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April 16, 2015
Release of Premier’s Advisory Council on Government Assets Reports
Today Ed Clark spoke to two reports coming out of the Premier’s Council, Improving
Performance and Unlocking Value in the Electricity Sector in Ontario, and Modernizing
Beer Retailing and Distribution in Ontario.
The mandate of this panel was to assess certain provincial assets to seek ways to
maximize value, including possibly selling these assets, in order to generate money to
allocate toward infrastructure investments. Today, the government announced that it
would implement the panel’s recommendations.
Use of Assets for Infrastructure
The government intends to introduce legislation that would, if passed, guarantee that
net proceeds from the ownership changes to Hydro One and any net proceeds from the
merger will go to the Trillium Trust and be used to finance transportation (transit, roads,
and bridges) and other priority infrastructure projects across the province.
Higher than anticipated revenues from assets, including GM shares, mean there will be
an additional $2.6 billion for the Moving Ontario Forward plan for a total of $31.5 billion
in dedicated funds available over 10 years. The government has indicated that about
$16 billion will be allocated for infrastructure projects within the GTHA and about $15
billion in the rest of the province. These amounts are higher than set out in last year’s
budget ($1.4 billion for the GTHA and $1.2 billion for elsewhere in Ontario). Municipal
governments will be anxious to see the funds put to work across all of Ontario.
1) Energy Assets
The report on the electricity sector focuses on extracting one-time capital plus ongoing
financial benefits from Hydro One. First, as the result of a mutual agreement, Hydro
One Brampton will be merged with three local distribution companies (Enersource
Corporation, PowerStream Holdings Inc., and Horizon Holdings Inc.) to create a new
large-scale company (MergCo Inc.) serving the central/western portion of the Greater
Toronto and Hamilton Area (GTHA).
Second, Hydro One, as an integrated entity (both distribution and transmission) will be
subject to partial sale through a phased Initial Public Offering (IPO) process. There are
a number of recommendations concerning how to maintain the interests of Ontario in
terms of rates, service quality, governance, and impacts to pensions.
A third initiative is to suspend the transfer tax (which was to help pay down stranded
debt in the sector) and the departure tax for municipal electricity utilities under 30,000
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customers on a three-year basis to encourage and facilitate acquisitions and mergers
between Local Distribution Companies.
Clark argues that these steps will protect the public interest, stimulate LDC
consolidation, and extract the best ongoing value for these assets.
There is little detail on the recommendation related to strengthening the mandate and
powers of the OEB so that upward pressure on rates as a result of these changes in the
industry can be managed. As well, the numbers provided in the report are theoretical;
the market realities may alter the planned outcomes.
The AMO Energy Task Force will be meeting soon to examine today’s announcement in
detail and to seek greater clarity around elements of implementation. An update will be
provided as further information is available.
2) Beer Store
The report outlines a new retail and distribution framework that is part of a negotiated
agreement with The Beer Store. Among other matters, the sale of beer will occur in up
to 450 grocery stores across the province and in a segregated portion of grocery stores
on top of the current outlets. There are other elements of the agreement that focus on
consumer convenience, pricing, supplier treatment, and The Beer Store governance.
The current bottle recycling program between The Beer Store and LCBO is being
extended, although funded differently. The impact of this change is not expected to
change current recycling behaviours. AMO is working with a number of organizations on
recycling related issues and will be working to ensure that this change does not result in
a greater amount of glass in blue boxes.
Copies of the Premier’s Advisory Council Reports are available here:
Premier's Advisory Council on Government Assets
AMO Contact: Cathie Brown, Senior Advisor, E-Mail: Cathiebrown@amo.on.ca,
416.971.9856 ext. 342.
PLEASE NOTE: AMO Breaking News will be broadcast to the member municipality’s
council, administrator, and clerk. Recipients of the AMO broadcasts are free to
redistribute the AMO broadcasts to other municipal staff as required. We have decided
to not add other staff to these broadcast lists in order to ensure accuracy and efficiency
in the management of our various broadcast lists.
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DISCLAIMER: Any documents attached are final versions. AMO assumes no
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RETAIN & GAIN:
Making Ontario’s
Assets Work Better for
Taxpayers and
Consumers
Premier’s Advisory Council on Government Assets
Initial Report
November 13, 2014
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Table of Contents
FOREWORD .......................................................................................................................................1
Overview ................................................................................................................................................... 1
Beverage Alcohol....................................................................................................................................... 3
Electricity ................................................................................................................................................... 7
Conclusion ............................................................................................................................................... 12
SUMMARY OF COUNCIL PROPOSALS ................................................................................................13
Beverage Alcohol..................................................................................................................................... 13
LCBO..................................................................................................................................................... 13
The Beer Store ..................................................................................................................................... 15
Winery Retail Stores ............................................................................................................................ 15
Electricity ................................................................................................................................................. 16
Hydro One ............................................................................................................................................ 16
Ontario Power Generation .................................................................................................................. 17
1.
2.
INTRODUCTION .........................................................................................................................19
1.1
Establishment of the Council ...................................................................................................... 19
1.2
Mandate and Principles .............................................................................................................. 19
1.3
Terms of Reference ..................................................................................................................... 20
1.4
Scope of Our Review ................................................................................................................... 21
1.5
Our Perspective........................................................................................................................... 22
1.6
Our Approach .............................................................................................................................. 25
THE BEVERAGE ALCOHOL SECTOR ..............................................................................................26
2.1
Overview ..................................................................................................................................... 26
2.2
LCBO ............................................................................................................................................ 29
Background .......................................................................................................................................... 29
Our Approach ...................................................................................................................................... 30
Our Observations ................................................................................................................................. 30
2.3
The Beer Store (TBS) ................................................................................................................... 42
Background .......................................................................................................................................... 42
Our Approach ...................................................................................................................................... 43
Our Observations ................................................................................................................................. 43
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Winery Retail Stores (WRS)......................................................................................................... 47
Background .......................................................................................................................................... 47
Our Observations ................................................................................................................................. 49
3.
THE ELECTRICITY SECTOR ...........................................................................................................50
3.1
Overview ..................................................................................................................................... 50
3.2
Hydro One ................................................................................................................................... 53
Overview .............................................................................................................................................. 53
Our Approach ...................................................................................................................................... 55
Our Observations ................................................................................................................................. 55
3.3
Ontario Power Generation.......................................................................................................... 64
Overview .............................................................................................................................................. 64
Our Approach ...................................................................................................................................... 67
Our Observations ................................................................................................................................. 67
3.4
Labour and Pensions ................................................................................................................... 71
SUMMARY OF COUNCIL PROPOSALS ................................................................................................73
Beverage Alcohol..................................................................................................................................... 73
LCBO..................................................................................................................................................... 73
The Beer Store ..................................................................................................................................... 75
Winery Retail Stores ............................................................................................................................ 75
Electricity ................................................................................................................................................. 76
Hydro One ............................................................................................................................................ 76
Ontario Power Generation .................................................................................................................. 77
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FOREWORD
Overview
The Advisory Council on Government Assets was charged by the Premier to review the
Liquor Control Board of Ontario (LCBO), Hydro One and Ontario Power Generation
(OPG) and to recommend ways to maximize their value to the people of Ontario.
In doing so, we took into account the government’s preference to retain core assets in
public ownership and, in maximizing the value to the taxpayers, we also found ways to
improve customer service and maintain an engaged employee workforce.
We were greatly assisted in our work by previous reviews done on these companies.
We benefited from excellent cooperation from the companies themselves. We received
numerous submissions from and met with many stakeholders. We found their
comments well-researched and thoughtful. We also had constructive discussions with
the unions representing workers in each of the companies. The Public Service of the
Ontario Government has an enormous well of experience and capability that was made
fully available to us.
We structured our review in two phases. Phase I, the results of which are included in
this report, incorporated detailed reviews of the subject entities, stakeholder
consultation and the development of our initial thinking on proposals for the future
direction of each company. Phase II will incorporate further discussion and consultation
on the proposals. This will further our goal of reaching agreement among the
appropriate parties, leading to definitive recommendations to government for
consideration in the 2015 Provincial Budget.
We have tried to conduct our review as transparently as possible. We approached our
task with a genuine effort to have no preconceived answers to the issues raised, but to
search for what is best for the people of Ontario, recognizing that we brought different
visions and experience to the exercise. We are pleased that we are unanimous in our
conclusions, which have also found broad agreement with the management of the
companies themselves.
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We have concluded that significant value can be added to the assets we reviewed
within the parameters set by the government for this review. Indeed, we believe that
the Province can, with the Council’s proposals, meet its key goals. It can retain all three
core companies and significantly improve their performance. The Province can dilute
its interest in some non-core assets where government ownership is not critical and
where private sector involvement could facilitate more efficient electricity distribution.
Our proposals would, over time, reduce the growth in electricity rates from those that
would otherwise occur and keep liquor prices below the Canadian average, while
improving consumer accessibility in a responsible fashion. Meeting these goals would
free up $2 to $3 billion of funds to finance much-needed infrastructure investments
without adding to the Province's debt or increasing the deficit.
Premier’s Advisory Council on Government Assets
Ed Clark, Chair
David Denison
Janet Ecker
Ellis Jacob
Frances Lankin
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Beverage Alcohol
We examined the liquor distribution system in Ontario that centres around three
quasi-monopolies — the LCBO as well as the privately-owned Beer Store (TBS) and
off-site Winery Retail Stores (WRS). This system provides a highly-controlled
distribution system for liquor that generally serves the consumer well, but limits
accessibility and innovation. It is also a complex system with many interlocking parts
that is prone to the creation of unfair value for those powerful enough to obtain
certain rights.
We believe that the Province can retain the value of the existing beverage alcohol
system while, at the same time, improving the customer experience, increasing access
in a limited way and giving taxpayers a fairer share of the benefits of the system.
We considered selling the LCBO. There is a definite interest in the market for such an
option, which offers simplicity and a large one-time financial benefit. However, we
struggled with the concept of handing a monopoly over to a private owner. We were
concerned that large outright sales of this kind in the past have proven to be far less
attractive than they initially appeared. Privatization or sale to a private buyer would be
a radical change to a system that actually works quite well and might require the
creation of new regulatory systems. As far as consumer benefits are concerned, it is
not evident to us that Ontarians would be materially better served by a privately
operated LCBO. Further, any new owner would want to ensure that the monopoly they
acquire is preserved. The Council believes that competition is a good thing, particularly
for businesses like the LCBO which are not natural monopolies. Indeed, we would
prefer to see some limited increase in competition rather than locking in a perpetual
monopoly. Therefore, we rejected privatizing the LCBO.
We also examined the possibility of dramatically opening up the market structure
currently controlled by the three quasi-monopolies in Ontario: the LCBO, TBS and the
off-site Winery Retail Stores. Experience elsewhere suggests this would materially
increase the number of access points, creating a more open marketplace but a more
costly distribution system. Such a bold overhaul of the system would represent a
radical change for the Province and would require a broad consensus that it is the right
thing to do. Such a consensus does not appear to exist today.
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We believe the LCBO should be retained in government ownership, but with the
constraints of public ownership somewhat unshackled and a limited increase in
competition to improve access and increase innovation. This would allow the LCBO to
improve profitability and enhance service in a socially responsible way, essentially
freeing up a public monopoly to act less like a public monopoly. This would include
more effectively using the LCBO’s buying power to lower costs. This should be done
gradually. The initial focus of the LCBO will be to increase margins from suppliers and
realize operational savings without affecting consumer prices. Should it be
subsequently decided to raise prices, we would suggest that they should be maintained
at below the national average.
Finally we believe, and the LCBO agrees, that there are a number of ways that
customer choice and access can be improved and operations streamlined to improve
profitability. The LCBO wants to update its website and create warehouse stores in
major cities to carry alternative items not offered in standard stores. We also think the
LCBO should explore the creation of specialty stores which emphasize craft beer or
spirits, and should further orient certain locations to reflect the neighbourhoods in
which they operate. As well, the online channel could make a broader array of products
available than are carried in LCBO stores. These would support an aspiration for the
LCBO to become a best-in-class liquor retailer. We expect to explore these ideas
further with the LCBO in the next phase of our work.
The Council believes that the LCBO can be improved by better distinguishing between
its true profit and the notional taxes it collects, as well as separately reporting its
various businesses. The creation of this new disclosure framework will enable
management to better represent and monitor performance and report on the
implementation of our proposals, as improvements to the LCBO's margins can be
better evaluated.
In supporting, retaining, and improving the LCBO, the Council believes it is important to
introduce more, even if limited, competition to provide more access as well as incentive
to innovate. To this end, the Council is open in Phase II to exploring suggestions of
how competition can be increased without undermining the fundamental economics
and advantages of the monopoly system. Specifically, we would like to explore with
craft brewers the possibility of opening a limited number of stores featuring craft
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beer from around the world. We would like to explore with the wine industry the
possibility of opening new private stores offering both Canadian and international
wines. Additionally, we would like to explore with distillers ideas regarding new
sales channels.
In the case of the other distribution channels — the Beer Store and the off-site Winery
Retail Stores — we do not believe as a matter of principle that the government should
continue to foster a marketplace that provides unique benefits to these privately-owned
quasi-monopolies. In our view there is unfair value flowing to the private sector owners
at the expense of Ontario taxpayers. As changes are made to the LCBO to enable the
Province to capture more value, we believe that similar adjustments should be made to
the other quasi-monopolies.
We believe that the relationship between the provincial government and the Beer Store
should be revised to ensure that Ontario taxpayers receive their fair share of the
profits from the Beer Store. Consumers should not see an increase in prices as a result
of this change. The Beer Store should be required to provide greater transparency, to
ensure that costs are allocated equitably among suppliers, and to treat both owners
and non-owners fairly, including with respect to the display of their products. The LCBO
should be enabled to sell 12-packs and should increase its Cost of Service charge
on beer.
In the case of the off-site Winery Retail Stores, only a select few wineries have off-site
wine store licences. This seems unfair to the other producers. We also note that these
wine channels permit the sale of what are essentially non-Canadian wines under the
brand of a blended Canadian wine at very favourable tax rates relative to LCBO wine
sales. This also seems unfair.
Given our bias to create more competition rather than less, we believe that wine stores,
in some format, are a positive feature of the distribution system. As well, we recognize
that stand-alone wine stores may not be able to sustain the same tax/mark-up system
as the LCBO with its broader product assortment. We propose to engage the
participants in a constructive dialogue to develop change that would reflect a fair tax
system and continue to see strong demand for Ontario-grown grapes.
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We need to find a balanced way to effect these changes so that value is not destroyed
for the participants, but rather is more equitably shared. We believe that there could be
a limited expansion of availability and would like to see an opportunity created for
competitive distribution outlets to be established which would provide ongoing
competition to the existing networks and force innovation.
In summary, we believe Ontario’s alcohol distribution system works relatively well. If
consensus can be reached with the relevant parties and with the necessary political
will, its limitations are largely fixable within the current construct by changing the
behaviour of the three quasi-monopolies, adding some selective competition and
making sure the public gets its fair share of profits.
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Electricity
Hydro One comprises three main businesses within one company: a transmission
business as one part of Hydro One Networks Inc. (Hydro One Networks), a large
distribution business spread across the province as the other part of Hydro One
Networks; and Hydro One Brampton Networks Inc. (Hydro One Brampton), a separate
urban distribution business.
There are opportunities for operational improvements in both the transmission and
distribution businesses. These have been recognized by management which is
committed to exploring them. Many of these changes can be implemented without
changing the current labour contracts. Other savings opportunities would require the
cooperation of the unions and agreement of the shareholder. Where improvements can
be made, the savings will accrue over time to electricity ratepayers.
Our view is that the transmission business is a well-run part of Hydro One with some
opportunities to deliver savings on both capital and operating costs that should be
pursued. While selling all or part of the transmission business would be attractive to the
capital market, we believe this is an asset that, if retained in public ownership, can play
a positive role in many aspects of electricity policy, including ongoing energy-sharing
discussions with Quebec. Accordingly, we believe Hydro One transmission should
remain in public hands as a core asset at this time.
We view the distribution business differently. There are huge challenges in Ontario’s
local electricity distribution system. There are too many entities, some of them
inefficient, that lack the capability and capital to modernize and adapt to the
changing environment.
The electricity distribution sector was reviewed in 2012 by the Ontario Distribution
Sector Review Panel. We agree with the Panel’s core conclusions — the need to foster
consolidation and promote agile action in a changing energy world. Indeed, we believe
these conclusions are supported by almost everyone in the industry, though not
everyone agrees on how best to implement them. Ontario needs a more consolidated
and efficient electrical distribution system. The system needs more capital, which is
unlikely to be available from the public sector owners given other pressing needs.
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The system also needs companies that can innovate and adjust nimbly to a very
different energy world in the future. The current system fails that test.
Two entities that are key to breaking this logjam are Hydro One Brampton and the
distribution business in Hydro One Networks. We propose that both be used, not to
force consolidation but to catalyze it. Consolidation will facilitate efficiencies, reducing
costs that in turn will reduce electricity rates from what they would have been. It will
also improve adaptability of the system and create companies that can grow and
create jobs. The Council would make this recommendation whether or not the Province
needed money to fund new infrastructure. It is simply good energy policy. The Province
should take action now as a catalyst and achieve savings over the long-term. We do
not believe that the Ontario Government should divert resources from its priorities to
fund consolidation of local distribution companies. Private sector capital is available to
do this.
We are open to looking at different ideas as to how to encourage consolidation. One
way would be to use Hydro One Brampton as a catalyst by merging it with one or more
GTA-area distribution companies and then bringing in private capital to give it the
financial capacity to undertake further consolidation. The Province could sell some of
its interest in the company in a secondary offering along with the other existing owners,
should government choose to do so.
We also recommend the separation of the transmission and distribution businesses
now within Hydro One Networks into two entities. We would then propose that the
government dilute its interest in that resulting distribution business by bringing in
private capital. We would suggest that the Province initially retain a minority share
(40% to 45%). This new company would then have the capacity to undertake further
consolidations. These moves would create two champions of consolidation that would
provide an entrepreneurial base for growth. We would expect other municipalities to
respond either by joining these entities or seeking their own new partners — public or
private. We would encourage both such moves.
Our preference would be to keep the distribution business in Hydro One Networks as a
new separate distribution firm and not break it up. We recognize that there may be
some limited circumstances where merging parts of the distribution business with
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specific municipal electrical utilities would foster further consolidation. But we would
resist “cherry picking”, as that would compromise the best outcome for taxpayers and
electricity ratepayers. We would want to ensure that, if portions were to be sold, any
sales would not reduce the value of the distribution business as a whole, and more
importantly, not raise electricity rates from what they would have been. The Council is
also open to other proposals and ideas that will come forward as part of Phase II.
We are very sensitive to the labour issues such a change of ownership raises.
There are a number of rights that have to be respected and a number of concerns
that will arise. We believe we understand these concerns but also believe that it is
very important to have the right process to talk through and understand each
party’s interests and concerns with the goal of finding sustainable, mutually
acceptable solutions.
We also recommend that the government insist on provisions to protect against
undesirable changes in ownership in the future. This would ensure that the Province
can safeguard against unintended consequences from diluting its ownership.
We view Ontario Power Generation as being two distinct businesses — a complex
and challenging nuclear business and a much more stable and straightforward
hydro/thermal business. We focused mainly on the non-nuclear business — looking at
possible operating improvements and whether there are assets that it would make
sense to sell.
Cost savings in the hydro/thermal business are not overly large, but should be
pursued. Similar savings are likely to be had in the much larger nuclear business.
Management, which has been working on a business transformation initiative since
2011, is aware of opportunities and is committed to exploring them further.
OPG’s portfolio includes assets — specifically its hydroelectric stations other than the
large hydroelectric generating stations at Niagara Falls and on the St. Lawrence River
— that could be sold to finance additional investments in provincial infrastructure.
There is an active market for such assets.
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However, a transaction involving these assets should not be OPG’s first priority as it
would involve a number of issues central to energy policy that would have to be
resolved before reaching a conclusion that such a sale would be in the public interest.
More important than pursuing a sale of hydroelectric generating stations, OPG faces a
core issue: the refurbishment of the Darlington nuclear power station. This is
paramount from a cost sustainability perspective. The scale and risk in this capital
project dwarfs all other business issues at OPG. We recommend a laser focus on
making sure Darlington comes on line safely, on time, and on budget. We also suggest
that the government consider strengthening project management experience on OPG's
board to help support the Darlington refurbishment.
To that end, we propose that OPG should consider creating, on a staged basis, an
internal structure — as if they were two separate entities focused on their very different
businesses. This could eventually lead to two separate organizations — a nuclear
company with a Board that has predominantly large project management experience
— and a non-nuclear company. However, moving aggressively now would risk
diverting management’s attention from the core priority of the Darlington refurbishment
and would also deprive the nuclear business of the financial support provided by
the non-nuclear operations. Accordingly, any structural changes should be made
over time.
Cost savings that are attainable at Hydro One and OPG are relatively small unless
both companies can alter their labour practices or modify their total compensation
packages. Both have total labour costs that feature elements of above-market wages,
benefits and pensions. Pension costs have recently been highlighted in the Report on
the Sustainability of Electricity Sector Pension Plans (the Leech Report) and both
entities operate under government-imposed restrictions that make them less productive
than their private sector counterparts in heavy industries with field operations. These
restraints impose a significant burden on electricity ratepayers and taxpayers.
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To understand how we got here one has to understand a very long history of ‘give
and take’ in bargaining. But, in today’s environment, the package of wages,
benefits, pensions, and practices, in some cases, exceeds not only private sector
standards, but public sector standards too. This is not true in all cases, especially
with highly specialized and technical staff, so one must be careful not to make
sweeping generalizations.
The Leech Report eloquently outlines the unsustainability of the pension plans in the
electricity sector, including both OPG and Hydro One. Simply put: they are not
consistent with public sector standards — and are not, in Special Advisor Leech’s
expert view, stable.
We recognize that both union leaders and employees — at all levels — are equally
concerned about ensuring the ongoing viability of these plans. We have a joint interest
in finding a good, mutually agreed-upon solution. There has been broad agreement on
a process to deal with this conversation. We recommend the government put urgency
behind this initiative and ensure a coordinated government response.
If these companies are to stay and thrive in the public sector, modernizing labour
practices to improve productivity is also critical.
Almost none of the potential improvements or restructuring at Hydro One or OPG will
be possible without consulting and negotiating with the Power Workers’ Union and the
Society of Energy Professionals. These negotiations will be complex and challenging,
but they are essential to long-term, sustainable operations. The current labour
agreements were struck at the bargaining table and should be changed at the
bargaining table. What is needed is to initiate a dialogue with management and the
labour unions in order to agree on the facts and work together to understand the issues
and the range of solutions.
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Conclusion
We believe that our review has produced a sound, actionable framework to improve
the operations of the entities we examined, to streamline the systems within which
they operate, and to improve service to customers. This would free up funding for
much-needed transit and transportation infrastructure investment.
Reducing government ownership in our electrical distribution systems through injecting
private capital while retaining a minority share will help spur needed consolidation in
the electrical distribution system to improve our electricity infrastructure.
At the same time, we estimate that between $2 billion and $3 billion, depending on
market conditions at the time, can be realized and invested in Ontario’s transit and
transportation infrastructure. These investments will create jobs directly and indirectly
through investments in critical infrastructure which will remove impediments to
economic growth. While the provincial government would get less ongoing income
directly from these companies, the investments in economic growth will help mitigate
this shortfall over time. In addition, this lost income would be more than covered from
the savings generated by the improvements we are proposing for the entities we
believe should remain publicly owned, including the LCBO.
The current beverage alcohol structure should continue — providing the benefits of a
lower-cost, controlled model — but changes are needed to improve customer
experience and returns to the Province. In addition, introducing limited competition will
add further incentives to innovate.
All of this can be achieved without increasing the expected debt levels or increasing
the expected deficit.
In the next phase of our work, the Council will engage with the companies and
stakeholders to explore the proposals we are making in this report and seek to develop
solutions that are pragmatic and, to the extent possible, supported by all parties.
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SUMMARY OF COUNCIL PROPOSALS
The following proposals, which have been developed based on our review and flow
from the observations outlined in this report, constitute an actionable framework
for change.
Beverage Alcohol
LCBO
Ownership
•
The Province should retain the LCBO.
•
The current beverage alcohol market structure should be retained but opened up to
greater competition.
Pricing & Mark-ups
•
The LCBO should move in a staged way to introduce a new pricing strategy,
enabling it to use its buying power to reduce costs based on objective criteria,
consistent with Canada’s international trade obligations.
•
Ontario beverage alcohol prices should be maintained below the Canadian
average.
•
The LCBO should continue to review minimum prices.
Retail Enhancement
•
The LCBO brand should take advantage of its brand by associating it with certain
products (“co-labelling”).
•
The LCBO store network should be expanded and differentiated by creating
warehouse (“Depot”) stores, converting some existing LCBOs to specialty shops
which emphasize craft beer or craft distillery products, and orienting the product
selection in certain stores to reflect their neighbourhood.
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•
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The LCBO should develop into a best-in-class online retailer, fully integrating its
website with its business to make a broader selection of products available to
consumers and to provide suppliers, including those that don't have access to
LCBO stores, access to the Ontario market. It should:

make products available for online order (“click & collect”);

connect shoppers to the LCBO’s warehouses; and

create an on-line marketplace to allow any supplier in the world to register
its products.
Labour
•
The bargaining process must be respected; any changes to current agreements
should be made at the bargaining table.
•
Labour practices should be updated to improve productivity and to implement our
recommendations.
Introducing Competition
•
Opportunities should be considered to introduce competition in a limited way, such
as exploring with:

craft brewers, the possibility of opening a limited number of stores featuring
craft beer from around the world;

the wine industry, the possibility of opening new private stores offering both
Canadian and international wines; and

distillers, the possibility of new sales channels.
Other Proposals
•
The LCBO should better differentiate its true profit from the mark-up it collects, as
well as separately report its various businesses.
•
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The LCBO should realize the operational savings identified.
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The Beer Store
•
The LCBO’s Cost of Service charges on beer should be increased.
•
The LCBO should be enabled to sell 12-packs.
•
Ontario taxpayers deserve their fair share of the profits generated from the
Beer Store.
•
Consumers should not see higher prices as a result of this change.
•
The Beer Store should be required to:

provide greater transparency;

ensure that costs are allocated equitably between suppliers; and

treat both owners and non-owners fairly, including with respect to display of
their products.
•
The possibility of opening a limited number of stores featuring craft beer from
around the world should be explored with craft brewers
Winery Retail Stores
•
The off-site WRS owners should be engaged in a constructive dialogue to achieve:

a taxation system that is fair; and

a set of changes that continue to see strong demand for Ontario-grown
grapes.
•
The possibility of opening new private stores offering both Canadian and
international wines should be explored with the wine industry.
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Electricity
Hydro One
General
•
The Province should retain the transmission business at this time given its current
policy role.
•
Hydro One should work to realize operational savings identified over time.
•
Hydro One should separate its distribution assets from the rest of its business.
•
The Hydro One distribution assets should be used as a catalyst to encourage much
needed consolidation and modernization of the electricity distribution system.
Distribution
•
Private sector capital, rather than public funds, should be used to support the
required consolidation of LDCs.

The Province should dilute its interest in Hydro One Brampton by merging it
with some other LDCs, including possibly with other GTA entities, based
upon a pre-agreed business plan to bring in private capital to help grow and
modernize the electricity sector.

The transmission and distribution businesses of Hydro One Networks should
be separated into two entities; the Province should dilute its interest in the
resulting distribution company to a minority interest (40% to 45%) by bringing
in private capital.
o
The Council’s preference is to keep the distribution business whole to
ensure a better outcome for ratepayers and taxpayers.

Provisions should be used to protect against specific undesirable changes in
the future ownership of these businesses.

•
Any transaction should not create further upward pressure on rates.
The current barriers and incentives, such as taxes, which impede consolidation
should be reviewed during Phase II.
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Labour
•
The bargaining process must be respected; any changes to current agreements
should be made at the bargaining table.
•
Labour practices should be updated to improve productivity and to implement our
recommendations.
•
Rights must be respected and specific concerns should be addressed as a result of
changes in ownership.
•
A co-ordinated government response is required to achieve sustainable pension
plans within Hydro One and OPG.
Ontario Power Generation
General
•
A laser focus should be taken to ensure Darlington comes on line safely, on time
and on budget.

The government should consider adding more large project management
experience to the OPG Board to oversee the Darlington refurbishment.
•
OPG should work to realize operational savings identified over time.
•
OPG should consider creating an internal structure over time as if there were
two separate entities focused on their very different businesses: nuclear and
non-nuclear generation.
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Labour
•
The bargaining process must be respected; any changes to current agreements
should be made at the bargaining table.
•
Labour practices should be updated to improve productivity and to implement our
recommendations.
•
A co-ordinated government response is required to achieve sustainable pension
plans within Hydro One and OPG.
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1. INTRODUCTION
1.1
Establishment of the Council
On April 11, 2014, the Minister of Finance announced a Council to provide advice on
government assets, reporting directly to the Premier. The Council is made up of Ed
Clark (Chair), David Denison, Janet Ecker, Ellis Jacob, and Frances Lankin.
Establishment of the Council was also discussed in the 2014 Ontario Budget.
1.2
Mandate and Principles
The Council’s mandate is to provide analysis, advice and recommendations on how
best to maximize the value and performance of government business enterprises and
other Provincial assets. This is intended to help the government deliver on its multiyear targets set out in the 2014 Budget. The government established three principles to
guide the Council’s review. These were:
•
The public interest remains paramount and protected;
•
Decisions align with maximizing value to Ontarians; and
•
The decision process remains transparent, professional and independently
validated.
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Terms of Reference
We were asked to report to the Premier on the government business enterprises under
review by the end of 2014 to contribute to the 2015 Budget process. The Council’s
terms of reference provided the following guidance:
•
Focus on core government business enterprises and operational agencies;
•
Give preference to continued ownership of all core strategic assets to generate
better returns and revenues to the Province;
•
Advise the government on efficient governance and how best to achieve ‘asset and
income optimization’ targets as set out by the government in ways that enhance
services and value to the customers and recognize the need for highly performing
engaged employees;
•
Consider possible asset mergers, acquisitions and divestments if there is a strong
business case and it would enhance value to the taxpayers of the province;
•
Advise on possible changes to the corporate structure of the government business
enterprises, including private-public sector partnerships;
•
Review and comment on possible directions and agency proposals and business
plans; and
•
Take into account the protection of the public interest, including providing for an
appropriate legislative and regulatory framework.
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Scope of Our Review
Within our overall mandate to review government assets, we were specifically directed
to examine three government business enterprises — the Liquor Control Board of
Ontario, Hydro One, and Ontario Power Generation. They form the foundation of the
government’s participation in the beverage alcohol sector and the electricity sector.
Within the beverage alcohol sector are three major retail entities:
•
LCBO
•
Beer Store
•
Winery Retail Stores
Although neither the Beer Store nor the Winery Retail Stores are government business
enterprises, they are regulated by the government and are part of the province’s
beverage alcohol system. As such, the Council concluded that it was impossible to
consider the LCBO’s place in the beverage alcohol sector without acknowledging the
Beer Store and off-site Winery Retail Stores as competitors and comparators with
the LCBO.
In the electricity sector, there are two government business enterprises:
•
Hydro One
•
Ontario Power Generation (OPG)
Given the short time frames associated with the Council’s advice to government and
the size and complexities associated with nuclear power generation, we restricted the
scope of our OPG review to its non-nuclear operations.
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Our Perspective
As we began our work, we set ourselves a goal to craft our advice in a way that would:
•
Retain core enterprises within public ownership;
•
Possibly divest some non-core assets to support investment in much-needed and
productive infrastructure without adding to the Province’s overall debt or increasing
the deficit;
•
Improve both business performance and customer service in the subject entities
while not increasing commodity costs to consumers.
We recognized from the outset of our work that all the entities operate within a tightly
constrained regulatory or policy regime; furthermore, this is by no means the first time
these sectors and entities have been reviewed.
Both the beverage alcohol and electricity sectors have been studied intensively over
several decades. A number of studies have proposed different structures and operating
models. Some of the operational recommendations of these studies have been
implemented, but most strategic and transformational recommendations have not.
As we embarked on our review, we asked some basic questions:
•
Could these publicly-owned companies be better run?
•
Could they be more customer-focused?
•
Are all the companies’ assets truly core to their mission?
And because these publicly-owned companies (like any company in the private sector)
have limited capacity to act, is there a set of practical steps that are within their
capacity that would unlock value?
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Our bias was clearly towards the do-able. It is easy to come up with dramatic shifts in
strategy — but such shifts would require deep cultural changes in the organizations,
and broad societal support to make them happen. We prefer a more measured
approach — each step of which improves what we have and actually gets things done
rather than adds this report to the list of earlier reports never implemented.
The Council was also guided by the government’s desire to find the financial capacity
to fund needed transit and transportation infrastructure in the province.
We started from the premise that all three entities under review would have
opportunities to realize value and improve performance as would almost any business
in Canada, whether public or private. However, we recognized that in many cases the
entities may have been constrained by the fact that they are government-owned;
in practice, they operate in an inherently political environment.
But we kept several things in mind.
As mentioned, government’s preference is to retain ownership of core assets. The
Council also believes that rushed asset sales are not in the public interest. Any sale
must be a carefully staged and competitive process.
We asked whether the government is, indeed, the best owner of these assets, and the
purpose served by government ownership. Would a company — in private hands — be
better able to serve the consumer or electricity ratepayer? Would bringing in the private
sector unshackle a company, allowing it to grow and create jobs?
These assets all earn income for the Ontario government — income that is important
given its deficit position. But the proceeds of any asset sale are unlikely to be
reinvested in new direct income-generating assets. The new infrastructure assets may
greatly benefit Ontarians and add enormous value to the provincial economy; this, in
turn, would create income indirectly, through increased economic activity for the
provincial government in the medium-term. But in the short-term, a loss of income is
likely. The Council was very mindful of that impact. So, to offset any loss of income,
it became even more critical to ensure better performance of the assets retained by
the government.
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The Council agreed that swapping ownership in infrastructure assets can make sense.
But it is important that any funds raised are used to invest in other assets that deliver
high societal or economic returns to the province. The government has made clear that
funds raised in this process will be used to invest in transit and transportation
infrastructure. Better infrastructure will allow the economy to grow faster, create more
jobs, and increase both competitiveness and productivity. In addition, of course, there
are jobs directly created by undertaking the investments.
Finally, we set out with a view that the Government Business Enterprises we were
reviewing have, in most cases, adapted relatively successfully to their operating
environment. The three management teams and boards have identified areas for
improvement and implemented several of those changes. We engaged each of the
organizations in our work so that we could explore opportunities collaboratively and,
ideally, come to a collective view on how to effect change that is meaningful
and achievable.
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Our Approach
We structured our review in two phases:
•
Phase I incorporated detailed reviews of the subject entities, consultations with
stakeholders and the development of our initial thinking on proposals for the future
direction of each company. These are included in this initial report for consideration
in the Fall Economic Statement; and
•
Phase II will incorporate further discussion and consultation on the proposals,
which would further our goal of reaching agreement among the appropriate parties,
leading to definitive recommendations to the government for consideration in the
2015 Provincial Budget.
As we move forward, we will continue our commitment to a collaborative and
transparent process as we work out specific ways to implement our
recommendations.
Phase I. In Phase I, we undertook two main streams of work — detailed reviews of the
entities in which we were supported by professional consulting expertise, and meetings
with selected industry associations and stakeholders who are either employed by,
regular clients of, partners of, or competitors with the three Government Business
Enterprises.
The major work streams in each of the three companies involved an analysis of each
organization and its operations, investigating issues and then developing and
evaluating options for performance improvement, cost savings, and/or the optimization
of asset value. We engaged a number of advisors and consultants to assist us in
this work.
We met with a wide range of stakeholders, among them all the business entities
involved and the oversight ministers. We met with representative stakeholders,
including unions, in both the beverage alcohol and the electricity sectors. The Council
also received a number of formal submissions in the course of our review, and we
very much appreciated the thoughtful and constructive input we received through
this process.
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2. THE BEVERAGE ALCOHOL SECTOR
2.1
Overview
The beverage alcohol sector in Ontario generated total retail sales of about $7 billion in
2013–14, of which about $3 billion went to the Ontario government through:
•
a dividend from the LCBO ($1.74 billion);
•
taxes on beer sales through the Beer Store and on-site manufacturers’ stores
($524 million);
•
taxes on wine sales through on- and off-site Winery Retail Stores ($33 million); and
•
the provincial portion of Harmonized Sales Tax on sales at retail stores and
licensed establishments ($650 million).
The Ontario system is dominated by three retail networks that are owned either by the
government (LCBO) or producers (the Beer Store and Winery Retail Stores) and that
have a quasi-monopoly on beverage alcohol wholesaling and retailing in Ontario:
•
The LCBO is owned by the Province and operates 639 stores across Ontario.
The LCBO also authorizes 217 Agency Stores, which are privately operated and
provide retail access to consumers in less densely populated areas.
•
Brewers Retail Inc. (BRI), which operates as the Beer Store, is owned by a
consortium of three foreign-owned brewers, and has 447 stores across
the province.
•
Off-site Winery Retail Stores are owned by six wineries and retail only their own
products at 292 locations across the province.
In addition to the channels listed above, local producers can sell their own products at
on-site manufacturers’ stores located at their point of production. Along with the
LCBO and the Beer Store, authorized producers are also allowed to sell their products
to licensed bars and restaurants, referred to as licensees.
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Certain other provinces have modified their systems in recent years:
•
Alberta is the only Canadian province or territory to fully privatize the retailing of
beverage alcohol. A provincial agency retains control over the importation of
alcohol into the province, and hires private companies to warehouse alcohol on
its behalf.
•
British Columbia is an example of a Canadian province with side-by-side public
and private liquor stores selling a full range of wine, spirits, and beer. Private stores
purchase liquor from the provincial agency at a discount to retail price, which was
initially set at 10%. Today, that discount ranges from 16% to 30% for certain stores.
•
Quebec also employs a hybrid model. The provincial agency is the only entity
permitted to retail spirits and wine bottled outside the province, with wine bottled in
Quebec and beer sold in private channels throughout the province, at convenience
and grocery stores, as well as specialty retailers.
The public policy rationale for the design of Ontario’s system was originally — and
largely remains — to control the distribution and sale of beverage alcohol. As such,
government plays a strong role in the sector. Since the inception of the system in the
late 1920s, government policy has focused on balancing consumers’ desire for access
to beverage alcohol against the social responsibility of mitigating its harmful effects.
The Province has focused on managing the health hazards of beverage alcohol by
limiting retail outlet density and controlling points of sale, preventing broader retail
availability. This public policy issue is not unique to Ontario or Canada. Few
governments treat beverage alcohol as simply a normal consumer product.
Many pieces of legislation, regulations and agreements govern the import, sale and
transport of alcohol in Ontario, including:
The Importation of Intoxicating Liquors Act (Federal) assigns importation authority
for beverage alcohol to provincial and territorial authorities.
The Liquor Control Act empowers the LCBO to retail beverage alcohol and to
regulate warehousing and pricing and authorizes BRI and the basis for on-site brewery,
winery, and distillery stores to sell their products to the public.
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The Liquor Licence Act regulates responsible use, licensee sales and service
requirements as well as establishes manufacturing and distribution conditions and
legislation for marketing and advertising practices.
The Alcohol and Gaming Regulation and Public Protection Act (“AGRPPA”)
establishes the Alcohol and Gaming Commission of Ontario (“AGCO”) and provides
legislation for beer and wine taxes and their collection.
The Beer Framework Agreement, signed in 2000 between the LCBO and Brewers
Retail Inc., acts as an operating agreement between the two entities. It gives the Beer
Store exclusive rights to sell beer in formats larger than a six-pack in communities with
a TBS location, and prevents the LCBO from wholesaling beer carried by TBS to
licensees. The Beer Framework Agreement can be terminated with six months’ notice.
International Trade Agreements, including the Beer Trade Memorandum of
Understanding between Canada and the US, North American Free Trade Agreement,
the Agreement between the European Community and Canada on Trade in Wines and
Spirit Drinks, as well as the proposed Comprehensive Economic & Trade Agreement
and Trans-Pacific Partnership, require treatment of imported products that is no less
favourable than that accorded to domestic products.
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LCBO
Background
The LCBO is a government business enterprise that has a monopoly for the
wholesaling and retailing of spirits and imported wine and competes with Winery Retail
Stores for Ontario wine sales as well as the Beer Store for beer sales.
The LCBO provides a direct return to the Province through an annual dividend.
This amounted to $1.74 billion in 2013–14, and has grown at a compound annual
growth rate of about 5.5% since 1994.
The LCBO is by no means a conventional liquor wholesaler and retailer. It operates
in a complex environment that has shaped the way the organization operates today.
The chart below illustrates some of the forces that affect the LCBO.
Regulatory Framework / Mandate
Liquor Control Act is guiding legislation
Balanced mandate between social responsibility
and financial returns to Province
Performs a number of activities because it is a part
of government (policy, communications, Freedom
of Information, French Language Services, etc.)
Suppliers and other stakeholders routinely appeal
to government for changes to the LCBO
•
•
•
•
Governance
Publicly-appointed Board of Directors has authority
to execute operations under LCA
Reports to Minister of Finance
In practice, financial decisions are made in
collaboration with the Ministry of Finance
•
•
•
LCBO
Labour Relations
•
•
•
•
Single union – Ontario Public Service Employees
Union
Approximately 90% of workforce is unionized
Average age of approximately 45 years; average
age of permanent employees within union of over
50 years
Staff turnover of less than 5%
Market Dynamics
•
•
•
•
Monopoly on spirits; near monopoly on wine
Competitor to the Beer Store for beer sales
Product pricing set on ‘cost plus’ basis
Intersects with public policy goals; LCBO provides
incremental support to suppliers
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Our Approach
The Council worked closely with LCBO management to understand their perspective
and explore opportunities to improve performance. We were also assisted by
consulting teams that undertook a focused diagnostic review to identify potential
operational and profit improvements.
Our Observations
General. Ontario’s beverage alcohol system is a product of its long history and has
evolved in piecemeal fashion over the years. It may well be that, given a clean sheet,
no one would design a system to operate as this one does. Given its status and
history, it is hardly surprising that the LCBO neither resembles nor operates like a
traditional private-sector wholesale/retail organization.
That said, the LCBO has evolved significantly over time, particularly over the past
decade or so. Substantial investments in stores and improved customer experience,
as well as a broad product assortment and a large footprint across Ontario, mean that
consumers are generally well served by the organization. Currently, 90% of the Ontario
population lives within 5 km of an LCBO or agency store. Operationally, allowing for the
constraints within which it operates, the LCBO has made substantial strides in
transforming itself from a government control mechanism into a modern wholesale and
retail organization.
All in all, we found that, despite the constraints put upon it by government policy and
labour agreements, the LCBO provides Ontario consumers with a very broad and
convenient network, a sophisticated retail experience and a significant assortment of
products that are, on average, priced below the Canadian average.
Ownership of the LCBO. One of the central questions we addressed was whether the
Province should continue to own and operate the LCBO or whether it should be
privatized in some manner. There have been arguments made over the years that the
proper role of government is to regulate and oversee rather than to own and operate.
In light of this, we considered the privatization options carefully.
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We considered selling the LCBO. There is a definite interest in the market for such an
option, which offers simplicity and a large one-time financial benefit. However, we
struggled with the concept of handing a monopoly over to a private owner. We were
concerned that large outright sales of this kind in the past have proven to be far less
attractive than they initially appeared. Privatization or sale to a private buyer would be
a radical change to a system that actually works quite well, requiring the creation of
new regulatory systems. As far as consumer benefits are concerned, it is not evident to
us that Ontarians would be materially better served by a privately operated LCBO.
Further, any new owner would want to ensure that the monopoly they acquire is
preserved. The Council believes that competition is a good thing, particularly for
businesses like the LCBO that are not natural monopolies. Indeed, we would prefer to
see some limited increase in competition rather than locking in a perpetual monopoly.
Therefore, we rejected privatizing the LCBO.
We also examined the possibility of dramatically opening up the market structure
currently controlled by the three quasi-monopolies in Ontario: the LCBO, TBS and the
Winery Retail Stores. Experience elsewhere suggests this would dramatically increase
the number of access points, creating a more open but more costly distribution system.
Such a bold overhaul of the system would represent a radical change for the Province
and would require a broad consensus that it is the right thing to do. Such a consensus
does not appear to exist today.
However, in supporting, retaining, and improving the LCBO, the Council believes it is
important to introduce more, even if limited, competition to provide more access as well
as pressure to innovate. To this end, the Council is open in Phase II to exploring
suggestions of how competition can be increased without undermining the fundamental
economics and advantages of the monopoly system. Specifically, we would like to
explore with craft brewers the possibility of opening a limited number of stores featuring
craft beer from around the world. We would like to explore with the wine industry the
possibility of opening new private stores offering both Canadian and international
wines. Additionally, we would like to explore with distillers ideas regarding new
sales channels.
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Maintaining government ownership of the LCBO does not imply a continuation of the
status quo — far from it. Working closely with management of the LCBO, we identified
significant opportunities to create greater value and improve performance. In essence,
we endeavoured to find ways that the LCBO, as a public monopoly, could act less like
a public monopoly. If it turns out that this cannot be done, our bias would be to look
again at ways to introduce even more competition than we are suggesting today. As
previously stated, we believe that competition is a good thing.
The LCBO operates under significant constraints in both pricing and mark-up.
Contrary to what many Ontarians believe, the LCBO does not actually set retail liquor
prices in the province. Within specified price ranges, the LCBO applies a fixed mark-up
(generally a percentage) to a supplier’s quote to determine the end price to
the consumer.
The government imposes only two pricing constraints on suppliers:
•
a requirement that minimum prices be charged for various categories of alcohol,
an important tool for the Province’s social responsibility mandate; and
•
a requirement for uniform retail prices for that product, no matter where it is sold
in the province or through which channel.
While the LCBO seeks the best value for consumers within these price bands, the
LCBO does not establish either wholesale or retail prices for products it buys and sells
— it simply derives its operating margin from the fixed mark-up. It is important to
understand the incentives that this system creates. Since the LCBO’s mark-up for wine
and spirits is based on a percentage of the supplier’s quote, cost concessions by
suppliers actually reduce the LCBO’s profits. As a result, there is little incentive for the
LCBO to use its buying power to reduce the price it pays to suppliers and, by
extension, the price it charges to consumers. Further, if the LCBO sees an opportunity
to increase prices, it cannot do so without suppliers charging a higher cost.
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Consumer Prices: In our review of pricing at the LCBO, we excluded beer, given the
Beer Store’s dominant market position. One might expect that wine and spirits prices in
Ontario would be higher than they are in jurisdictions where more competition exists.
However, our analysis indicates that this is not the case. In developing our price data,
our consultants:
i.
examined self-reported provincial data aggregated by the Canadian Association
of Liquor Jurisdictions (CALJ), which provides price data for an agreed-upon set
of 42 wine and spirits products, four times per year; and
ii.
conducted independent price checks of 43 wine and spirits products at seven
government- and 16 privately-operated liquor retailers in Alberta, British
Columbia and Quebec.
The CALJ data indicate that beverage alcohol prices in Ontario are generally below the
Canadian average. The independent store visits turned up a similar result when
comparing Ontario with Alberta, British Columbia and Quebec. The chart below
illustrates the price gaps. Based on the CALJ data, the LCBO would have to increase
prices for spirits by 3% and wine by 9% to reach the Canadian average.
Required LCBO Price Increase to Reach
Canadian Average
9%
3%
Spirits
Wine
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Reducing Cost of Goods Sold: The LCBO is one of the largest purchasers of
beverage alcohol in the world, yet has too little incentive to use its considerable
purchasing power to reduce the cost of goods sold (COGS) as any typical commercial
wholesaler or retailer would.
Using data from CALJ, we analyzed prices paid by the LCBO to wine and spirits
suppliers for 42 products, comparing those to other Canadian jurisdictions. Although
this limited set of items did not encompass the entire assortment available at the
LCBO, we found the results striking as, in many cases, suppliers received higher
prices in Ontario than they did in other Canadian jurisdictions. As illustrated in the
chart below, the cost of goods sold is higher than the average for all provinces
(the darker columns on the left) – by 4% for spirits and by 3% for wine. Compared
with the lowest-cost third of the provinces (the lighter columns on the right), costs are
10% higher for spirits and 7% higher for wine.
Cost of Goods Sold Relative to Other Canadian
Jurisdictions (% Above)
10%
7%
4%
3%
Spirits
Average of Provinces
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Wine
Best Third of Provinces
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In essence, in Ontario, products are purchased from suppliers at above-average costs,
yet the LCBO sells the same products to consumers at below-average prices. Two
factors largely explain this:
•
Cost: the distribution system in Ontario is highly integrated and much more efficient
than those of other jurisdictions; and
•
Margin: under the fixed mark-up structure, the LCBO cannot maximize its profits,
effectively transferring value from taxpayers to suppliers.
Nowhere is this latter point more apparent than with minimum prices. The combination
of a relatively high price floor and a fixed mark-up structure forces prices paid to
suppliers upwards. The effect of this reverberates throughout the LCBO’s product
assortment, as these higher minimum prices put upward pressure on other products
within the same category. We do not believe it is good policy for suppliers to receive
windfall profits as a result of a social policy. As a result, we have discussed with the
LCBO opportunities to competitively procure products that are listed at the minimum
price. These initiatives would be based on objective criteria and consistent with
international trade obligations.
The current minimum price for wine is not effective, as only a small portion of wine sold
in the province changes hands at or near the minimum price. Given the role minimum
prices play in encouraging responsible consumption, we note that wine has the lowest
minimum price per litre of absolute alcohol content, substantially trailing beer and
spirits. The government should consider raising minimum prices closer to real market
levels and be prepared to move minimum prices up even further if warranted.
This should be done in a way that allows the LCBO to capture the resulting increase
in profits.
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There are opportunities to improve the customer experience within the existing
store network. Our discussions with LCBO management and our review of the retail
experience in other sectors and jurisdictions led us to conclude that the LCBO can
improve the customer experience in a number of ways. These represent meaningful
opportunities for the LCBO to increase margins while, at the same time, delivering
better value for consumers. These include:
•
Co-labeling: The LCBO could do more to monetize its strong brand by associating
it with specific products, to the benefit of both its customers and the LCBO. Tags on
products indicating “Buyer’s Picks” — combined with preferential shelf space for
these goods — could help consumers in their buying decisions. As these
opportunities would be auctioned to domestic and foreign producers for specific
products, this would provide strong financial returns for the LCBO. Both co-labeling
and preferential shelf space are examples of non-discriminatory ways to
increase margins.
•
Store Network: Virtually all new LCBOs are large visually-appealing stores. This
enables the organization to offer meaningful shelf space to local wineries and craft
brewers and to allocate its high retail labour costs across a larger footprint with
higher sales. We have worked with the LCBO to find ways in which it can enhance
its overall store portfolio by creating variations within its network. Opportunities
identified include:

Craft and Cider Destination Stores: Elevating Craft. The LCBO now has
a small number of ‘Destination Stores’ that carry a significantly broader
selection of local wines. We believe that this store-within-a-store concept can
be replicated to create certain specialty Craft Beer and Cider Destination
Stores. These would be of interest to consumers, while also representing a
meaningful opportunity for craft brewers.
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
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Craft Distillery Sections: Empowering Licensees. Craft distilled spirits
represent a small but increasingly popular market segment. To address this,
the LCBO has proposed setting up Craft Distillery Sections in specific stores
across the province. This specialized shelf space would enable licensees to
purchase craft distillery inventory in small quantities through the LCBO
store network, while highlighting this growing segment for retail consumers
as well.

Niche Stores: Meeting Local Consumer Demand. The LCBO could create
specialty boutiques in specific stores that better cater to the tastes and
demands of the local community. For example, a store on the Danforth in
Toronto could specialize in Greek wines and spirits while in Little Italy
customers could find an exclusive selection of Italian wines and beers.
These niche stores, while better serving their communities, could become
popular destinations for many customers.

Depot Stores: A New Buying Model. We discussed with the LCBO a
design for a select number of new stores that would offer a limited selection
of products sold by the case at all price points. These “LCBO Depot” stores
would be much more basic in nature and would sell competitively-procured
products not currently carried by the LCBO, emphasizing great value
for customers.
The LCBO could improve customer experience through an integrated online
platform, becoming a best-in-class online retailer. Although the LCBO is
introducing a new website and digital platform, we — along with the LCBO
management team — believe that more can be done to foster an integrated consumer
experience. Current proposals being explored include:
•
Online Retailing of In-store Assortment: Click & Collect. Stores would be
integrated with an online ‘click and collect model’ that would enable customers to
order products online for pick-up at their local LCBO. We believe this would
represent a significant improvement for customers. When combined with new
initiatives such as Depots, it would expand the assortment of products available
and provide a different type of retail experience.
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•
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Online Retailing of Warehoused Products: Private Stock. Today, LCBO
warehouses contain thousands of products, many of which are held for agents and
sold exclusively to licensees. These products are not available in LCBO retail
stores. We believe the LCBO can use its online platform to create a new sales
channel for these products; consumers could buy these products through the LCBO
website and pick them up in their local LCBO store. This would enable agents and
suppliers to benefit from a new sales channel and provide consumers with access
to niche products.
•
Open Marketplace: Online Retailing of Any Products. Even with the above
initiatives, consumers in Ontario will have access to only a small fraction of the
beverage alcohol produced worldwide. We believe the LCBO can use its online
platform to create an open marketplace on its website, allowing suppliers and
agents around the world to list products for consumers to purchase for pick-up at
their local LCBO store. The marketplace would be open to all producers, and would
also be an interesting opportunity in the context of interprovincial sales.
Accountability and measuring performance. Although many — including the LCBO
management team — view the organization as an integrated entity, we see the LCBO
as a business with three core segments:
•
Retailer: the largest liquor retailer in Ontario by points of sale and total dollar sales;
•
Wholesaler: one of the largest beverage alcohol buyers the world;
•
Private contractor: engages with private-sector agency store operators and
authorizes wineries to deliver products directly to licensees.
Each of the businesses has its own unique dynamics. Almost certainly, performance
differs across the three areas. However, the LCBO does not currently assign
accountability or measure performance in a way that reflects this.
In addition, sales of beverage alcohol within Ontario through non-LCBO channels are
subject to commodity taxes levied by the Province. LCBO sales, however, are not
subject to these, as they are effectively included in the business’s mark-up.
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There are a number of issues with the above, including:
•
Overstatement of profits: by combining notional taxes with business profit, the
LCBO creates a false sense of profitability for both management and employees.
The LCBO, like most retailers, is a thin margin business. By not presenting itself as
such, it is more difficult for the organization to have the appropriate cost orientation.
•
Misallocation of profits: the LCBO now allocates the organization’s wholesale profit
and notional taxes to its retail channel, risking suboptimal business decisions.
The Council believes that the LCBO can be improved by better distinguishing between
its true profit and the notional taxes it collects, as well as separately reporting its
various businesses. The creation of this new disclosure framework will enable
management to better represent and monitor performance and report on the
implementation of our proposals, as improvements to the LCBO's margins can be
better evaluated.
Operational effectiveness. We examined all areas of the LCBO’s operations and
generally found them to be well designed and operating efficiently within their
constraints. However, as with any business, there is room for improvement in some
areas. We, together with management, identified opportunities within:
•
work practices and scheduling;
•
efficiency of warehouse-to-store delivery;
•
marketing programs; and
•
freight savings.
The LCBO management team is committed to pursuing these opportunities.
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Labour costs. Labour accounts for nearly half of the organization’s operating
expenses. The LCBO has about 7,700 full- and part-time employees, of which about
7,000 are represented by the Ontario Public Service Employees Union (OPSEU).
The collective agreement between the LCBO and OPSEU establishes labour rates and
work practices that have a significant impact on how the LCBO operates. While these
reflect benefits that the workforce has achieved at the bargaining table, they also
impede the organization’s ability to modernize and streamline its operations.
Our consulting review compared the LCBO’s wages to several comparable privatesector companies (Canadian Tire, Shoppers Drug Mart, and The Source), and
determined that, on average, LCBO wages are about 90% higher than those paid by
typical Canadian retailers. Further, LCBO staff and casual employees earn more than
their counterparts at the Beer Store (the middle columns in the chart below), which is
also unionized.
This difference was not uniform across all job categories:
Wage Rate Comparison
$33
$23
$26
$21
$15
$11
n/a
Store Manager
$13
n/a
Staff
Casual Employee
LCBO
TBS; Avg. of Starting & Maximum Wages for Staff (300 series) & Casual (Temp); does not reflect higher wage rates
prior to last collective agreement
Private Sector Peers
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The gap between staff wages and those of store managers is much narrower in the
LCBO (the dark columns on the left) than in the peer group (the columns on the right).
Most LCBO store managers are not unionized, and have had their wages frozen by
government for the past six years, while wages for unionized assistant managers and
staff have increased annually with government support over that same time period.
This wage compression limits the ability of the organization to promote from within.
In 30 extreme cases within the LCBO store network, a non-unionized store manager
actually earns less than a unionized assistant store manager.
Perhaps the starkest example of the constraints that the LCBO’s labour costs impose
on the organization relates to staffing on Sundays. While full-time staff are paid an
hourly rate of $26, these employees earn one-and-a-half times their regular rate of pay
on Sundays. When benefits are included, this results in a fully-loaded cost per
employee of about four times the wage rates of our private sector peer group. This
makes the cost of having stores open on Sunday prohibitive and out of step with other
competing channels.
The existing collective agreement provides LCBO management with some measure of
flexibility to manage its operations, assign and re-assign workers and determine the
complement of the workforce. The LCBO has increasingly relied more heavily on the
use of casual staff as a tool to manage scheduling and costs more efficiently. However,
other provisions exist that inhibit management’s ability to reorganize and restructure
the workplace to improve operational effectiveness.
The current labour agreements have evolved over time as part of the give and take of
the bargaining process. We believe that this is how they should be changed in the
future. It is in the interest of all stakeholders that the LCBO be able to evolve as a
customer-focused organization. If it cannot adapt, pressures will grow to increase
competition even further than what we have proposed. We would therefore recommend
that the primary focus be on addressing things that make it more difficult for the LCBO
to operate as a customer-focused retailer and to implement our recommendations. In
addition, we believe that it is important that any future wage increases remain
consistent with the government's labour strategy for the broader public sector.
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2.3
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The Beer Store (TBS)
Background
The Beer Store was originally established as a brewers’ co-operative in 1927. Today,
it is owned by three brewers — Labatt (owned by Anheuser-Busch InBev), Molson
Coors and Sleeman (owned by Sapporo):
TBS Ownership & Operating Structure
Labatt
(AB InBev)
Molson Coors
Sleeman
(Sapporo)
The Beer Store
(“Brewers Retail Inc.”)
447 Retail
Outlets
Agency
Stores
Licensees
Total beer sales to consumers and businesses in Ontario are about $3 billion annually,
almost 80% of which is accounted for by TBS. The Beer Store has an open-listing
policy; any brewer can list products in TBS stores, provided it pays certain one-time
and ongoing fees. In addition, TBS operates the Ontario Deposit Return Program
(ODRP) on behalf of the government, providing a network of locations where
consumers can drop off empty containers and redeem their deposits.
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TBS employs about 7,000 people in Ontario. The three owners also operate breweries
in the province with an estimated 1,300-1,600 manufacturing jobs. The craft brewers
employ more than 1,000 people in Ontario.
The retail price of beer in Ontario contains a complex mix of taxes or mark-ups, levies
and charges, depending on where the product is sold.
•
Like all other beverage alcohol products, beer prices are set by the supplier and are
subject to minimum and uniform pricing rules.
•
The LCBO mark-up, which applies to imported beer and domestic beer sold in the
LCBO, is set equal to the Beer Tax, which is applied to domestic beer, to ensure
compliance with trade obligations. This value is a fixed dollar amount per litre.
•
To cover expenses associated with selling beer through their networks, the Beer
Store and LCBO charge brewers Cost of Service fees, which vary between the
two channels.
•
Several federal taxes and the Harmonized Sales Tax also apply to beer sales.
Our Approach
We approached our review of the Beer Store as an adjunct to our work on the LCBO.
Our principal focus was to assess whether the Beer Framework Agreement confers a
material financial benefit on the owner brewers. Our analysis used publicly available
information as well as information from the LCBO on its own beer retailing operations.
Our Observations
TBS operates an efficient and relatively low-cost retail system. We developed an
indicative assessment of costs per litre of beer between LCBO and TBS. Based on our
consultant’s analysis, we estimate that TBS’s costs are significantly lower than those of
the LCBO.
A major contributing factor to this discrepancy is the cost of labour. As previously
indicated, TBS wage rates for both permanent and casual employees appear to be
meaningfully lower than those at the LCBO. Further, the LCBO has a very different
business model than the Beer Store, one that is more consumer-friendly and requires
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more staff in each store. There is also a significant difference in non-store selling,
general and administrative (SG&A) expenses between the Beer Store and the LCBO,
largely as a result of their structure and organization.
The LCBO’s Cost of Service charges for beer are too low. The LCBO’s in-store
Cost of Service charge has not been updated since 1989. Since that time, consumer
prices have increased by 64%. As a result, the LCBO’s Cost of Service charges may
not be high enough to cover the business’s fully-allocated costs.
TBS and LCBO networks overlap closely. Not only are 86% of people in Ontario
within a five-minute drive from a retail beer outlet, but almost 90% of TBS locations are
within two kilometres of an LCBO and just over 60% are within one kilometre.
The current system could work better for consumers. Only the Beer Store is
allowed to sell beer in cases of 12 or 24. This limits accessibility for consumers, many
of whom prefer the LCBO’s retailing experience, while preventing them from benefitting
from the price breaks associated with larger pack sizes.
Canada is a very profitable market for brewers. Examination of publicly-available
information for the owner brewers indicates that operating margins in Canada are
materially higher than in other markets. This results from the operating environment in
Canada which features:
•
minimum price floors, and
•
efficient distribution networks; and in certain markets
•
control over distribution, and
•
the ability to set the retail price for beer.
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The TBS structure has the potential to generate material advantages for the three
owners. Although the Beer Store operates on a break-even basis, we believe that TBS
owners benefit from their ownership of the network. We believe there are a number of
ways in which this may occur:
•
Service charges. Non-owner brewers pay fixed service fees to sell their products
in TBS. TBS owners pay an amount that varies from year-to-year, depending on
actual TBS costs. As a result, any incremental service charges paid by non-owners
directly benefit the three owners. This creates a risk that the costs of the system
are not borne equitably by producers.
•
Incremental owner market share. It is in the three owner brewers’ interest to
create programs and structures to increase their own market share through the
Beer Store. TBS owner brands account for roughly 74% of sales in the LCBO, while
we estimate that their share of beer sales in the Beer Store is over 80%.
The Ontario system benefits both owner and non-owner brewers. Although owner
brewers benefit disproportionately from their ownership of the Beer Store, significant
elements of the province’s beer market benefit all brewers. These include:
•
Packaging. Under the Beer Framework Agreement, the Beer Store has the
exclusive right to sell 12- and 24-pack formats of beer in Ontario in communities
with a TBS location. This drives sales to TBS stores, further improving the
network efficiency.
•
Integrated distribution system. Canada is a highly profitable market for brewers.
This is particularly true in Ontario. Rather than having to compensate the high
number of distinct retailers and wholesalers, as in Quebec, brewers in Ontario use
a fully-integrated and highly efficient system with significantly fewer points of
access, reducing costs of reaching the end consumer.
•
Licensees. Brewers may charge different prices to licensees than to retail
consumers. As a result, many brewers charge materially higher prices to licensees
than to retail customers.
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•
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The Beer Store network. Small brewers benefit from the structure and set-up of
the distribution network, given TBS’s open-listing policy. Moreover, the cost-ofservice fee at the Beer Store is lower than at the LCBO, improving margins for
small and large brewers alike.
We believe that the relationship between the provincial government and the Beer Store
should be revised to ensure that Ontario taxpayers receive their fair share of the profits
from the Beer Store. Consumers should not see an increase in prices as a result of this
change. The Beer Store should be required to provide greater transparency, to ensure
that costs are allocated equitably among suppliers, and to treat both owners and nonowners fairly, including with respect to display of their products. The LCBO should be
enabled to sell 12-packs and should increase its Cost of Service charge on beer.
The Council would like to explore with craft brewers the possibility of opening a limited
number of stores featuring craft beer from around the world.
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2.4
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Winery Retail Stores (WRS)
Background
Total wine sales in Ontario amount to about $2 billion, approximately $700 million of
which represents Ontario wine. Wine produced in Ontario comprises two categories
of products:
•
Ontario Vintners Quality Alliance (VQA), a designation which signifies that they
are made from 100% Ontario-grown grapes; and
•
International Canadian Blends (ICB), a blend of Ontario and imported wine that
must have a minimum of 25% Ontario wine in each bottle.
ICB wines accounted for 75% of total Ontario wine sales by volume and 60% of total
Ontario wine sales by value in 2014.
Wine is sold through two primary channels — the LCBO and a network of Winery
Retail Stores (WRS) located both on-site at many wineries and, in the case of a few
wineries, off-site as well. The WRS network also includes sales through farmers’
markets, the internet, and wine clubs, and accounted for just over $250 million of the
Ontario wine sold in the province in 2013–14.
There are 491 stores in the WRS network — 199 on-site and 292 off-site. The number
of on-site stores is based on the number of wineries and can change over time, while
the number of off-site stores is fixed. Most off-site WRS are in a store-within-a-store
format in grocery stores with Loblaws having the greatest number — 120 WRS stores.
The following chart depicts the ownership of Ontario WRS.
Ontario WRS
491 stores total
On-site WRS
199 stores
Constellation
164 stores
Andrew Peller
Limited
104 stores
Colio Wines of
Canada Ltd.
13 stores
Off-site WRS
292 stores
Magnotta
Winery Corp.
8 stores
Chateau des
Charmes
2 stores
Diamond
Estates
1 store
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The capped network of 292 off-site WRS was allowed to continue operating under
grandfather clauses in international trade agreements. These stores are only allowed
to sell wine that is produced by the owner, and no new off-site winery retail stores can
be added. There is no public disclosure provided for activity in these channels.
Over time, the vast majority of the WRS network has been consolidated under two
large, publicly-traded entities — Constellation Brands Inc. and Andrew Peller Ltd.
•
Constellation, based in the US, is the leading producer of premium wine in the
world with almost $5 billion in annual revenue. In Canada, Constellation sells wines
across all categories and price points.
•
Andrew Peller Ltd., based in Niagara, is the second largest producer and
marketer of wine in Canada with wineries in Ontario, British Columbia and Nova
Scotia. It has annual revenues of just under $300 million.
Together, Constellation and Peller own 92% of the off-site WRS stores in the province.
The other owners are smaller wineries, but certainly dependent on their store network:
•
Magnotta, based in Vaughan, is the third-largest Ontario winery, producing and
selling over 180 ICB and VQA wines.
•
Colio, based in Lake Erie North Shore, sells approximately 30 VQA and ICB wines
in Ontario as well as over 20 global destinations.
•
Chateau des Charmes, based in Niagara-on-the-Lake, sells approximately
30 wines through the LCBO, WRS, and online sales channels.
•
Diamond Estates owns and operates two wineries in the Niagara region and
acts as an agent for 29 international fine wines and several imported cider and
spirits brands.
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Our Observations
Industry Support. We believe that the domestic wine industry should continue to be
supported, just as jurisdictions across the world support their own wine industries.
Benefits from off-site WRS accrue to select few owners. The concentration of
ownership of off-site WRS leaves most Ontario wineries at a significant sales,
marketing and retail distribution disadvantage. The cap on the number of off-site WRS
imposed under trade agreements increased the intrinsic value of each licence. These
licences are also transferable, implying that this value has accrued entirely to their
private owners.
Winery Retail Stores enjoy significant tax advantages. Both ICB and VQA wines
are subject to much lower tax rates, 16.1% and 6.1% respectively, on sales through the
Winery Retail Store network than those through the LCBO, which incur a mark-up of
65.5% in addition to certain fixed levies. As a result, owners of off-site winery retail
stores enjoy a material tax advantage on sales through their channel that is unavailable
for wineries without an off-site licence.
However, it is important to recognize that the economics of a store that offers only
wine, indeed only the wines of a single producer, work differently than the LCBO with
its wide range of products. As a result, we understand that these stores may not be
able to carry the same tax/mark-up regime. We also acknowledge the important role
that ICB wines play in creating demand for Ontario grapes.
We propose to engage the participants in a constructive dialogue to develop change
that would reflect a fair tax system and continue to see strong demand for Ontariogrown grapes. The Council would like to explore with the wine industry the possibility of
opening new private stores offering both Canadian and international wines.
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3. THE ELECTRICITY SECTOR
3.1
Overview
Ontario’s electricity sector comprises generation, transmission and distribution of
electrical power as well as several oversight, regulatory and integrating agencies.
The Ontario government sets the Province’s energy policy and priorities. The
Ministry of Energy is responsible for the development of the government’s Long-Term
Energy Plan (LTEP). The LTEP outlines the government’s vision for the energy sector,
including supply mix, cost, reliability, conservation, and community engagement.
The latest version of this plan was released in December 2013.
The Ontario Energy Board (OEB) is a quasi-judicial administrative tribunal that
ensures that consumers and industry pay fair and reasonable rates for the electricity
and natural gas they use.
The OEB licences all generators in the province that produce electricity for sale
through the markets administered by the Independent Electricity System Operator or
through bilateral contracts. This includes all but very small generators that own or
operate facilities with a capacity of less than 500 kilowatts. In addition, the OEB sets
payment amounts (commonly known as rates) for Ontario Power Generation’s
hydroelectric and nuclear facilities, which represent about half of all generation
in Ontario.
For the province’s high voltage transmission system, the OEB grants operating
licenses, approves new developments, and establishes rates. Ninety seven per cent of
the transmission system is owned and operated by the Province, through Hydro One;
the remainder is privately owned and operated, and also subject to OEB regulation.
The OEB also sets licence conditions for local electricity distribution companies in
Ontario and establishes rates for nearly all of these entities, regardless of their
ownership. Hydro One services only approximately 25% of the electricity customers in
the Province.
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The Independent Electricity System Operator (IESO) manages Ontario’s electricity
market and links generation, transmitters, distributors, and the consumers. This
involves a number of tasks: the IESO manages the flow of electricity from Ontario’s
neighbouring jurisdictions; it establishes hourly market prices that inform generation,
transmission, and distribution activity; its day-to-day operations continuously match the
Province’s electricity demand with the supply offered by generators; it also carries out
short- and medium-term planning and produces an 18-month outlook of whether
expected electricity supply will be able to meet forecast demand.
The Ontario Power Authority (OPA) manages long-term electricity supply planning,
coordinates province-wide conservation programs, and contracts with suppliers for
clean energy savers. As of January 1, 2015, the IESO and the OPA will be merged into
a single new entity that will be known as the IESO.
Ontario Power Generation (OPG) produces about half of the electricity generated in
Ontario, mainly from its nuclear generating stations and hydro plants. The remainder of
Ontario’s electricity needs are provided by renewable generation (hydroelectric, wind,
solar and bioenergy), natural gas fired plants owned by private sector companies, and
by privately operated nuclear generation from the Bruce Nuclear Generating Station,
which is owned by OPG and leased to Bruce Power, as part of a long-term contract.
Hydro One is the largest electricity transmission and distribution company in the
Province, with two separate businesses contained within its largest business subsidiary
— Hydro One Networks Inc.
The first major business in Hydro One Networks is transmission (sometimes referred to
as ‘Tx’). Hydro One owns and operates about 97% of electricity transmission assets in
Ontario, delivering power across almost 30,000 km of high-voltage transmission lines
to local distribution companies including its own distribution business, industrial
customers, and other local distribution companies. The remaining transmission in the
province is privately held.
The second major business in Hydro One Networks is distribution (sometimes referred
to as ‘Dx’), which provides distribution services primarily to rural areas. The distribution
business within Hydro One Networks is the largest distribution business in the
Province, serving more than 1.4 million customers with over 123,000 km of wires.
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The Council’s review also covered the distribution business contained within Hydro
One called Hydro One Brampton Networks Inc., which serves urban customers in the
City of Brampton only. Hydro One Brampton is a subsidiary of Hydro One and is
managed separately from the larger distribution business contained in Hydro
One Networks.
Currently, about 70 local distribution companies (LDCs) in Ontario deliver electricity
to about five million customers. LDCs vary considerably in size. Hydro One Networks’
distribution arm is the largest, followed by Toronto Hydro and PowerStream with about
735,000 and 347,000 customers respectively. In contrast, the smallest LDCs in the
province have fewer than 2,000 customers. About a third of the LDCs in Ontario can be
considered as small, and they combine to serve less than 4% of the province’s
customers.
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3.2
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Hydro One
Overview
The Minister of Energy represents the interests of Ontario as shareholder of Hydro
One. From a fiscal perspective, the Province currently accounts for its ownership of
Hydro One as a Government Business Enterprise (GBE) and consolidates its financial
results in the Province’s Public Accounts on a modified equity basis, which means that
the company’s net income (i.e., the difference between its revenues and costs), in
addition to payments in lieu of taxes, counts as revenue to the Province.
Before 1999, generation, transmission, and mostly rural distribution, were integrated
within Ontario Hydro. In 1999, Ontario Hydro was restructured; its generation assets
were acquired by Ontario Power Generation and its transmission and distribution
assets were acquired by Hydro One. Both OPG and Hydro One were commercialized
under the Electricity Act, 1998 and incorporated under the Ontario Business
Corporations Act.
Hydro One has total assets of around $21 billion and around $9.7 billion in long-term
debt. Hydro One issues its own debt in the public capital markets. This debt is not
consolidated on the Province’s financial statements.
In 2013, Hydro One had revenue of $6 billion and net income of about $800 million
($521 million for the transmission business, $258 million for the distribution business
in Hydro One Networks, and $16 million for Hydro One Brampton). In addition to the
net income of the company, additional revenue to government comes from payments in
lieu of taxes, which amounted to about $110 million in 2013.
Taken together, the distribution and transmission businesses account for almost all of
Hydro One’s revenue.
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Business Segment
11. C.12 - CW INFO
Subsidiary
Distribution
• 41% of Hydro One’s Assets
•
•
•
Hydro One Networks Inc.
Hydro One Brampton Networks Inc.,
Hydro One Remote Communities Inc.
Transmission
• 55% of Hydro One’s Assets
•
Hydro One Networks Inc.
Other
•
Hydro One Telecom
Hydro One Remote Communities Inc., a subsidiary of Hydro One, both generates and
distributes electricity to remote communities in mostly the northern part of Ontario,
primarily using diesel fuel generation and a small amount of hydroelectric generation.
The Council did not review its operations but does recognize its importance to northern
and rural communities and does not propose any changes.
The Other segment in Hydro One is primarily comprised of Hydro One Telecom,
an unregulated portion of Hydro One’s business that provides fibre-optic capacity to
telecommunications carriers and commercial customers as well as Hydro One
Networks. The Council did not review the telecom business because of its small size
and inter-connectedness with the transmission business in Hydro One Networks.
Hydro One uses a centralized shared services model for other corporate functions to
deliver common services across its multiple subsidiaries. Hydro One also manages
group liquidity through the issuance of debt at the parent company level.
Hydro One has about 5,800 full-time employees, about 90% of whom are unionized
and mostly represented by either the Power Workers’ Union (PWU) or the Society of
Energy Professionals (SEP) under various Collective Bargaining Agreements (CBA).
Employees at Hydro One Brampton, as a separate subsidiary of Hydro One, are
represented by the International Brotherhood of Electrical Workers and Unifor. They
are part of the Ontario Municipal Employees' Retirement System (OMERS) Pension
Plan, rather than the Hydro One Pension Plan.
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Our Approach
We pursued two general lines of enquiry in our review of Hydro One. First, we
conducted a focused operational review designed to identity opportunities for
performance improvement and cost savings.
Second, we analyzed the company’s transmission and distribution businesses to
assess whether they offer opportunities to unlock greater value, either financially or in
support of improving performance of Ontario’s electricity sector, through various forms
of restructuring or divestiture.
Our Observations
Productivity improvement and cost savings. We focused our attention on the
operations of the transmission and distribution businesses as well as the Hydro One
corporate parent. Our view was that, regardless of any restructuring or divestiture of
assets, the company should pursue operational improvement opportunities in both its
operating and capital expenditure portfolios. Any savings realized would accumulate
over time, and the benefits would ultimately flow to electricity ratepayers.
A review of Hydro One Networks’ 2013 cost base indicated that it spent a total of
$2.4 billion on capital and operating expenses, made up of $1.3 billion in capital
expenditure and $1.1 billion on operating, maintenance and administration (OM&A).
Of the $2.4 billion total, just over $1.3 billion relates to labour costs, which is the largest
overall cost category. This reflects the nature of the business; while transmission and
distribution wires are large physical assets, they are primarily maintained and
serviced manually.
The Council, through its review of productivity improvements and potential cost
savings, determined that there are opportunities in addition to the company’s current
business plan. All operational improvement opportunities, both those in the company’s
business plan and those identified in our review, can reduce capital and operating
expenses. Over time, this can help reduce upward pressure on electricity rates.
Accordingly, all improvement opportunities should be pursued. Some of these,
although more limited in size, are within the company’s control. Hydro One
management is aware of our findings and is committed to exploring these savings.
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Others, however, including labour practices and costs, are more transformational and
will require that management and labour unions work together.
Asset Optimization. The second element of our review focused on the potential for
restructuring Hydro One to improve the province’s electricity distribution system and
realize value from non-core assets.
Transmission. Our review indicated that the transmission business is generally well run
and performs well as an income-earning business. The transmission business in Hydro
One has exceeded the return on equity level set by the OEB in each of the last four
years and has maintained a lower-than-authorized debt leverage, which has reduced
Hydro One’s interest expense and improved the financial position of the company.
The Council’s terms of reference asked us to consider possible asset mergers,
acquisitions and divestments if there was a strong business case. Research on the
global investment market and recent transactions involving government assets
indicated that there is a strong appetite among institutional investors for stable, efficient
businesses such as electricity transmission assets. While selling all or part of the
transmission business would be attractive to the capital market, we believe this is an
asset that, retained in public ownership, can play a positive policy role in such matters
as ongoing energy-sharing discussions with Quebec. Accordingly, we believe Hydro
One transmission should remain in public ownership as a core asset at this time.
Distribution. We view the distribution business differently. There are huge challenges in
Ontario’s local electricity distribution system. There are too many entities, some of
them inefficient, that lack the capability and capital to modernize and adapt to the
changing environment.
The distribution business of Hydro One Networks has experienced lower historical
economic performance when compared to the transmission business. The distribution
segment has performed below the deemed return on equity set by OEB in each of the
past four years. As noted earlier, it also has more opportunities for potential
improvement — a benefit that should ultimately flow to electricity ratepayers.
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Annual OM&A Cost per Residential Customer
$496
2013 analysis shows Hydro One Distribution costs were
about $496 per customer
$336
$239
$234
$221
$210
$163
Hydro One
Toronto
Hydro Ottawa PowerStream
Veridian London Hydro Hydro One
Networks Inc. Hydro-Electric Limited
Inc.
Connections
Inc.
Brampton
System
Inc.
Networks Inc.
Limited
Hydro One distribution (excluding Brampton) costs were about $496 per customer in
2013 -- a higher cost than all major Ontario comparators including Brampton at $163.
•
Hydro One’s large geographic coverage and remote customer base is partly
responsible for its higher costs
•
Brampton, as an urban-based LDC, serves a more compact market, so lower costs
can be expected
Source: 2013 Yearbook of Electricity Distributors
We found that the OM&A cost for electricity distribution within Hydro One Networks on
a per customer basis was $496, which is significantly higher than several other larger
local distribution companies. Many, but importantly not all, of these costs can be
attributed to the different terrain, lower density, and extensive physical distances
associated with areas serviced by the distribution business of Hydro One Networks.
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For example, the distribution business in Hydro One Networks has three categories of
residential rates: low density, medium density, and high-density. There are also
seasonal rates for properties that are not occupied year round e.g., cottages.
These categories mean that not all of Hydro One’s residential customers pay the
same distribution rates. Because of its large service territory, the distribution arm of
Hydro One Networks also has larger areas with low density, which in turn means
higher costs.
Labour Costs. With respect to labour costs, there are significant differences between
the averages of distribution companies that provide similar services. We recognize that
these comparisons of costs cannot be made in isolation. However, we were interested
in the comparison between the distribution business of Hydro One Networks and Hydro
One Brampton. As an example, the average annual salary — including bonuses and
overtime — of employees in the distribution business of Hydro One was $101,000 in
2013, 35% more than the $75,000 earned by employees who perform similar work in
Hydro One Brampton. On a fully-burdened basis, the gap in employee costs between
the distribution business of Hydro One Networks and Hydro One Brampton is more
significant. Total employee costs of $136,000 at Hydro One Networks are 45% higher
than employee costs of $94,000 at Hydro One Brampton.
We acknowledge that overtime costs can also be significantly different in the two
operating areas: an average of $16,000 in overtime costs per employee for the Hydro
One Networks distribution business versus $5,000 at Hydro One Brampton. Travel time
accounts for part of this; in less densely-populated areas of Ontario, travelling to any
location can take a significant amount of time. However, it is worth noting that the
average salaries in Hydro One Brampton, which perform similar work, are $67,000
versus $83,000 in the distribution business of Hydro One Networks.
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Average Fully-burdened Compensation Costs per Employee in 2013
$160,000
Allowances and Other
Government Obligations
Health Benefits and OPEB
Pension
Bonus
Overtime
Salary
$140,000
$120,000
$100,000
$80,000
$60,000
$40,000
$20,000
$-
Hydro One Dx
Hydro One Brampton
The Council’s review of employee costs in the distribution business in Hydro One
Networks is not intended as a criticism of the collective bargaining process, nor does it
suggest an intention to side-step the bargaining table. We simply want to underscore
the implication of what has developed over time. The distribution business in Hydro
One Networks has a labour cost structure that is well above other publicly-owned
utilities in the province. Because these costs are passed on to ratepayers, the rates
paid by those customers served by Hydro One are higher than rates charged by other
utilities that are also publicly-owned but not by the Province of Ontario. This means that
other utilities are reluctant to merge with Hydro One even if it were to make sense from
a business point of view because their customers' rates would go up.
The Council understands the need to achieve maximum efficiency in the deployment of
expensive skilled labour. The Council favours both fair compensation for workers and a
safe and reliable electricity system. However, left in place, the result of comparatively
higher labour costs and underperforming business operations may be detrimental to
future growth and performance.
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Bringing in Private Capital. In comparing the transmission assets and distribution
assets side-by-side, although transmission is probably more attractive to the public
market, there remains solid appetite for distribution assets in the investment sector.
We researched and reviewed significant activity in the global electricity transmission
and distribution markets, where transactions have occurred recently in North America,
Europe and Australasia. There has been an increasing focus globally on the
vertical unbundling of assets to ensure that wholesale (i.e., transmission) and retail
(i.e., distribution) businesses are separated from their parent companies before
any transaction.
Most important for Ontario electricity ratepayers, our analysis of a number of recent
transactions in the sector suggests that these transactions have not led to higher
electricity prices because the regulated jurisdictions have maintained a significant
influence over allowed returns through their respective regulators. Indeed, more
efficient operations and economies of scale in partnering with other local distribution
companies could reduce the total distribution system costs and pressure on rates over
the medium- and long-term.
The OEB monitors the performance of all regulated electricity and gas utilities, both
public and private, through transparent reporting requirements. The OEB also directly
enforces service quality standards and approves rates. Gas service is provided by
private utilities in Ontario today, and there is no evidence that they underserve the
public. Whether public or private, electricity utilities have an obligation to serve and to
offer connection to all parts of their service areas. The OEB-regulated rate of return on
assets is the same for urban and rural areas. This won’t change.
A core principle to the Council is that no transaction should proceed if it would lead to
rate increases. The government has also indicated that one of its overriding principles
is that no re-alignment will take place in the electricity sector if it puts upward pressure
on electricity distribution costs.
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We believe that the government should use its ownership of these two businesses —
the distribution business in Hydro One Networks and Hydro One Brampton — to break
the current deadlock in the LDC landscape. Facilitating such consolidation is good
energy policy and will also lead to a more efficient, adaptive, and lower-cost system in
the future. The Council would make this recommendation whether or not the Province
needed money to fund new infrastructure. It is simply good energy policy.
Hydro One’s distribution business and Hydro One Brampton should be used not to
force but to catalyze consolidation in the distribution sector in the province.
Consolidation will facilitate efficiencies, reducing costs that in turn will reduce the rate
of growth of electricity rates. It will also improve adaptability of the system and create
companies that can innovate, grow and create jobs.
In the Council’s view, there is far less reason to regard distribution as a core strategic
asset than transmission. About 75% of electricity customers in the province are served
by distributors other than Hydro One.
In addition, we agree with the core conclusions of the 2012 Ontario Distribution Sector
Review Panel. Indeed, we believe that the conclusions are generally supported by
virtually everyone in the industry, although not everyone agrees on how best to
implement them.
Ontario needs a more consolidated and efficient electrical distribution system, but LDC
consolidation is just a means to that end. The system needs more capital, and it needs
companies capable of innovating and adjusting to a very different future energy world.
Studies worldwide have envisaged dramatic changes in the sector, with leading-edge
distributors moving beyond distribution to include limited production and storage of
energy. Should this innovation not occur in Ontario, consumers will ultimately
be underserved.
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We are open to looking at different ideas as to how to facilitate consolidation. One way
would be to use Hydro One Brampton as a catalyst by merging it with one or more
GTA-area distribution companies and then diluting the government’s interest to allow
private capital to bring in the financial capacity to undertake even further consolidation.
Ontario could also divest itself of its interest in the new company in a secondary
offering along with the other existing owners, if they choose, to allow taxpayers to
realize the value of its asset.
The Council is recommending the separation of the transmission and distribution
businesses currently within Hydro One Networks into two entities. We also then
recommend that the Province dilute its interest in that resulting distribution business.
The Province would retain a minority share. This new company would then have the
capacity to undertake further consolidations. These moves would create two
champions of consolidation that would provide an entrepreneurial base for growth.
We would expect other municipalities to respond either by joining these entities or seek
their own new partners — public or private. We would encourage both such moves.
Our preference would be to keep Hydro One’s distribution business, excluding Hydro
One Brampton, essentially whole — not break it up. We recognize that there may be
some limited circumstances where merging parts of the distribution business with
specific municipal electrical utilities would foster further consolidation, and we will
examine such proposals carefully. But the Council would resist “cherry picking”
proposals, as that would compromise the best outcome for taxpayers. The Council
would also want to ensure that, if any part were to be sold, such sales would not
reduce the value of the distribution business as a whole, and more importantly, not
raise costs for electricity ratepayers from what they would have been.
We are very sensitive to the labour issues that such a change of ownership raises.
There are a number of rights that must be respected and a number of concerns that
will arise. We believe we understand these concerns but we also believe that it is very
important to have the right process, to talk through and understand possible solutions.
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We also recommend that the government insist on certain provisions to protect against
certain undesirable changes in ownership in the future. This will ensure that the
Province can safeguard against unintended consequences from diluting its ownership.
The Council intends, as part of Phase II, to review current barriers and incentives, such
as taxes, that impede consolidation.
Taken together, we believe these combined actions could facilitate embedded LDC
consolidation and encourage additional mergers while also leaving the ultimate
decisions to individual shareholders who own these utilities rather than forcing
consolidation through legislation. Using legislation to force the companies together in
the absence of any strategy or willingness on the parts of the partners would be a
heavy-handed approach that the Council does not support.
Diluting the Province’s ownership in the distribution business of Hydro One Networks
would enable efficiency savings for electricity ratepayers, introduce additional privatesector capital into the distribution system and generate productivity improvements.
Over time, it would release capital that the government can use to build much-needed
transportation infrastructure in the province. Our evaluations and market analysis
indicate that the gains to the provincial government shareholder could be substantial.
And while this would reduce income to the government by selling a net income-earning
asset, it would allow the Province to re-invest this unlocked capital in other priorities
such as transit and transportation infrastructure.
Whatever the ultimate course of action, we recognize that the government would have
to work through a number of important issues. Negotiating the details necessary to
reach an agreement in diluting the Province’s ownership of electricity distribution
businesses within Hydro One is complex. However, the Council is confident that these
details can be overcome — such agreements are frequently negotiated in the
private sector.
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Ontario Power Generation
Overview
Ontario Power Generation (OPG) generates about half of the Province’s electricity
through three main business lines:
•
nuclear (2 generating stations, Pickering and Darlington);
•
hydro (65 large and small hydroelectric dams); and
•
thermal generation (3 operating generating stations).
OPG also co-owns the Brighton Beach thermal station in Windsor and the Portlands
Energy Centre in Toronto. Most of OPG’s hydro assets are rate-regulated by the OEB,
but OPG also has hydro assets under Hydroelectric Energy Supply Agreements with
the Ontario Power Authority. Ontario’s electricity needs are also served by non-OPG
renewable generation contracts (hydro, wind, solar and bioenergy), natural gas-fired
plants owned by private sector companies, and by Bruce Power, a private sector
nuclear operator that leases the Bruce Power Nuclear Generating Stations from OPG.
A legacy of the former Ontario Hydro, the company is wholly-owned by the Province.
The Minister of Energy represents the interests of Ontario as shareholder of OPG.
Unlike the distribution business in Hydro One, Ontario Power Generation has no direct
interactions with individual power consumers. Essentially it has only one major
“customer” for its power: the Independent Electricity System Operator (IESO).
OPG is consolidated into the Province’s financial statements on a modified equity basis
similar to Hydro One, meaning the company’s net income counts as revenue to the
Province. However, unlike Hydro One, OPG does most of its borrowing from the
Ontario Electricity Financial Corporation (OEFC).
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The company currently has about $4 billion in debt owing to the OEFC, and total
long-term debt as at March 31, 2014 was about $5.6 billion. OPG has total assets of
about $25 billion, excluding funds it has set aside for nuclear fixed asset removal and
nuclear waste management. It produces about $5 billion in total revenue annually of
which about 60% comes from nuclear, 27% from hydroelectric power, and 13% from
thermal and other revenue sources.
OPG currently employs around 9,700 full time staff plus about 800 seasonal workers.
About 90% of the workers are members of the Power Workers’ Union or the Society of
Energy Professionals.
The generation company has endured considerable turmoil since its inception. Political
intervention and uncertainty as well as operational challenges have put the company
under continuing scrutiny. There have been challenges with previous nuclear
refurbishment projects and debate about the terms of the Bruce Power contract.
In that same period, OPG has become a company in transition as it has ceased
coal-powered generation, and substantially downsized its workforce. It now faces a
major challenge with the planned Darlington Nuclear Generating Station refurbishment
and planned shutdown of the Pickering Nuclear Generating Station.
Nuclear Generation. Nuclear generation assets owned by Ontario Power Generation
include all of the nuclear generation plants in Ontario at Bruce, Pickering, and
Darlington. However, OPG only operates the stations at Pickering and Darlington.
The Bruce Nuclear Generating Station is leased and operated by the Bruce Power
Limited Partnership, a partnership involving TransCanada, Borealis Infrastructure (a
trust established by the Ontario Municipal Employees Retirement System), the Power
Workers’ Union, and the Society of Energy Professionals under contract with the
Ontario Power Authority.
More than half of the nuclear power produced in the province comes from OPG’s
facilities at Darlington and Pickering. However, this dynamic will change with the
planned shutdown of the Pickering Generating Station in 2020. Taken together, nuclear
generation comprises about half of the base load electricity supplied to the province.
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OPG’s nuclear business is heavily cost-intensive, primarily due to the cost of
engineering and safety for Ontario’s large reactors. In 2013, OPG’s nuclear operations
suffered a net loss of about $140 million. Because Ontario Power Generation
generated a total net profit in 2013 of $135 million, this means that all of the profit
generated within the company was derived primarily from the hydroelectric dams.
The Council also observed that the company’s overall business performance is directly
affected by the low price of power it receives from Ontario electricity ratepayers. OPG
receives prices below what is paid to other generators in Ontario, specifically, an
average of $57 per MWh vs. $99 per MWh.
The largest looming issue in OPG is planning for the refurbishment of the Darlington
Nuclear Generating Station, which is projected to cost $10 billion in 2013 dollars,
excluding interest and inflation. The project is scheduled to begin in full in October
2016 and be completed by 2025. The cost of this project will make it one of the largest
capital project undertakings in Ontario’s recent history.
Hydroelectric Generation. Hydroelectric generation assets within OPG include large
hydroelectric dams on the Niagara River (Sir Adam Beck Hydroelectric Generating
Stations), in St. Catharines at DeCew Falls (DeCew Generating Stations), and on the
St. Lawrence River (RH Saunders Generating Station).
Several other small and medium-sized hydroelectric generation facilities are located on
other river systems around the province; these facilities produce power both cheaply
and efficiently for the province’s base load with some peaking capacity.
The small and medium-sized hydro-electric assets within OPG are primarily “run of
river” operations, generating power based on when and how much water flows — they
have very little long-term storage capacity. This is different from the topography and
hydroelectric generation supply in Quebec, which has large reservoirs of water that can
be held behind dams during periods of low demand and drawn upon when needed.
Exceptions to this storage variable for OPG include the Sir Adam Beck Pump
Generating Station and its 300-hectare reservoir, and recent investments on the Lower
Mattagami, though still on a much smaller scale than Quebec.
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Thermal Generation. OPG’s thermal business segment includes both natural gas
and oil fuelled facilities. OPG’s Lennox Generating Station, located in Napanee, is
fuelled by both oil and natural gas. In contrast, OPG’s partnerships at the Portlands
Energy Centre and Brighton Beach are both natural gas-fired combined cycle
generating stations.
OPG also owns four former coal-fired facilities. The conversion of the Atikokan
Generating Station from coal to use biomass was completed in 2014. Thunder Bay
Generating Station is also being converted from coal to use advanced biomass as fuel.
The Lambton Generating Station and Nanticoke Generating Station ceased generating
electricity in September 2013 and December 31, 2013, respectively.
OPG’s thermal stations operate as peaking facilities, depending on electricity demand
over the course of a day. This peaking ability provides Ontario’s electricity system with
the flexibility to meet changing daily system demand and capacity requirements.
Our Approach
We approached our review of OPG in a similar way to Hydro One, but restricted our
work to the non-nuclear operations of OPG. Our decision was based on feasibility
(it would be impossible to study the complexities of the nuclear generation sector in
only a few months) and practicality (acknowledging the scope already before the
Council in considering the LCBO and Hydro One).
We pursued two main lines of enquiry for the OPG’s non-nuclear segment. First, our
consulting teams conducted a focused operational review of the company, which was
designed to identify opportunities for performance improvement and cost savings.
Second, we analyzed the company’s non-nuclear generation assets to assess whether
restructuring or divestiture could offer opportunities to unlock greater value.
Our Observations
Operational excellence. Our consulting team worked with OPG management to
identify improvement opportunities within the $1.4 billion of annual spending that
supports the company’s hydro and thermal operations. When we excluded one-time
capital projects such as the Lower Mattagami and the Niagara Tunnel, this left about
$550 million for analysis.
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In 2013, OPG spent about $171 million on maintaining its hydro/thermal facilities.
How these facilities are maintained, managed, and serviced could present
savings opportunities in areas such as terms of labour costs, operating practices,
and maintenance.
Similarly, spending on materials and services is also a significant cost driver within the
company. Total 2013 non-nuclear spending on third parties was $465 million for the
hydro, thermal and corporate operations. Examples of savings opportunities in these
areas could include better contract management, early payment discounts, and
vendor consolidation.
While the Council did not review OPG’s nuclear operations, the sheer size of the
expense associated with the sector suggests that additional opportunities may be
available. Based on OPG’s 2014 business plan, OM&A expenses for nuclear
operations are expected to be $2.4 billion compared to $0.6 billion for
hydro/thermal operations.
Our review of non-nuclear operations identified a number of opportunities for
improvement and cost savings. However, these were relatively immaterial in the
context of an organization with $25 billion in assets. In part, this was because we did
not examine nuclear operations. Discussions with management suggest that there may
be material savings to be had in streamlining some areas within nuclear. Only some of
these savings are within the direct control of OPG or the Province. Management is
aware of the potential opportunities and committed to exploring them further. Any
savings yielded by these actions will flow to taxpayers and electricity ratepayers
over time.
Labour costs. Labour costs are a material component of the company’s overall
spending, but OPG has significantly reduced its employment footprint in recent years,
shrinking by approximately 2,100 employees over the period from January 2011 to
September 2014. The company’s now employs about 9,700 people. In addition, the
footprint of the company is expected to contract further over the medium-term, as there
are roughly 4,000 employees associated with the Pickering Nuclear Generating
Station, which is scheduled to shutdown in 2020.
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Analysis indicates that wage rates for OPG’s employees in general industry support
roles are significantly higher than in the Ontario Public Service and their peer
organizations in the US and Canada. OPG’s pension costs also significantly exceed
those of its public sector peers. For example, the education sector in Ontario funds
50% of pension costs whereas OPG funds 75% of contribution costs plus any plan
shortfalls. Management has begun to address these costs by instituting pension reform
for executives and management beginning in 2016, which also serves as a response to
recent commentary from the Office of the Auditor General of Ontario. Broadening this
reform to the full workforce would clearly increase the financial benefit substantially,
but would require negotiations with the company’s unions.
It is clear that average labour costs in some segments of OPG, at least in support
functions and in some roles within the hydro/thermal operations, are over market when
compared to other public and private sector organizations, particularly with respect to
pensions. Labour costs in nuclear and the majority of hydro/thermal roles, are either at
market or, in some cases, slightly below market levels. It is important to recognize that
not everyone can be painted with the same brush. Still, materially reducing costs in the
company will require addressing these issues in cooperation with the two main
bargaining units, the Power Workers’ Union and The Society of Energy Professionals.
Asset Optimization. As with Hydro One, we reviewed OPG’s assets (only the
hydroelectric and thermal businesses) to assess whether opportunities exist for the
Province to unlock value through divestiture or dilution of its interest. The principal
assets we examined were the “small” hydroelectric dams. Our evaluation indicated that
these assets represent a substantial value. External market review confirmed that there
is definite interest in such assets. However it also became clear that divestiture of
some or all of these assets would be a relatively complex exercise, requiring not only
commercial negotiations, but issues of water management and aboriginal land usage
rights. In addition, divesting some or all of these assets would deprive OPG of almost
all of its profits, leaving little to support the nuclear business.
Finally, we considered the near-term priorities of the company, primarily relating to the
Darlington refurbishment. Distracting management through a complex divestiture would
materially raise the overall risk profile of OPG.
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Accordingly, a transaction involving these assets should not be OPG’s first priority, as it
would involve a number of issues central to energy policy that would have to be
resolved before reaching a conclusion that such a sale would be in the public interest.
Darlington Refurbishment. This is the core issue for the company. The magnitude of
risk in this capital project dwarfs all other business issues at OPG — $10 billion in
2013 dollars, excluding interest and inflation. Cost overruns can dwarf any savings that
can be found elsewhere in the system.
We recommend a laser focus on making sure Darlington comes on line safely, on time
and on budget. We also suggest that the government consider strengthening project
management experience on OPG's board to help support the Darlington refurbishment.
We propose that OPG should consider creating an internal structure on a staged basis
— as if they were two separate entities focused on their very different businesses. This
could eventually lead to two separate organizations — a nuclear company with a Board
that has predominately large project management experience — and a non-nuclear
company. However, moving aggressively now would risk diverting management’s
attention from the core priority of the Darlington refurbishment and would also deprive
the nuclear business of the financial support provided by the non-nuclear operations.
Accordingly, any structural changes should be made over time.
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Labour and Pensions
As we have already noted in our observations on both Hydro One and OPG, various
labour agreements result in a very high burden of labour and pension costs. These are
generally higher than those for similar companies in heavy industry with field
operations as well as higher in some cases than in the public sector itself.
We believe that it is in the interests of both management and the unions to seek
negotiated solutions that will, over time, bring total compensation packages more
in-line with public sector standards. The current situation is not sustainable and
diminishes the opportunity for the companies to be able to grow as well as deliver
better returns to taxpayers and ratepayers.
As we noted earlier, the Report on the Sustainability of Electricity Sector Pension Plans
(the Leech Report) concluded that the pension plans in this sector in Ontario are
neither sustainable nor affordable. The report makes recommendations to the
government as a guide for developing a new pension policy framework for the
provincial electricity sector.
The Leech Report makes three main recommendations:
•
equal cost sharing for ongoing contributions, which would see the employee and
employer contributions migrate to a target of 50/50 over time;
•
establishment of a contribution ceiling in the range of 9 — 12%;
•
shared responsibility for the sustainability of pension plans among the parties.
The Council broadly supports the adoption of these recommendations. In addition,
there is clearly a need for the parties to discuss and bargain changes to benefit plans,
salary and wage rates and other forms of compensation such as premium payments.
As well, work practices including management flexibility in the areas of managing and
streamlining operations, redeployment, decontrol or change of employer and
contracting out are issues that should be addressed.
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The Council fully recognizes and is sensitive to the importance of agreements being reworked through a proper bargaining process. Clearly, the issues are challenging and
contentious. However, they are central to the long-term sustainability of both Hydro
One and OPG, and it is clearly in the best interests of all parties to reach a new
agreement that will provide a fair and sustainable framework.
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SUMMARY OF COUNCIL PROPOSALS
The following proposals, which have been developed based on our review and flow
from the observations outlined in this report, constitute an actionable framework
for change.
Beverage Alcohol
LCBO
Ownership
•
The Province should retain the LCBO.
•
The current beverage alcohol market structure should be retained but opened up to
greater competition.
Pricing & Mark-ups
•
The LCBO should move in a staged way to introduce a new pricing strategy,
enabling it to use its buying power to reduce costs based on objective criteria,
consistent with Canada’s international trade obligations.
•
Ontario beverage alcohol prices should be maintained below the Canadian
average.
•
The LCBO should continue to review minimum prices.
Retail Enhancement
•
The LCBO brand should take advantage of its brand by associating it with certain
products (“co-labelling”).
•
The LCBO store network should be expanded and differentiated by creating
warehouse (“Depot”) stores, converting some existing LCBOs to specialty shops
which emphasize craft beer or craft distillery products, and orienting the product
selection in certain stores to reflect their neighbourhood.
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•
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The LCBO should develop into a best-in-class online retailer, fully integrating its
website with its business to make a broader selection of products available to
consumers and to provide suppliers, including those that don't have access to
LCBO stores, access to the Ontario market. It should:

make products available for online order (“click & collect”);

connect shoppers to the LCBO’s warehouses; and

create an on-line marketplace to allow any supplier in the world to register
its products.
Labour
•
The bargaining process must be respected; any changes to current agreements
should be made at the bargaining table.
•
Labour practices should be updated to improve productivity and to implement our
recommendations.
Introducing Competition
•
Opportunities should be considered to introduce competition in a limited way, such
as exploring with:

craft brewers, the possibility of opening a limited number of stores featuring
craft beer from around the world;

the wine industry, the possibility of opening new private stores offering both
Canadian and international wines; and

distillers, the possibility of new sales channels.
Other Proposals
•
The LCBO should better differentiate its true profit from the mark-up it collects, as
well as separately report its various businesses.
•
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The LCBO should realize the operational savings identified.
APRIL 28, 2015
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The Beer Store
•
The LCBO’s Cost of Service charges on beer should be increased.
•
The LCBO should be enabled to sell 12-packs.
•
Ontario taxpayers deserve their fair share of the profits generated from the
Beer Store.
•
Consumers should not see higher prices as a result of this change.
•
The Beer Store should be required to:

provide greater transparency;

ensure that costs are allocated equitably between suppliers; and

treat both owners and non-owners fairly, including with respect to display of
their products.
•
The possibility of opening a limited number of stores featuring craft beer from
around the world should be explored with craft brewers.
Winery Retail Stores
•
The off-site WRS owners should be engaged in a constructive dialogue to achieve:

a taxation system that is fair; and

a set of changes that continue to see strong demand for Ontario-grown
grapes.
•
The possibility of opening new private stores offering both Canadian and
international wines should be explored with the wine industry.
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APRIL 28, 2015
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Electricity
Hydro One
General
•
The Province should retain the transmission business at this time given its current
policy role.
•
Hydro One should work to realize operational savings identified over time.
•
Hydro One should separate its distribution assets from the rest of its business.
•
The Hydro One distribution assets should be used as a catalyst to encourage much
needed consolidation and modernization of the electricity distribution system.
Distribution
•
Private sector capital, rather than public funds, should be used to support the
required consolidation of LDCs.

The Province should dilute its interest in Hydro One Brampton by merging
with some other LDCs, including possibly with other GTA entities, based
upon a pre-agreed business plan to bring in private capital to help grow and
modernize the electricity sector.

The transmission and distribution businesses of Hydro One Networks should
be separated into two entities; the Province should dilute its interest in the
resulting distribution company to a minority interest (40% to 45%) by bringing
in private capital.
o
The Council’s preference is to keep the distribution business whole to
ensure a better outcome for ratepayers and taxpayers.

Provisions should be used to protect against specific undesirable changes in
the future ownership of these businesses.

•
Any transaction should not create further upward pressure on rates.
The current barriers and incentives, such as taxes, which impede consolidation
should be reviewed during Phase II.
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APRIL 28, 2015
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Labour
•
The bargaining process must be respected; any changes to current agreements
should be made at the bargaining table.
•
Labour practices should be updated to improve productivity and to implement our
recommendations.
•
Rights must be respected and specific concerns should be addressed as a result of
changes in ownership.
•
A co-ordinated government response is required to achieve sustainable pension
plans within Hydro One and OPG.
Ontario Power Generation
General
•
A laser focus should be taken to ensure Darlington comes on line safely, on time
and on budget.

The government should consider adding more large project management
experience to the OPG Board to oversee the Darlington refurbishment.
•
OPG should work to realize operational savings identified over time.
•
OPG should consider creating an internal structure over time as if there were two
separate entities focused on their very different businesses: nuclear and nonnuclear generation.
Labour
•
The bargaining process must be respected; any changes to current agreements
should be made at the bargaining table.
•
Labour practices should be updated to improve productivity and to implement our
recommendations.
•
A co-ordinated government response is required to achieve sustainable pension
plans within Hydro One and OPG.
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