter financial statement. Just so I'm clear, I think I heard you tell the committee a while ago that the third-quarter report, which will be released later this week, will show that at the end of the third quarter, 1997, Ontario Hydro will have about $633 million less in income than planned.
Mr Conway: I'm now looking at page 17 of the documents that you and Ms Ng brought to the committee on October 28. It's the financial outlook chart, page 17. Have you got that chart? I presume that's based on that plan.
Ms Ng: It will make it about $110 million before write-offs. The budget was $740 million. It's going to be $630 million less, so the net income for the year now is projected to be about $110 million before write-offs.
Mr Conway: Can you tell the committee anything about 1997 NAOP costs that will impact on that number? Are there any costs that are likely going to be incurred or assigned to the year 1997 that could affect that Hydro net income number of roughly negative $350 million?
Ms Clitheroe: There are two issues here. One is current expenditures. I believe all of our current expenditures are captured in that number of $630 million less. Then there is the question or whether or not the board opts to accrue NAOP expenditures from future years into 1997. Were that to occur, the write-off would be much larger and then it would be much more negative.
Ms Ng: The $1.8 billion is actually as of January 1 this year, so essentially if we're talking about $350 million negative net income after the write-off, that would take the $1.8 billion down by $350 million.
Mr Conway: Depending on how you did the accounting, if you were to assign a good chunk of those NAOP costs, whatever they're going to be, to 1997, you could be in a situation where there would be no retained earnings at all.
Mr Conway: Have the technical people at Hydro given you any comfort that that difficulty is being dealt with and that those problems are not going to continue into the fourth quarter of this year or into the first part of next year, causing the same haemorrhaging with your income?
Ms Clitheroe: My advice from the nuclear operations is that some of the problems they were experiencing were with Darlington. There was an important software problem that they were working on with the AECB that was causing our Darlington plant to run at less than 50% capacity. That has now been dealt with and Darlington is virtually, if not completely -- Mr Andognini will be here later and you can ask him if it's completely back up to full capacity. We don't expect that specific issue to reoccur.
The nuclear folk and the research lab have done a lot of work up at the Bruce on the condition of the tubes and steam generator. That assessment on the A units has been completed and they have some handle on those units having been down and the possibilities for them coming back up.
Mr Andognini has advised me that there is still some further discovery to be done. I am concerned that there can be additional problems with the nuclear reactors going into next year if he uncovers another issue which needs to be dealt with immediately and would bring those reactors down. He is keeping me as fully apprised as he can as to what he thinks the technical issues may be.
Ms Clitheroe: Some of it is work in progress that I'm advised by the nuclear operations people may not be useful in the future. We would be considering writing off that if they do confirm that that work in progress on nuclear operations is not useful. That is the bulk of it.
There are some other operations which we have considered, ventures that have been sold or assets that have been sold, and the realizable asset has been less than what was on the books, so there's a write-off there as well.
Ms Clitheroe: I can give you only broad parameters. Mr Andognini will be here after me and he could give you more technical details. It is work in progress at the Bruce site which, when the NPAG team has come in and reviewed the work that needs to be done at the Bruce site, they are considering would not have a useful life by the time that work in progress were reactivated. I'd have to ask you to speak to him about the technical issues surrounding that work.
Mr Lessard: The extent of the write-offs, the $475 million, is that something that had been planned for? Is that the amount you planned for or is that something that has changed in your anticipated third quarter financial results?
The Chair: Thank you, Ms Clitheroe. When you began your comments, it appeared as though they had been prepared. I wonder if you would be good enough to table that with the committee. That would facilitate some of our considerations.
I know that we have asked, as the testimony has gone on through the afternoon, for certain documents. If they could be tabled with us this week, we'd appreciate that very much. Ms Clitheroe and Ms Ng, thank you very much for attending upon the committee and for your testimony. We appreciate that very much.
Mr Farlinger, if you would be good enough to attend upon the committee, please. Welcome once again to the committee. We appreciate your coming back for a second appearance by public request. I hope you will relax and make this an appropriate exchange. I know the committee have a number of questions to ask of you and I do appreciate your responding so willingly to the invitation from the committee to be here.
Mr Bill Farlinger: I'm Bill Farlinger. I'm the chairman and presently the president and chief executive officer of Ontario Hydro. With me is Carl Andognini, who's the author of the report which you've been spending so much time on and who is our chief nuclear officer in charge of implementing the recommendations in that report. I appreciate the opportunity of being here again and look forward to having this discussion with you.
A lot has happened since I appeared here seven weeks ago. Foremost is the government's white paper and the new competitive structure, which I'll talk about in a minute. In the meantime, I've followed with interest the deliberations of the committee and I've noted a number of recurring issues and prevailing questions. Among these, I note four that are particularly important.
The first issue is the timing of the board's decision about the nuclear asset optimization plan. How long did it take the board to make a decision on NAOP? I'd say a year or more. I say that because the seeds of NAOP had been growing for a long time.
Let me remind you how the board saw its role. Ontario Hydro has an obligation to provide safe and reliable electricity for all of Ontario, and the board has to exercise due diligence in ensuring that Hydro carries out this function. For over a year the board has been aggressive in identifying and responding to the underlying cause of the deterioration of our nuclear performance.
In April 1996, in response to a system failure, the Pickering nuclear station was shut down. Pickering was put on the AECB's watch list, with the possibility of losing its licence. Board and management concerns about sustained improvement in nuclear performance obviously escalated.
The board as a whole became seized with the urgency of the need for change. All board members became involved with nuclear matters. From June 1996 onwards the Pickering situation was a regular item at all board meetings, with status reports from the station director.
The level of concern was reflected in personnel changes. The Hydro board became more interventionist and three senior members of nuclear management were replaced. There was increased involvement of outside resources. Reliance on Hydro's own resources had not turned around persistent performance problems, and peer reviews pointed to the need for cultural change in nuclear.
In August 1996, the president contracted the services of Gregory Kane, a US expert with experience in improving nuclear ratings. His recommendations and benchmarking work were major inputs to the Ontario Hydro Strategic Plan for Excellence in Nuclear Operations, approved by the board in August 1996. The plan was based on achieving performance excellence in safety, production and cost. It focused on reducing maintenance and procedure backlogs and housekeeping and material conditions to improve the quality of operation and maintenance. Gregory Kane's analysis was the first third-party perspective on a recovery strategy.
By the fall, it was clear to the board that while some progress was being made with this plan, something more comprehensive, integrated and accelerated was called for. Once again, the Hydro board intervened. A second independent opinion was needed, and it took shape in the form of US nuclear expert Carl Andognini and the nuclear performance assessment group, which was engaged in December and began work early in 1997.
The mandate of the team was to conduct a systematic, comprehensive and brutally honest assessment of Hydro's nuclear operations, and to make appropriate recommendations for returning Hydro stations to world leadership.
An overview of the independent integrated performance assessment process was presented to the nuclear review committee in April 1997 by the nuclear performance assessment group. The team discussed the mechanism for performance reporting, and a nuclear finance recovery team was established. The chief nuclear officer presented the board with monthly updates right up to the July meeting preceding the board decision in August. In addition to these monthly updates, Dr Mohan Mathur, the chairman of the nuclear review committee, and Don Fullerton, the chairman of the audit-finance committee had an oral briefing from Mr Andognini on the NAOP recommendations prior to the August 12 board meeting. The board learned through these updates that the nuclear plants were in worse condition than thought at the beginning of the year, and that far-reaching interventions to turn their performance around would be required.
The independent integrated performance assessment was completed and the report documents were distributed to the board on August 6. On receiving the IIPA findings indicating the severity of nuclear problems, and facing regulatory uncertainty with respect to the continued operation of the stations, the board decided on August 12 to initiate a course of recovery action.
This decision to take action emanated from a full day's intense discussion on the assessment of nuclear plants. This assessment considered, among other things, the impacts of recovery on reliability, safety, the financial situation of Hydro, options to NAOP, the impacts of carrying on business as usual and the effects on stranding if there was a change in the industry structure.
The discussion and ensuing decision grew from the previous year and a half's analysis and assessments. It might appear to a third party that technically the board made the decision in one day, but I think it's fair to say, as Dr Mathur's testimony noted, it was the experience of the last year and a half that drove the board decision.
Concerns have been raised about further detailed financial analysis taking place after the board approval in August. This is not an unusual business practice. You heard board members Bullock and Kerr mention that the process used at Hydro with NAOP is in keeping with best practices in large investor-owned corporations like Noranda and Laidlaw. This is consistent with my own experience, both in public accounting and as a board member of organizations facing large decisions.
Let me put the financial perspective into the context of broader risks as the board saw it. The board decision to proceed was not a judgement that analysis and a review of options weren't necessary or valuable; it was a judgement about timing, urgency and flexibility. The board had a second opinion from Carl Andognini's review team confirming that the situation was poor and getting worse. So the board decided to begin recovery in August; a judgement to begin now and let the analysis catch up later, analysis that could corroborate or modify, although not likely reverse, the course of the NAOP decision.
The board decision to act prior to a more detailed financial analysis was prudent from a safety and reliability perspective. The risks that most seized the board revolved around what would happen to safety margins, output and licensibility of the stations without undertaking recovery immediately. Key issues were dealt with. For example, the recommended Basis for Continued Operation identified activities required for continued safe operation of the stations. Questions around the analysis were not central to the decision to proceed.
In the board's view, the marginally acceptable conditions of the plants represented an immediate threat to their licensing, and to delay beginning recovery for a couple of months of analysis while the plants continued to deteriorate would have been neither responsible nor prudent. Dr Mathur expressed this in his testimony when he noted that the situation was getting pretty bad and that we had to address the problem as soon as possible. If we had delayed, I am sure you would now be critical of that, and rightly so.
Dr Bishop also signalled the seriousness of the situation in her testimony, noting that "It would only be a matter of time before other stations reached the operating level of Pickering; that is, in danger of regulatory shutdown." The risk of regulatory and/or operational shutdown or curtailment was seen by the board as overwhelming.
But while safety was paramount, other factors were not forgotten. The board passed a resolution making NAOP's approval conditional on future work and analysis. Implementation of the board's decision is subject to determinations on spending, scope and timing of recovery actions.
Follow-up work ensued. The audit and finance committee of the board, as well as the full board, spent two days in Thunder Bay on September 7 and 8, financially reviewing NAOP, the lay-up provisions and the associated impacts on generation. Ernst and Young were asked to conduct a financial and risk assessment. Their review and recommendations were presented to the board on September 9.
The board requested detailed descriptions of more options around closing the A plants and their financial implications. That analysis was reviewed on September 26 at a joint audit-finance and nuclear review committee meeting of the board. They also reviewed the Ernst and Young report and its recommendations.
You have heard Ernst and Young and Eleanor Clitheroe describe how the bottom-up financial analysis will take the form of a going-forward assessment as the need for financial commitments arise, and that a monitoring, analysis and integration process will subject NAOP initiatives and expenditures to review through the business planning process. So the board did see NAOP as a flexible plan, not as something cast in concrete.
I have already detailed the depth of the board's involvement with nuclear issues and, in particular, the deliberations leading up to the decisions taken at the August board meeting. Like the Hydro board, the government was advised, through its board participation and regular posted reports, on the serious nuclear situation and the proposed recovery plan.
The second issue that has emerged during the committee discussions is whether there are any credible alternatives to trying to recover nuclear performance and whether Ontario Hydro, this committee and the people of Ontario should have confidence that the NAOP recovery will work when other Hydro recovery efforts have failed. Instead of undertaking the cost of nuclear recovery, could we not look for non-nuclear alternatives? The answer is no, at least not in the next several years. If you don't want to sink money into restoring the fleet of nuclear units, what would your alternatives be: gas-fired generation, coal-generated power from the US, surplus hydroelectric power from Quebec? We are planning to use our interconnected facilities with the US and Quebec to the maximum amount over the next two years. Unfortunately, that will only deliver about 15% of our requirements.
What about new gas-fired generation in Ontario? You'd need at least a couple of years to build the plants, and so you'd hope that the deteriorating nuclear units would keep you going until then. That's a bad bet. Nuclear's current sunk costs have to be paid anyway, and the going-forward cost of the nuclear B units and Darlington will be under two cents a kilowatt hour. Non-nuclear alternatives are not available in large enough quantity, in short enough time and at low enough cost to be a real alternative. As we move into a competitive environment, there will be time to gradually replace nuclear with other options if the market dictates that direction for investment. But we simply need the nuclear power we have for quite a long time yet. The bottom line is that we don't have any choice but to pursue nuclear recovery. But what confidence is there that this recovery will be successful? There are several reasons.
First, the nature of the recovery plan is different from previous improvement efforts. The IIPA looked both deeply and broadly in an integrated fashion across all the nuclear stations. It followed a well-accepted, rigorous procedure that has proven successful in the United States. While its findings reflected those of other assessments, the IIPA organized them in a systematic way that went to the root causes of the problems and provided a foundation for a comprehensive recovery plan. The root causes IIPA uncovered were mostly ones of management practices, systems and attitudes, not those of hardware. This is similar to the US experience, where there has been success in nuclear turnarounds.
Second, the nuclear performance assessment group team should enjoy the utmost confidence of Ontarians. It is a handpicked group, selected on the basis of sound reputation and demonstrated track record in nuclear plant recoveries.
Third, while there is a limited number of qualified workers available for recovery, the NPAG team has confidence in the quality of Hydro's nuclear workers. They are highly educated and want to do a good job. Their problem is the lack of training and effective operational systems. These will be provided under the NAOP plan.
As you're aware from correspondence among John Murphy, Hydro and your committee, Hydro has identified barriers in the collective agreement. I think you know that John Murphy and the Power Workers' Union have indicated a willingness to introduce more flexibility around the agreement to allow the recovery to take place expeditiously. I know that Mr Murphy, the union and the workers all want to see recovery take place just as eagerly as management does. I'm confident we will be able to work out solutions. That the PWU has proposed that an alternative to NAOP should not be taken as lack of confidence on their part that NAOP can succeed. They have suggested that nuclear recovery can be undertaken all at once across a broader front than the NPAG team's experience indicates.
As for the society bargaining unit, I have talked to John Wilson and he has given me assurances also that the society too is willing to show flexibility in ensuring successful nuclear recovery. The reason I raise the labour issues is that inflexibility around adapting our collective agreements to the challenge ahead can absolutely torpedo our efforts at effective and timely nuclear recovery.
The third issue is whether there are credible alternatives to NAOP in terms of nuclear recovery. As Carl Andognini and Rick Machon have indicated, our assessment of the qualified resources available limits the recovery to 12 units over the first three years, thus the layup of the remaining seven. As Mr Machon noted, the question of availability of resources is not just a matter of the number of workers, but also their skill mix and the lack of management and operational systems to be able to absorb them into a first-rate operating and recovery team. Even if we had enough skilled workers, we still would not have the management systems in place to deploy them effectively across 19 units at the beginning.
Is there any flexibility around the layup plan, say, laying up less than seven or delaying the layups? Laying up the older units to recover the newer and larger ones is a core conclusion of the NAOP judgement. I know it is Carl Andognini's view that the more you stretch your resources, the less your chances of success. From my point of view, reflecting the board frustration over the last two years, what we can't afford is yet another failed turnaround effort. To use a basketball analogy, the board thought it wiser to take the sure layup rather than risk the three-point outside shot.
What about other variants? Might you recover 12 units and continue to operate some others as you got the 12 into shape? Would you be flirting with the safety margins of the units you don't recover? Would you jeopardize your effort on recovering 12 by still having to operate a couple more? What about letting a third party recover and/or operate some units while your NPAG teams recover the 12?
I said on my first appearance that if anyone could show us a better plan we would certainly want to make adjustments. We are prepared to be flexible around the perimeter of NAOP timing of lay-ups and possibly involvement of other parties. We are mindful of the impacts of layups on the Bruce community, but we must consider the best option from the perspective of the province as a whole. We will continue to review our plan and change it where appropriate. If circumstances were to change dramatically, such as a big change in natural gas prices, we would revisit the timing and span of the layups and the recovery of units.
The fourth issue is the question, is NAOP compatible with the framework of impending competition? When directors Jim Bullock and David Kerr appeared before you, they were asked whether the Hydro board had considered the implications of NAOP in the context of a competitive industry structure. Mr Bullock said that the analysis was projected against the existing monopoly structure. Mr Bullock's response was correct. But the board has considered what a competitive structure might look like and what Ontario Hydro's role in it might be. In fact, Hydro's corporate strategy not only contemplated a future competitive structure but argued strongly for the introduction of retail competition. The problem of analysing the financial impacts of the recovery plan against a future competitive structure is that so much is unknown and depends on what the elements of that structure are and when it would be in place.
Furthermore, Hydro owes its obligations, and the board its due diligence to discharge them, under the current monopoly structure as long as it's here. The obligation to keep the lights on reliably and safely rightly dominated the board's thinking. But the board was not unaware of a possibility of changes in the industry. Where a specific issue, like stranding, could be addressed, it was part of the discussion at the board.
The markets will open up to retail competition about the time that the laid-up A units would have to justify their recovery investment. The decision to sink money into the A units or not would depend on how they could withstand the test of the competitive marketplace. The cost of their refurbishment would have to be recovered through revenues and sales earned in that marketplace.
The costs of recovering the B units and Darlington would be collected during the transition years to competition simply because their continued output and the measures that will guarantee it are needed to keep the lights on, and the incremental cost of NAOP on a kilowatt-hour basis is so attractive that you would pursue the investment whether you were a monopoly looking to keep the lights on or a generator competing in a marketplace and looking to earn a return on your investment.
But what about the power to replace the loss of the laid-up A units? The white paper calls for supply decisions on replacement power during the transition period to be subject to market tests. Generators from inside and outside Ontario will be able to bid, and have been asked to bid, the additional needs created by the layup of the nuclear units through an interim market run by a group within Hydro that is separate from the generating business. That would mean that the proposed increased fossil production identified in NAOP would compete with other generators in Ontario and outside the province.
In conclusion, I propose that the Hydro board's decision to move ahead with the nuclear asset optimization plan was not only the right decision in light of their current obligations but a planning pathway that will fit the initiatives and transition work ahead in implementing the direction of the white paper. There are many details and processes yet to be worked out in making the new competitive structure a reality. So too, there will be some flexibility around NAOP's implementation if that will better meet our goals of improving safety and performance of the billions of dollars of assets that the province has invested in nuclear power.
Looking back on the events of 1997, I'm confident that those documenting the history of our industry will note two landmarks: (1) It was the year that the Hydro board of directors seriously grappled with the root causes of nuclear problems and took decisive action to correct them; (2) it was the year that the Ontario government seriously acknowledged the monopoly industrial structure as a major contributing cause to inefficient investment and moved to replace it with the discipline of a competitive market.
The Chair: We'll begin the questioning, five minutes a round. I will remind members of the select committee that there will be a vote, I think about 5:45, so we will stand down at that point and return at 7 pm. In the meantime we'll continue the questioning as long as we can, and we'll begin with Mr Kwinter.
Mr Monte Kwinter (Wilson Heights): Thank you, Mr Farlinger. I want to address a couple of concerns that I have. Number one is this letter from Mr Gourley to Ms Clitheroe in response to a board request, a memorandum for a rate increase. It was an overall rate increase for 1998. In Mr Gourley's response he says, "It does not appear that the board had sufficient information with respect to the costs associated with the proposed nuclear asset optimization plan...to determine the rate level which would enable Hydro to meet its statutory debt retirement obligations."
Also, in the Ernst and Young report, they said: "Within the NAOP plan certain major capital expenditure items have been identified as key risks. However, the potential cost estimates have been excluded from the analysis and the exclusion of these costs could have a material impact on the analysis and the decisions."
We have a situation where Ernst and Young have taken a look at what went into the decision and said that there wasn't enough information of some key risk factors to enable that decision to be made. Mr Gourley, in a letter to Ms Clitheroe, says that there's no justification -- and there are some concerns with the rate increase; I want to get to the rate increase in a minute -- there isn't sufficient information to determine whether or not these costs associated with NAOP would enable the statutory debt retirement obligation.
These are two outside groups, one the Ministry of Finance, the other Ernst and Young, who are saying effectively that there wasn't enough information for you to make this decision, yet we just heard from you today that you felt there was ample investigation and that, notwithstanding there could be some adjustment, you had the necessary information to make this decision. Do you have a comment on that?
Mr Farlinger: Yes, I'd be pleased to. First, Mr Gourley and E and Y are on different missions. The Hydro board has had to look very hard at whether or not it should raise rates. The government has said, "Don't raise rates," and this has been exacerbated by the decision that the monopoly will end and the competition will come. We think that's a good thing, but I guess we'd like to know where the financial position of this company is going to be at the time that happens and what the plan for restructuring this company or these companies will be.
There's an ongoing discussion and dialogue between the company and the government, saying: "You tell us not to raise the rates, but under the legislation we're required to raise rates in a monopoly situation if we aren't going to meet certain tests." That's the test you referred to, Mr Kwinter, which is sort of a technical calculation, but at the moment it means we're supposed to budget for a $600,000 annual profit. Why do we not raise the rates so we can budget for a $600,000 profit? There are technical ways of dealing with that. One way of dealing with it is to get a directive from the government saying, "Don't raise rates and don't pay any attention to this section of the act." There have been a number of discussions going on and that's what Mr Gourley is writing to Eleanor Clitheroe about.
E and Y were asked to do a couple of things for us after the August meeting: to review a bunch of the financial calculations and also to ensure that we were covering off every detail and had it documented, so, if you like, the paperwork on all the decisions. One of the things they fussed about was whether, when Carl had dealt with six different options that we could go through on this plan, did he have a nice, tidy piece of paper setting them out? No, he didn't. He had given the board what the six options were. So they told him to tidy up his act and put this into a nice piece of paper, and I'm sure that paper's been lodged with this committee.
They also said, as his report had said, that certain things weren't provided for in the recovery plan. That's what you were referring to, Mr Kwinter. There were three or four things of some significance, none of them of any material significance to the sort of decision we were taking, but for purposes of tidiness and clarity. Auditors are funny people. They cover off all the loose ends. They said, "You didn't estimate the costs for this issue and that issue." Carl can tell you better what they were, but what I had identified was that none of these things were of significant money that they would stop the operation. After all, if the net result is that we're going to create power in those 12 units at a marginal cost of less than two cents a kilowatt hour, if we had had another two tenths of a cent a kilowatt hour, it doesn't make any difference. That's a very competitive cost for power.
It's true that they wrote that report and some of those items were not identified in terms of costs because they can't be. We don't know what the estimate is in a couple of those cases yet. We do know it's not enough to stop the program.
Mr Lessard: You began by referring to the issues that have been raised by questions throughout the hearings and you indicated that one of the issues was whether Hydro rushed into NAOP and said, "This is something that's been going on for a year or more and the seeds have been growing for a long time." Those were your words.
Mr Lessard: When you said "for a long time," I'm assuming you're referring to even more than that year that you've been looking at NAOP, but for a longer period of time than that. I wonder if that's something you'd agree with. I'm wondering why the decision to get into NAOP hasn't been going on even longer than a year.
Mr Farlinger: That's a fair question. Certainly I think knowing that things are bad is a growing awareness over time, and certainly there were some reports. You've had some people here. Ken Hare wrote a report three or four years ago saying that there were problems in the nuclear.
The thing that made it crystal clear that we had big problems was when that whole plant went down and didn't come back when it was supposed to come back. You didn't have to be any sort of nuclear expert to know that we had big, big trouble when Pickering went down. That's a year and a half ago.
Mr Lessard: You said that when you consider other options, there aren't any non-nuclear options that you're really considering seriously at this point. I'm wondering whether, realistically, you expect all of those nuclear reactors that you expect to be down to come back into service.
Mr Farlinger: I think they could all come back, yes. I'm not saying they will all come back; I'm saying under the right circumstances they could all come back. One of the major right circumstances is what the price of natural gas is going to be in two, three or four years from now.
Mr Lessard: You made another point as far as the refurbishing of these nuclear power plants and having to try and determine whether the price of the power that will be generated by those plants is going to be competitive, considering coming into a competitive environment. Do you feel, given the circumstances that you know now, you will be able to undertake the work that's necessary to bring those plants back into operation? Will those plants be competitive in a competitive environment that you anticipate after the year 2000?
Mr Farlinger: The bellwether cost of power right now that is talked about colloquially in the industry is 4.5 cents for natural gas electricity. Today's estimate for bringing back Pickering is 2.5 cents. For bringing back Bruce, today's estimate is 3.5 cents. That gives you a margin below what the competitive cost of power is as of today. Will that be the competitive price of power three years from now? I don't know.
Mr Lessard: In response to a question that I had asked earlier with respect to write-offs in the amount of $475 million, I had asked what sort of work in progress was represented by those write-offs and it was suggested that I put that question to Mr Andognini. I wonder if you could give us some idea as to what that work may be?
Mr Lessard: That might be helpful, because it seemed as though she was indicating that this was work that was in progress. I think she had mentioned Bruce specifically and indicated that this was work that wasn't going to be beneficial in the long run and it was technical in nature. That was why she had indicated that Mr Andognini may be of assistance.
Mr Andognini: There was one computer system that was under development that went over budget and didn't perform in its trial period the way it should have been done and has been cancelled. I know that's one of the items. I do know that another item is relative to Bruce B, unit 2, which is partially written off, and that unit is one that's out of service now. Those are the only two that I know relative to Bruce B. The one she was talking about is a computer system that was being designed by AECL that had some difficulties in its trial period and has been cancelled.
Mrs Johns: Thank you both for being here. When you drew to our attention that it was seven weeks since you were here last time, I think a couple of minutes ago I was quoted as it being 15 weeks, so I think it's gone a lot longer for us than for you.
I just wanted to ask you a couple of questions. Today, for the first time, we heard that -- and my quote here would be, "The Hydro board became more involved." You started to talk about them becoming more involved with, I think, Caine, and then bringing in Mr Andognini, and also with the change in some of the senior management staffing in generation. I guess we didn't know that before today and I was wondering if you could tell me the role that the board may have played in changing senior management, how that may have changed, so that we can see that there is some evolution from the early days of your tenure.
Mr Farlinger: The first thing you referred to was, after Pickering went down, the senior management did fire the leader of Bruce A. Some of the board members thought we were living in the old Hydro culture where nobody gets fired and thought other senior people should be fired. I spoke to the president about the leader of the nuclear, Ron Field, who was the head of all the nuclear, and Mr Charlebois, who was the head of Pickering. I said, "How can you leave those people in place with this thing in such a shambles?" He had a lot of reasons he didn't want to fire them, so finally we had a meeting of the five senior directors and Mr Kupcis, we had a discussion about it and he decided to fire them. So that was a hands-on involvement the board had with respect to the management issue, if you like.
Later on in the fall, when the nuclear excellence program wasn't doing much, at least in the opinion of the board, we had more discussions with board members. I myself had more discussions with Dr Kupcis about getting some, what I call, insurance. I said, "You say you think these people, mostly internal people, can fix this thing and we aren't sure they can, so we need some outside insurance on this thing." We had a number of discussions about that and finally convinced him that he should get on. He went down to INPO and, through the good graces of the people in INPO, found Carl and did a good job of hiring all those people. So the hands-on job of doing this was the CEO's. The impetus came from the board.
Mrs Johns: One of the things you said that I agree with of course -- and I think I've made my position pretty clear throughout this, that I think 1997 will be recognized as the year the board finally took seriously the problems at Ontario Hydro and grappled with them, and you didn't go further. I would say part of that is because you were the chair, and I want to say that I think we owe some thanks to you for that too.
We come through here and we talk about hiring Mr Andognini, and I don't want to be offensive. I guess I didn't know Mr Andognini was going to be here when we started to talk. We've heard for 10 years about how they've come up with nuclear plans to be able to move forward and they don't seem to be able to implement them over there. I guess if we've learned anything we've learned that we should be a little sceptical of Ontario Hydro and their plans. They started way back with Franklin and they keep going every time.
I want to know from you, Mr Farlinger, first of all, if you've got some kind of iron-clad deal to keep Mr Andognini here for the next four or five years till we get this done and how you're going to make sure this plan is fully implemented so that we don't have another failure like we've had for the last 10 to 15 years.
Mr Farlinger: I guess you take things on faith at first, and then how you find them. Certainly we acquired Andognini based on his reputation and based on the recommendation of the INPO people. You know what INPO is. That's the self-regulating agency of the nuclear industry in the United States that has done such a wonderful job. After Three Mile Island, this thing was set up. Yes, they have a regulator just like we do, but the industry itself has taken the decision that if we have any more serious problems in this industry, we're all losers. Therefore, we're going to self-regulate ourselves.
They have a very tough marking system which is on a simple report card system. You get 1, 2, 3, 4 or 5; 1 is good and 5 is you're about to be closed down. That's something that everybody can understand. It isn't a big, long list of potential things that you might do to fix your thing.
I was told we couldn't be on that system. We now are on that system. There is a world nuclear organization called WANO. It is related to INPO. It has a bunch of INPO people on it and so on and we are now being monitored by WANO. We weren't before. We had our own system of internal Ontario Hydro people marking it. We've got that system, by the way, to monitor how we're doing. That's how we got Carl and his merry men, as I sometimes refer to them. They're not very merry; they're sort of serious, dedicated people.
Can I just wander for a minute? This I find interesting, that these guys think -- a few of them are in the twilight of their careers and others aren't. They see this as the biggest thing that -- well, it is the biggest thing by a mile that's ever got in trouble in nuclear: Ontario Hydro. You know, if you want to be first, we're absolutely first by a mile in terms of the size of our operation here and the trouble we're in. They are incredibly dedicated people because in their profession they've taken on the biggest challenge that's ever existed.
That's all positive and everything we've seen of these people so far is good. Now we have to start monitoring. As capable as we are as a board of monitoring, we've got this outside agency also to monitor our progress and give us marks and give us simple report cards we can understand whether we're A, B, C, D or E -- WANO does A, B, C, D or E, INPO does 1, 2, 3, 4 or 5, the same thing.
Mr Kwinter: I have two questions for you and then my colleague would like to follow up. We talked about some of these risks that hadn't been accounted for from a financial point of view. One of the things that has been raised -- and you've said that the seven reactors that are going down may come back, but they may not. If they don't, there's a decommissioning cost and that's calculated at maybe $700 million, which gives you a $5-billion obligation. Do you not consider that a relatively major, outstanding, potential obligation?
Mr Kwinter: It's not included in the NAOP costs though. They haven't projected them. That was one of the concerns that was expressed by Ernst and Young. I think Mr Andognini, in his testimony earlier when he appeared, said that it was not calculated in.
Mr Andognini: It is not in the NAOP program, sir, and it wasn't put in the program because it's a cost that will be incurred whether NAOP exists or doesn't exist. What we're trying to do and what we have done is put a program together that really turns a liability into an asset. We have studies underway right now by Mr LaGuardia that are investigating what the cost will be associated with decommissioning for those units.
Mr Kwinter: One last question I have is that in the white paper it suggested that as part of the stranded debt there could be a swap of debt for equity. Do you have any idea of what proportion of that debt would be swapped and how that's going to be handled?
Mr Farlinger: When we get into stranded costs, there is a basic assumption that affects the value: What will the competitive price of power be in competition? A guess that a lot of people are using is that 4.5 cent figure I gave to you. You might think naturally power will end up being at the lowest cost of replacement power, if that's the cost. But three years from now, will that be 4.5 cents or four cents or 3.5 cents or five cents? Nobody's too sure about that. There are pretty big swings in these things and those small half-a-cent swings make an enormous amount of difference on whether or not you can service your debt.
We've made calculations, as you know. I think you've had that information here. Sixteen billion dollars was the figure in our annual report last year. I think that was based on four cents. I can't give you a better answer than that.
Mr Conway: Mr Farlinger, the government announced the white paper a couple of weeks ago and that clearly had an impact on all that we're discussing. Is there a business case for Ontario Hydro over the next couple of years to increase its rates, taking account of the fact that competition is coming, taking account of the fact that income has been slipping, according to what Ms Clitheroe tells us, because of ongoing problems in the nuclear power division? Given those kinds of factors and the issues of stranded debt and stranded assets, is there a business case for a rate increase over the next couple of years?
But looking to our neighbours to the south with whom we might have the most competition, particularly given that we've got a lot more ability to export and import power to the Americans than we do have transmission capacity to Manitoba or Quebec, we probably could go for a little increase and still be competitive. It also depends on where our Canadian dollar stands, of course. We are benefiting very much from the low Canadian dollar at the moment in that comparison.
Mr Conway: Would NAOP specifically, and Hydro's current corporate planning generally for the next couple of years, change if the Ontario government were to say, "We will, effective January 1, 1998, not guarantee any Hydro debt beyond that which has been incurred and accounted for up to but not beyond that date of January 1, 1998"?
Mr Farlinger: I don't see how it could be. I think we'd have to pay whatever interest rate we had to pay to roll over the debt. I've said to you before that we think we can get along on a cash flow basis here without retiring any debt, but we'd have to roll it over.
Mr Conway: Let me come to that because the committee I think -- some of us at least -- has been distressed to find out again as late as this afternoon that there appear to be software problems over at Darlington, the newest of the plants, that have caused a deterioration in performance and therefore a deterioration in 1997 income such that income for the year is going to be $633 million below plan. That means that we're going to probably have negative net income of about $350 million for this year. Hydro tells us that in the calculations that undergirded NAOP -- and that's before these latest problems -- you were looking at four years at least of negative net income. That's before competition.
Your retained earnings are draining away. You're looking at very tough financials for the next two or three years and we're heading into competition. The question arises, what kind of shape are you going to be in as a corporation to implement NAOP in whatever form is finally decided and at the same time prepare for the onslaught of competition which, in the short term, is clearly going to have downward pressure on your revenues, which are already a problem?
Mr Farlinger: Mr Conway, our nuclear is in a bad mess. That's why we're into this program. What the company is trying to do, what the current management is trying to do, is to do the best they can with a bad mess. The bad mess may cost the people of Ontario some money.
Mr Conway: Is that the issue that the committee really should be focusing on? If I read your 1996 annual report, if I listen carefully or even casually to a lot of testimony I've heard over the last number of weeks -- and this has really been brought to the fore with the release of the white paper -- the real question for the taxpayer is just how big is that stranded debt charge going to be, where is it going to be placed and how is it going to be discharged.
Is the real corporate strategy at Hydro these days, Mr Farlinger, to say, "Well, the government" -- because you've been reported as being a bit uncomfortable with at least a couple of components in the white paper, and I can understand that. We're not going to have a rate increase for a couple of years, but that's really immaterial because the real rate increase that awaits the ratepayers of Ontario Hydro and the taxpayers of Ontario is this multibillion-dollar stranded debt. It may be as little as $12 billion; it may be as high as $23 billion.
Mr Farlinger: With respect to the stranded debt, I'm not dismissing the fact that we have problems. We obviously have problems and it's tight whether or not Ontario Hydro can compete without having the government pick up some part of the debt. There's no question about that. But don't forget, we're servicing the stranded debt right now. There's no cost increase above what we are today and we are competitive with our neighbours at today's prices. I'd say to you it's a narrow thing whether or not the consumers can't pay the stranded debt charge because we're paying it today.
Mr Farlinger: We have very difficult labour contracts at the moment in terms of mobility of our workers. It's all based on a seniority system. If Carl wants to move a new nuclear guy from one spot to another, everybody else who has more seniority than that person, even if he doesn't work in nuclear, has bumping rights and can get a chance to take the job on first. It's enormously difficult and the process takes six months or a year to get through. We need some relief from those things in order that he can move with reasonable dispatch to move his resources around to where he needs them. We think the unions are going to work with us to help out on this problem.
Mr Farlinger: We're having a lot of ongoing discussions and we are optimistic, but we haven't really got it to the test yet. We're about there. We're about to find out whether the good talks we've been having will be put into action, but I stated that in the caveat in my prepared remarks. If we don't get this, it's going to seriously set back this program.
Mrs Fisher: I will be pleased to share my time with Mr O'Toole. Welcome back. I'm sure you haven't spent as many hours -- maybe a few of them, though -- watching the proceedings of the hearings to date. I have to say that after about seven weeks on this committee, one is much wiser with regard to what they thought they knew before and what they now know, I think all because of the type of input we've had.
I would like to start by saying that bad news is not always the most easily accepted, but I do respect the fact that finally Ontario Hydro is dealing with something that some of us on the outside could see happening and ultimately did happen. Now we have a chance, I guess, to recover our situation.
I just have a very few quick questions. The IIPA identifies human resources problems; I don't think anybody has denied that. Nobody in any of the presentations nor of this committee has argued that at all.
I had a request to meet with a couple of unions already that haven't been named so far in the recovery process and that is of the construction force. These people are the ones who built the sites. I just don't know; I don't hear anything. I hear a lot about the PWU and the society and I just wonder what room there is to lean on some resources of people who worked in the construction of these plants and will have to be called on to refurbish as well.
Mr Andognini: I'd like to address that, Mrs Fisher. The problem is not just resources. You've got to go back to the late 1970s and early 1980s, when Ontario Hydro was a very strong engineering-construction organization. When the needs for plants died out, that organization never shifted from an engineering-construct to an operate-and-maintain organization, and that is true today.
The processes to support operation, the management systems, the programmatic issues that are required to support day-to-day operation of an nuclear facility are not currently in place. Just adding resources would tend to make your problem worse instead of better. All it would do is increase costs, delay scheduling and cause confusion.
Mr Andognini: I have talked to the building craft union. I recently sent them a letter and told them that I will meet with them just as soon as we have the conditions with our own unions resolved. I can't go to them until the conditions with our own union are resolved. Once that's done, I will meet with them.
Mr Farlinger: I'm sorry. They will be giving us a review and a rating on each of our plants every 18 months. In a sense, they're reviewing the plan but they're not taking the plan and saying, "If you accomplish this much by this and that date." They do an independent review of each plant and we get an A, B, C, D or E.
Mrs Fisher: I agree with your comments earlier about the price of gas. One of the things that needs to be incorporated in the other half of that equation, I think, is the environmental impact and those costs, if we could put a price to them.
Mrs Fisher: If we're going to look in the nearer future, which I hear some hope today -- again, I don't mean to be disrespectful -- that there's a possibility of rethinking the process of the NAOP recovery plan, are you in support of the public-private partnering proposal that was put forward to Hydro in 1996, I guess it was? We were going to have the consortium here but they're not here today. There was a proposal that was put for the recovery of Bruce A and it did call for public-private partnering. Are you willing to look at that again and see what opportunities are there?
Mr John O'Toole (Durham East): I'll just take a couple of minutes quickly. I really have a two-part question, if I may. I'm really picking up on the theme of where we've been, to predict where we're going. The 1996 annual report serves as a good warning shot, if you will, and I'm just going to specifically refer to the write-offs of $2.56 billion in that report. It refers to the adequate nuclear recovery plan. "Nuclear recovery plan" has a ring to it. It sort of sounds like the recovery plan of Mr Andognini. That's the first part, if you'd like to respond to it.
Secondarily, picking up on Mr Conway, I find this a most fascinating read. I did early on and it's been reinforced as we've moved along. On page 19, actually the footnote, which refers to admittedly what you have said, how we are going to deal with this big package here. We've got $15 billion or more of debt that we can't handle and be competitive. This is right in here. I could quote it. You know it. I'm sure you probably were involved in writing it.
Those are the knowns. The inconsistency overall that I'm wrestling with is saying -- and you've admitted it here today. I think you're quite forthright; I've read the newspaper columns on your concern about rates and the government's wish to freeze them, the impact on jobs; being competitive. Those are inconsistent themes. If a corporation is dealing with a serious debt burden, and there is some room in the market to kind of do this, basically do you think that we can rely on recovering the debt and keeping rates frozen? That kind of sums it up into a question that the Chair has permitted me to ask. Or do we need to be aware that, to get out of this, somebody is going to pay the $15 billion, either the new producers or somebody on a rate base --
Mr Farlinger: Let me try to help with this stranded-debt thing. Let's say that the price of competitive power on average will be 4.5 cents, just to use that for an example. And let's say that right now we are charging 6.5 cents. Let's think about sending the customer a bill, which we now are, for 6.5 cents, and after competition comes in we're going to send them a bill for 4.5 cents plus two cents stranded-debt charge to pay off the stranded debt. In some jurisdictions they've just put that charge on the grid, so any power that flows anywhere, in our case in the province, whether it comes from an American company or anybody, there is a two-cents charge that goes to pay off the stranded debt.
You're still paying the same price for your power, so we are still as competitive as we were. As soon as the stranded debt is paid off, the two cents drops off and now everybody is paying 4.5 cents. We are paying that stranded-debt charge effectively now; that's the important point. Now, is it really going to balance out? That I'm not so sure about. Part of it is going to balance out. A good part of the stranded debt we're paying for today and we will pay for it in a little different form when competition comes in.
Mr Conway: Mr Farlinger, the government's white paper contemplates over the next couple of years the breakup of Ontario Hydro into several entities. It would strike some observers that your situation, which is admitted on all sides to be very difficult now, to manage your way through the nuclear recovery plan and to meet the ongoing obligations of a big power utility, but to do that -- and in response to a question from Mr Lessard on things like not just your financial obligations but your labour contract issues -- is it your view that the breakup of Ontario Hydro in the next few years into several smaller, distinct units helps or complicates Ontario Hydro's ability to get through the difficult night of the next couple of years, particularly when we think about the nuclear asset optimization plan?
Mr Farlinger: I guess my vision of the future, which may prove to be wrong, is that sooner or later, when competition is there, the government will get out of most of the businesses that we're now in and privatize this thing. Why would the government continue to compete with the private sector once you bring competition in? Where that takes me is to saying, "How could the government get the most out of its asset when it sells its asset?" I'm told by the investment community that a utility that has a grid as well as generation is more valuable than one that doesn't, that there are synergies there that investors will pay for. Therefore, I think it's too bad in a sense for the people of Ontario to get less money for their asset than they might otherwise get. If my assumption's wrong and the government is not going to dispose of these things, then the principle doesn't stand up.
Mr Lessard: Just to follow up on that, your recommendation is, if the government were to decide to privatize Ontario Hydro, that it do so as part of a big package rather than to split it up into separate parts.
Mr Farlinger: No, I think the grid and the generation might stay together. I think that would be a more saleable product. I think the retail could go out and be dealt with separately. We have a very big retail business, as you know. I think it could be dealt with quite separately.
A question I'd like to toss to you, Mr Farlinger. You've kind of rolled down an interesting road in the last few months, one that's had a lot of challenges in it. They brought in Mr Andognini to do a review. We could have gone the road that we've gone on Ontario Hydro for many years of Strong and Franklin, where each of them said they improved it. But obviously from the figures we've seen it's continued to deteriorate under the various leaderships. Have you ever had any regrets of bringing this to a head and trying to sort it out?
Mr Farlinger, thank you very much for your attending upon the committee. We appreciate your answers and the evidence you gave. I know some members of the committee have asked if you'll table additional information. I'm sure you have made a note of that and you'll do so; you'll give the clerk a copy of your prepared statement, so we have that for Hansard as well. That will facilitate the members being able to read that quickly during the week. I appreciate your presence here.
Members of the committee, it's almost time for us to go to the House for a vote. May I remind members of the committee that the dinner hour is being held in committee room 1 this evening. So if you'll note that, committee room 1 for your dinner, for members of the committee only. We will reconvene at 7 pm in closed session to begin to deal with the issues surrounding the report.