The Need for Fundamental Change in BC Hydro Planning and Rate Design

Since it was established in the early 1960’s to develop BC’s hydroelectric resources and to extend the provincial grid, BC Hydro has served its customers well.  The cost of electricity has been escalating in recent years; nevertheless, the rates British Columbia households and industry pay for largely emission-free, reliable electric service are among the lowest in North America. And those rates would be even lower if not for some very costly policies imposed by the provincial government, most notably the series of government directives that the Campbell government issued forcing BC Hydro to make investments that were not justified and to buy high cost, low value power it did not need.

A major factor underlying the success BC Hydro has had was the development of the generating stations and reservoirs on the Peace and Columbia river systems in the 60’s and 70’s. The willingness of the government to assume the risks those large investments entailed, and the access BC Hydro had to government-guaranteed financing left the utility with a large base of low-cost, high value supply. It is those ‘heritage’ assets that are responsible for the relatively low electricity rates British Columbians enjoy today.

Steps that BC Hydro has taken in recent years have squandered some of the cost advantage from the historic development of its large hydroelectric system.  It is not just the needless costs imposed by ill-considered government policies, though that clearly has been a major factor; it is the rigidities and inconsistencies inherent in the nature of BC Hydro itself.

The basic approach BC Hydro takes in the planning, development and operation of its power grid is to start with a forecast of future load growth in order to determine when and to what extent new resources will be needed to meet future requirements. Then, based on an analysis of the costs, expected performance and characteristics of alternative supply and demand-side resources, it develops a plan to invest or acquire new resources that, together with existing facilities and purchases, can reliably meet forecast loads at minimum present value cost.

The development plan and associated investments are subject to review and approval by the BC Utilities Commission (BCUC), as are BC Hydro’s annual costs of service and the level and structure of the rates BC Hydro can charge each class of customer to recover those costs. 

It is a ‘top down’, highly regulated approach. This may have served BC customers well in the past; however, there are a number of reasons why it is not well suited to respond quickly and efficiently to the changing market conditions and circumstances that are evident today.

Changing nature of supply

Historically, the main sources of electricity, large hydro and thermal power generating stations, offered high-valued supply. While they differed in their cost and operating characteristics, they provided reliable energy supply, dependable peak capacity and the opportunity to generate electricity when it was most needed and valuable.

The renewable energy sources that are being developed today (in particular, run-of-river hydro, wind, and solar) don’t have those high-value characteristics. They all provide energy supply, but they offer limited or no dependable peak generating capacity and, without battery or other storage support, no ability to shape their supply of electricity to when most needed or valuable.

There are two important consequences of the changing nature of new supply.

The first is that one cannot simply compare the costs of different sources of supply in order to determine what will best meet future needs. The estimated levelized cost per megawatt of output does not indicate what options will most cost-effectively meet a utility’s needs. A much more sophisticated analysis of the integration of different resources into the utility’s operations and trading opportunities is required for that.

System planners and traders understand this, but the complicated modelling and system- and market-dependence of the evaluation results are often not well received or appreciated in regulatory proceedings with their typical reliance on simpler, transparent metrics and with the pressures being brought to bear by proponents of renewable IPP resources. This was well illustrated in the recent BCUC review of the completion of the Site C project, where major differences in peak generating capacity and shaping capability were given little or no weight in the comparative evaluation of the alternatives, despite their critical role in determining the value of what would be produced.

The second important consequence is that for a utility like BC Hydro, with its considerable hydro reservoir storage capability, the rapid development of renewable resources in neighbouring jurisdictions is creating very attractive opportunities to meet a large portion of its energy requirements through trading activities. Because of widespread use of solar in the U.S. southwest, the market price of energy commonly falls to near zero during the middle of the day, when solar production is high and demand relatively low. And in the U.S. northwest and Alberta, with the extensive development of wind resources, the market price of energy can fall to very low, even negative levels when strong wind conditions result in excess supply relative to the demand prevailing at the time of the spikes in wind production.

Opportunistic purchases of surplus energy in neighbouring jurisdictions can offer the lowest cost source of energy for British Columbians. However, for BC Hydro to take full advantage of that requires a change in perspective and government policy.  It will require government and regulatory authorities not to be swayed by the self-serving protectionist arguments that IPPs and partner community interests bring in their lobbying and regulatory submissions. And it will in particular require the elimination of the government’s self-sufficiency policy imposed as part of the Campbell government’s Clean Energy plan. That parochial, protectionist requirement never made economic sense and makes even less sense now.

BC Hydro must ensure it has the capacity to meet provincial demands during peak periods and other times when market prices can be very high. But it needs the unfettered ability to take full advantage of the exceptionally low market prices that are increasingly available many hours of the day and times of the year. The goal should be to enhance the opportunities for BC Hydro to buy low cost energy in neighbouring wholesale markets by reducing transmission interconnection and domestic take-or-pay contract constraints – not to create or maintain artificial policy, regulatory or other barriers to such purchases.  

Changing nature of demand

In the traditional ‘top down’ planning model that BC Hydro has used to develop its system expansion plans, the demand for electricity is effectively taken as a given. Forecast demand indicates what amount of resources will be needed, the only question being what mix of resources should be added – what investments in new supply or in demand side conservation and efficiency measures should be made to meet the future requirements.

That top down approach would make sense if demand was relatively insensitive to price and the costs of supply. However, while one can debate whether that was ever the case, it clearly is not now. The demand for electricity can and will respond to differing prices and costs of supply – particularly the markedly different costs of supply that are increasingly evident by time of day.

Unlike traditional lighting loads, some of the fastest growing sources of the demand for electricity – charging batteries for electric vehicles (EVs), programmable appliances, computers and phone devices—are potentially very flexible in terms of when the demands are made. And energy management technology is increasingly available that enable customers (or the utility on customers’ behalf) to control the timing and extent of electrical use for charging, heating and other applications in response to cost and other conditions.

The planning challenge now is not how supply should respond to a pre-determined forecast of demand. The challenge is as much how demand can optimally respond to the marginal costs of supply. It is not simply the decisions that BC Hydro must make; it is the decisions that customers make that will determine whether needs are manifested and met in the most efficient way.

There will be a big difference in the costs incurred by the utility and its customers if growing EV requirements, for example, are manifested in time periods when BC Hydro can readily purchase low cost energy to meet the demand as opposed to other times when market prices are very high and/or new resources would be required. It is not just demand by EVs. The costs incurred by the utility depend on the time pattern of all of its load – the more the demand occurs in lower cost periods, the less will overall system costs and rates have to be.

With government policy now encouraging electrification for heating, transport and industrial process loads, all in an urgent effort to reduce greenhouse gas emissions, it is even more important that there is an efficient interaction of demand and supply in order to minimize costs.  This will require major changes from the top down regulatory approach of the past.

For customers to be able to make efficient decisions and investments governing their use of electricity, they need price signals that align their interests with those of the utility. The benefit-cost test that customers explicitly or implicitly make to consume electricity at any point in time or to select a monthly service plan that best meet their needs must mirror the benefit-cost test the utility would do to assess the consequences of their decisions on the utility as a whole. The prices customers face must reflect the marginal costs the utility will incur.

BC Hydro’s current rate design does not begin to provide the appropriate price signals. The two-tiered energy rates for industrial and residential customers are intended to signal the long run marginal costs of energy for incremental use, but the long run marginal cost estimates on which they are based are out of date. More importantly, long run marginal costs are not the costs that BC Hydro will face as a result of a decision by customers to use more energy – not while BC Hydro has considerable surplus and not even over the longer term when BC Hydro can purchase more energy in wholesale markets to meet additional demand. 

The marginal costs BC Hydro incurs to meet incremental demands for energy will depend on market conditions when the incremental use takes place and that will vary greatly by season and time of day. A fundamental problem with BC Hydro’s standard tariffs is that the rates do not vary by time of use despite the marked differences in the marginal costs of supply. The rates simply do not signal the consequences to BC Hydro of a decision to consume – they don’t align interests as required for the efficient interaction of demand and supply.

There are some innovative optional rates BC Hydro has introduced for large industrial customers to better reflect the marginal costs of decisions to consume, but they are very limited in application and problematic because of concerns about customers using these rates more to avoid the contribution to the recovery of fixed costs that they make under the standard tariff than to shape their requirements to time periods of low marginal costs.

The point is, a major restructuring of rates is required not as an afterthought to the development of the system plan, but as an integral part of it. That will require the structuring of energy rates or rate plans that properly reflect marginal costs. And to the extent BC Hydro offers different rate options to suit different risk and use profiles, as it would be well-advised to do, it will need to separate the recovery of fixed costs from the charge for and recovery of energy costs. Options should be available to meet different customer interests and needs, not to enable customers to minimize their contribution to the recovery of fixed system costs.

Need for new directions

BC Hydro is in the process of developing a new resource plan that will be subject to BCUC review. And there will be new revenue requirement and rate design applications that follow. The question is whether BC Hydro and the BCUC will more or less follow past practices and approach or whether it will embark on fundamentally new directions that recognize and respond to the rapidly changing conditions of supply and demand for electricity. Will they:

·      Resist simplistic cost comparisons and pressures to force BC Hydro to acquire low value resources as has been done in the recent past;

·      Recognize and support strategic investments in those resources that add greatest value to the BC Hydro system;

·      Support policies, strategies and measures, including expanded interconnections with neighbouring systems, that enable BC Hydro to take full advantage of the low-cost surplus energy increasingly available in wholesale markets throughout western North America;

·      Recognize appropriate rate design as an integral part of any efficient system plan;

·      Restructure rates in order that they fully align the interests of customers with those of the utility – where the costs that customers face when deciding when and how much to consume electricity reflects the marginal costs the utility will face to supply them.