This article was originally published in Maclean's Magazine on March 2, 1998
Ontario Hydro's $6 Billion Loss
It was a sight to behold: men and women who have dumped all over the province's public electrical utility from the dawn of political time, running in rhetorical circles in an effort to persuade worried voters and nervous consumers that Ontario Hydro's decision to write $6.6 billion off its books is not really all that bad.
From Premier Mike Harris on down, the avowed enemies of bloated bureaucracy spent last week insisting that the largest corporate write-down in Canadian history should be viewed merely as an accounting adjustment, that it will not mean anything for the utility, its customers or the government's dramatic restructuring plans for Hydro. Never mind that Hydro's write-down resulted in a $6.3-billion loss for 1997 that has rendered the Crown corporation technically bankrupt. Harris insisted that all was well - or as well as can be expected, given that the money is what must be reinvested in Hydro's plants and equipment after years of neglect and mismanagement, particularly in the nuclear division, plus the cost of splitting Hydro apart into several operating companies. "They are no stronger or no weaker than they were yesterday," the premier said the day Hydro unveiled the bad news.
Harris reiterated Hydro's promise that power rates will remain frozen until the year 2000. Asked for his assessment of the historic event, Energy Minister Jim Wilson echoed his boss, stating emphatically that the accounting changes would not affect Hydro's $31-million debt, nor its credit rating. The ministry of finance, meanwhile, hopes that after its breakup Hydro will be efficient and profitable enough to pay for its own restructuring. Says Karen Sadlier-Brown, a senior economist with the Ontario ministry of finance: "As they move forward, I believe, they will have the cash flow to cover it."
This is a fine, uplifting notion. But so far, few people outside the pink granite walls of Queen's Park are buying it. Indeed, on the face of it the idea that Ontario Hydro's financial crisis might somehow take care of itself without too much trouble does not make a lot of common sense. On the contrary, seeing those billion-dollar losses in black and white only heightened concerns outside the loyal ranks of government that the red ink at Hydro will soon start showing up on everybody else's bottom line. "They try to make it sound so painless, as if it's only accounting and they could do it all again next week, the rates aren't going to go up," said Bob Kanduth, manager of public affairs for the Ontario Municipal Electric Association, a group that represents the 276 municipal utilities that distribute Hydro's product to 2.8 million households across the province. "But wherever it comes from, absolutely, absolutely, the writeoff doesn't go into a black hole. This money has to be paid eventually."
It is not only consumers who are worried. Because the province has historically guaranteed all of Hydro's $31-billion debt, the utility's financial weakness could soon undermine Ontario's own ability to borrow. The day after Hydro published its numbers, Canadian Bond Rating Service (CBRS) of Toronto issued a fax alert informing investors that it was revising its outlook for the province's long-term debentures from stable to negative. This is not yet a downgrade of Ontario's coveted double-A credit rating. But it means that the agency is flagging its concern over what lies ahead should the province not stick to its resolution to phase out financial guarantees for Ontario Hydro. In light of the fact that Hydro now owes bondholders $4.5 billion more than it owns in assets, with no readily apparent means to restore the balance, provincial auditor Erik Peters wondered, "How do we explain to the taxpayers whether or not that increases the risk?" Will the taxpayers "have to make good on the guarantees that the government has given?" he asked. These are good questions, to which no one has any answer - because nothing like this has ever happened before.
One thing that everybody seems certain about, however, is that last week's numbers are more than some accountant's figures on a page. When Hydro dropped its last bombshell, in August, 1997 - revealing that its nuclear generators were in such a sorry state that seven of them would have to be shut down - the company estimated that the tab would total between $5 billion and $8 billion. It came down smack in the middle. The $6.6-billion charge taken last week represents the cumulative loss of value in a number of Hydro's worn-out power plants - as well as future costs of upgrading its better-performing operations, both nuclear and non-nuclear, in preparation for what is still widely expected to be their eventual sale.
There is plenty of expensive work ahead. Hydro has earmarked $147 million to pay the cost of getting ready for deregulation in 2000; $830 million to upgrade its transmission and distribution divisions, plus pay for environmental cleanups; and $1 billion to cover the cost of decommissioning seven nuclear reactors. The largest portion, however, is the almost $4.6 billion that is going to be required for Hydro's "nuclear asset optimization plan," the utility's euphemism for all the re-engineering work that needs to be done to bring the 12 nuclear reactors that Hydro hopes to keep operating back up to industry standards. "A big part of that charge is for nonperforming assets that Hydro has to rehabilitate," said CBRS's Paul Calder. "They are going to have to come up with the money to pay for that."
Hydro officials talk as if that will be no problem. They claim they will have more than enough money by pooling their retained earnings with roughly $2 billion in yearly cash flow that Hydro hopes to generate from continuing operations. But there is a catch. The problem, according to utilities analysts and Hydro customers, is that raiding Hydro's savings and diverting its income to the necessary repairs will make it difficult, if not impossible, for the utility to continue with its plan to reduce its $31-billion debt to $27 billion by 1999. The province wants the debt to drop before it restructures the utility into generating, transmission and distribution arms, and invites other suppliers to compete for Ontario customers. If Hydro can't borrow more money, or still wants to make those debt payments, it is left with only two options: increase electricity prices, or sell off some part of itself, in the form of shares, assets or joint-venture partnership arrangements.
Provincial and Hydro officials have sworn loudly and long that prices will not go up. Hydro chairman and acting CEO William Farlinger, who is holding the fort until newly appointed president Ron Osborne (who, for the remainder of this week, continues in his post as president of Bell Canada) joins Hydro in March, even characterized the write-down as something that "reinforces Ontario Hydro's commitment to recovering the substantial investment made by ratepayers in our nuclear facilities."
But the municipal distributors have their doubts. They remain convinced that users will end up paying twice for Hydro's mismanagement, because a portion of the $6.6 billion is bound to be added to the estimated $10 billion to $20 billion in existing debt that the government plans to hive off from Hydro before breaking the utility up. That obligation has become known as the "stranded debt," and where it will come to rest is anybody's guess - but most analysts are betting it will eventually fall on the shoulders of customers. Even at its current level, servicing the stranded debt could add 20 per cent to average household electricity bills. Predicts Kanduth: "One way or another we will end up paying for it."
The only other way to raise this kind of money, as far as most observers can see, is for Hydro to get down to the business of selling equity or assets to outside investors - a political hot potato that Queen's Park, by all accounts, views as a far worse prospect than persuading the public to pay its share of the stranded debt.
Hydro and government officials insist they have ruled out a public share sale for the foreseeable future. But they may not entirely mean it. They remain willing to talk about the potential sale of private equity stakes to foreign partners. British Energy Ltd. of Edinburgh, the company that engineered the successful turnaround of the United Kingdom's troubled nuclear reactors, approached Hydro with a partnership proposal early this year. The day before announcing the accounting charge, Hydro executives confirmed that they had been in discussions with other foreign groups as well. British Energy isn't saying what, if any, impact the write-down is having on its talks. "It is too early for me to be drawn on that either way," said British Energy spokesman Doug McRoberts. "We are still in the middle of our scoping exercise. We have made no secret of the fact that we are interested." If nothing else, the week's events have given Hydro's managers new reason to look closely at all offers that come with the promise of fresh cash.
GREAT CANADIAN WRITE-DOWNS
Hydro's losses take the gold and the silver
1. Ontario Hydro (1997) $6.6 billion
2. Ontario Hydro (1993) $3.6 billion
3. BCE Inc. (1998) $2.9 billion
4. Dofasco Inc. (1990) $713 million
5. BCE Inc. (1993) $400 million
6. Placer Dome Ltd. (1992) $397 million
7. Barrick Gold Corp. (1997) $385 million
Source: Company reports
Maclean's March 2, 1998