Regulatory short circuit

Thanks to regulatory risk, Ontario is paying far too much for solar power.

Steve Nagy, of First Solar, looks over rows of solar panels during an opening celebration of the completion of the Sarnia Solar Project, the largest operation photovoltaic facility in the world, in Sarnia, Ontario, October 4, 2010. (Photo: Dave Chidley/CP)

Ontario is almost certainly paying too much for solar power, thanks to an unstable regulatory regime that forces the province to pay a substantial risk premium to investors.

In a recent study, Guy Holburn of the Richard Ivey School of Business and Charles Morand of Inflection Point Capital Management examined the solar power market in Ontario. They surveyed 12 “developers, utilities and independent power producers” of solar power in Canada, and asked the group about the importance of 17 different factors in determining if they would invest in a particular jurisdiction, and asked how Ontario measures up on each factor.

Not surprisingly, developers see the rate paid for solar power by the Power Authority and the length of “purchase power agreements” as the two most important factors. A close third is the “stability of the policy environment.” Ontario scores highly by investors for both the rate paid and length of agreement. However, on a scale from 1 to 5, with 1 being “very unfavourably” and 5 being “very favourably,” Ontario scores a miserable 1.5 on the stability question. The only factor to score lower is the “presence of a hard long-term target” for solar production at 1.25. A second-survey of 36 manufacturers listed the target as the second-most-important investment factor and ranked Ontario’s performance poor as well.

Ontario is seen by investors as having unstable policy due to a combination of its past history and existing rules. Holburn and Morand point to the cancellation of the Renewable Energy Standard Offer Program (RESOP) in October 2009, that came “without any warning and without the need for the Minister to answer for this decision before Parliament,” as being of concern to investors. There are fears of similar actions in the future, as the Green Energy Act allows for changes to program rules “without the need for legislative approval.”

There is a risk in any system based on ministerial decision-making that the rules will survive only as long as the minister. Ontario has had six different ministers of energy since 2005 (five different persons with Dwight Duncan serving twice non-consecutively). With an upcoming election bringing the potential of a new government, the policy environment must be considered highly unstable. In contrast, in Germany the rules are placed inside the legislation and can only be altered by parliamentary action. This is an approach Ontario would do well to consider.

Investors are sophisticated, and recognize that a rules change can greatly impact the value of an investment. The easier it is for the rules to change, the more inherently risky an investment becomes. This flexibility comes at a price as it forces regulatory bodies “to offer comparatively more attractive—and more expensive—incentives to investors to compensate for heightened regulatory risk in the province.” This is a price paid by all Ontarians.

The bigger question is whether Ontario should subsidize solar power in the first place. The rate given to small-scale solar rooftop installations (80.2¢/kWh) dwarfs the wholesale peak price for electricity (approximately 6¢/kWh). Solar does have a number of nice properties that are not fully accounted for by its price: production correlates well with peak demand periods (hot sunny days) and the distributed nature of solar leads to reduced line losses. As well, the production of solar power produces no smog or greenhouse-gas emissions.

None of these advantages necessarily requires a special price for solar, however, as peak pricing systems can be used to account for demand volatility, and emission taxes can be used to take account of any environmental externalities. However, if Ontario is going to continue to subsidize solar power production, it should do so in the least costly way possible. For the sake of all of our wallets, let’s hope whoever is elected in October will bring stability to the solar power market.

Mike Moffatt is an economist at the Richard Ivey School of Business and blogger for Worthwhile Canadian Initiative.