Convergence and Deregulation in the Energy Marketplace

Head Table Guests

Margaret Samuel, CFA, Manager, Capital Markets, National Trust and a Director, The Empire Club of Canada; Wayne Pau, OAC Student, Danforth Collegiate; The Rev. Ian McLean, Minister, St. George's United Church; Elyse Allan, Chief Executive Officer, Board of Trade, Metropolitan Toronto; Ann Curran, Principal, Lewis Companies and a Director, The Empire Club of Canada; Catherine Sherrard, Chair, Toronto Hydro; and Janet Griffin, Vice-President and Director, Nesbitt Burns.

Introduction by Julie Hannaford

If we have learned anything from the series of speakers this year at The Empire Club of Canada, it is that the face of industry as we understood even a decade ago has altered as dramatically as our perception of our place within the global marketplace, and as drastically as our understanding of possibility has expanded within the technological sphere. From the former Chancellor of Germany, Helmut Schmidt, who gave us a glimpse of Europe and the union at the end of the twentieth century, to the leaders in communications industries, who told us that our very understanding of the word communication must be altered, to the bankers from both Canada and the U.S., who told us that competing nationally would be eclipsed by the necessity of operating in a global banking universe, we have been given one constant message: if progress, industrial development, and technological expansion release us from being the captive of limited possibilities, we shall be delivered into a new captivity unless we understand the dimensions of the global marketplace as something other than mere placid consumers.

It should not be surprising then that the delivery of energy is undergoing equally dramatic shifts and changes today.

We expect from our leaders in industry the ability to learn from the past, predict the future, and provide an example for the assimilation and use of change in the sectors they represent. Ronald Munkley, who addresses The Empire Club of Canada today, offers an understanding of the history of the energy industry from the perspective of one who has worked directly in it (as a pipeline construction worker while a student), and as one of the key players in the shaping of regulation and development of the energy industry for the future. Within Consumers Gas, he began as a staff engineer, becoming Manager of Operations, then General Manager for the Western Region of Consumers Gas, then Vice-President for System Operations and Engineering, and Senior Vice President for Operations in April, 1992. He was appointed President and Chief Executive Officer of Consumers Gas on April 1, 1994.

Our guest brings his perspective on the energy industry not only from his leadership of Consumers Gas, but also as Chairman of the Board of the Canadian Gas Association, as a member of the Board of Trustees of the Institute of Gas Technology, and a member of the Business Council on National Issues.

None of us are uninvolved or unaffected by energy delivery. The issues surrounding it affect our working lives, our recreational lives and our community.

Ladies and gentlemen, please join me in welcoming Mr. Ron Munkley, President and CEO of Consumers Gas, to The Empire Club of Canada today.

Ron Munkley

Good afternoon ladies and gentlemen. It is a pleasure and an honour for me to address The Empire Club of Canada. Your club is a venerable institution which has been a part of the Toronto scene since 1903. That's a pretty impressive record of service and continuity.

Toronto was a young city in 1903, well on its way to becoming a vigorous and enterprising centre of commerce for Canada. But let me take you on a mental voyage even further back into Toronto's early history. Try to imagine the city over a century and a half earlier, 1848 to be exact, and let's say it's late on a February afternoon.

Picture it. It's damp and slushy underfoot and thick streamers of fog are wafting in off the lake. By the way, you could actually see the lake from most of the main north/south streets in Toronto in 1848. Daylight is fading quickly and a lamplighter is just beginning his nightly rounds. To the cold and weary citizens out on the streets back then, the lamplighter is a very comforting sight. His taper will kindle gas street lamps throughout the city, bringing welcome illumination, and a sense of warmth to all of those Torontonians on their way home after work.

The lamplighter was to become a very familiar sight because Toronto had chosen to set up its first street-lighting system with 100 new gas lamps and that first 100 was the foundation for an extensive street-lighting system (and gas-pipeline network) which grew quickly. Put in the context of the time fewer than a dozen North American cities had gas street lighting. Yet, Toronto, still a fledgling and muddy city on the edge of a forest, was one of them. That simple commitment to public comfort and safety must have seemed like a bold and visionary decision then, because the financing of public ventures was no less controversial then than it is today. The enterprising attitude of the time made change very acceptable. It ensured that the status quo, dark public streets, was simply not an option. A vision of prosperity, the lure of new technology, a commitment to change--to do things better than before--was leading this city of 16,000, quite literally, out of the dark and into a commercially vibrant new era.

It would have been fun to have lived here then. They were exciting days as both public and private ventures took flight. Like Consumers Gas, for example. You see the company that supplied the gas for those lamps that February evening was my company. By 1848, Consumers Gas had built the first buried water system for the city of Toronto and it was the company that built and supplied those first street lamps with gas. That was how we got started.

It was the beginning of our enterprise, and the beginning of a partnership with this city that continues to flourish and grow almost 150 years after it began. In fact, we were one of the very first shareholder-owned energy companies on the continent. And, just as Toronto, and Ontario, have changed and grown, so have we. Today, Consumers Gas is still a company primarily engaged in the distribution of natural gas. But we've moved into several other areas as well.

We've become one of North America's foremost providers of retail energy services, and we are positioning ourselves to expand both our retail and our distribution business as our markets evolve here and elsewhere--and those markets are evolving. As incongruous as it may sound analysts have described the utility business as one of the "most turbulent on the planet today."

But, let me come back to Consumers for a few minutes. In very brief terms Consumers Gas can be described as a shareholder-owned, largely regulated, utility and service company with assets of approximately $3.5 billion and 3,800 very dedicated employees. You'll note that I emphasized the fact we are a service company. In fact, we have a very large portfolio of consumer products ranging from appliance sales and service to financing, rentals, heating insurance, natural gas for vehicles and many others. I might add that our employees have created a reputation for excellence that is second to none. In independent survey after survey Consumers Gas consistently outranks other companies, other utilities and other service companies when it comes to corporate image and customer satisfaction with service.

Our company serves over 1.3 million residential, commercial and industrial customers in Central and Eastern Ontario, the Niagara Region, Western Quebec, and in Northern New York State. We have over five million interactions with customers every year! We are very significant contributors to the Ontario economy. We will make capital investments of about $2 billion here over the next five years and spend more than another billion operating the system and serving our customers. We'll pay Revenue Canada and the 175 municipalities we serve over $500 million in taxes and we make a profit for our shareholders. I am happy to tell you that our financial results for 1996 were our best ever.

So that's "Consumers Gas 101"--the bare facts so to speak. I want to talk about the changes we're making to respond to the demands of today's marketplace and in fact to lead those changes but I should describe that marketplace a bit first.

Ladies and gentlemen, I can tell you that the energy industry is one of the most volatile industries anywhere right now. In fact energy markets overall are becoming more competitive and aggressive--not just in price but also in terms of consumer choice, and better services. The Canadian gas industry in particular has gone through enormous transformation over the past 10 years and I see 10 more years of change ahead. In fact, the changes we are likely to see in the next few years will be every bit as fundamental as those we've already been through. It started when several Canadian provinces and the federal government hammered out an agreement to deregulate the wholesale gas commodity business on October 31, 1985. It was called "an Agreement among the governments of Canada, Alberta, British Columbia and Saskatchewan on Natural Gas Markets and Prices," but it has been affectionately called the "Halloween Agreement" (for obvious reasons) ever since.

What did it accomplish? Well, first it created a climate in which natural-gas prices and other contract terms could--for the first time--be freely negotiated between Canadian buyers and sellers. In that regard, it was a bit of a global milestone. We were leaders in energy deregulation back then. Secondly, it enhanced access for buyers to natural-gas supplies and producers to natural-gas markets. Essentially, it paved the way for a truly competitive market for natural gas in Canada. But most of all, it prevented the obstruction of freely negotiated commercial transactions. In other words, the agreement opened up the industry to let the marketplace do its work.

And work it has. Deregulation in the buying and selling of natural gas has spawned a whole new era of competition. Gas pricing has become truly market-based, driven by market forces. It has brought new players into the business and it has allowed for the introduction of new technologies, which are helping us to expand markets and serve our customers better. You might say, it helped our industry create the same sense of progressive evolution that those "high tech" street lamps did back in 1848.

But more importantly, prices dropped! Even with the price bumps over the past year due to exceptionally cold weather and high demand, gas prices are lower in Ontario now than they were in 1985, in real money terms, no inflation adjustment nonsense here. The Canadian gas industry is efficient and responsive now. You can bet that the current demand bumps will be satisfied by new supplies quickly. That's been the industry track record in the late 80s and early 90s.

We know that this is just a beginning. As restructuring is introduced throughout the entire energy sector for gas, oil and electricity and as the regulatory framework continues to be relaxed and redefined how we do our business will change even more. Basically there are three main trends driving the whole energy industry today.

First, real competition is burgeoning across the continent. Generally speaking, if a product or service can be provided competitively there is no need to regulate it. After all, regulation is only a substitute for competition in any case. In the Ontario gas business, 65 per cent of the gas is now flowing through purchase agreements which have been negotiated freely between customers and natural-gas marketers. There are a lot of new competitors in the business, so there are a lot of choices for customers.

Second, customer expectations are changing. Five years ago, customers might have just shrugged their shoulders when the telephone company or the gas company told them to wait six weeks for an installation. Can you imagine what your reaction would be today? The fact is, that with more competitive options, customers can afford to be more demanding. They still want value for money but they also want quality, newer products, customised service and convenient financing. In other words, they will buy the best energy solution--not necessarily the cheapest fuel.

The third major trend influencing our business worldwide is that governments are "balancing the books." They are much more fiscally prudent. The era of seemingly unaccountable, unrestrained spending has ended. Governments at all levels today are seeking private-sector partnerships for the delivery of low-cost, high-quality service. Moreover, they are looking to companies like Consumers Gas who can effectively blend private-sector ingenuity with public-sector accountability. After all, we've worked in a public forum for 150 years.

So the rules of the game are changing. Just to stay in the game today requires vision and the courage to change. The status quo is not an option.

There are a few pretty basic questions in front of energy industry executives these days:

• What are the options open to us?
• How do we prepare our companies to play by the new rules?
• In fact how can we help get those rules?

First of all, we have to be prepared to look for growth in emerging, as well as in traditional markets. We must also be prepared to work co-operatively as an industry, to capture the opportunities. And we have to be able to adapt to change. Sometimes that's a tall order for big organisations.

For our part, we know that natural gas will continue to be the energy of choice as we move into the 21st century. It is safe, secure, cost-efficient and environmentally preferable. It is the best fuel available. But only if we in the industry can continue to meet our customers' value expectations. So we've been restructuring our company in order to use new technologies to make us even more effective.

I won't bore you with another "company restructuring" overview, though. I'm sure you've heard a few of those these days. Let me simply say that our employees are enthusiastic about change, and our customers can see that. They tell us so. But that may not be enough in this new era. New strategies must be introduced--strategies that will help us expand our customer base and serve the new customers, as well as our traditional customers, more efficiently.

Let me give you some examples of what Consumers is doing. First of all, we're getting back into the water-delivery business that was actually in our roots in the mid-1800s. In particular, we've formed a joint-venture company with one of the highest-rated water companies in the world and together we've been selected by York Region as their partner to work with them to resolve their long-term bulk-water needs. And by the way, York Region did not abdicate its role as a service provider. Rather, by putting public interest first, it will have a secure, reliable, long-term water supply, while maintaining rate stability. Most had predicted that was impossible in York Region because of its geography.

It's an excellent example of how partnering on commodity delivery could provide even more efficient solutions for all our end-use customers, both for water and gas. And that business has tremendous potential elsewhere in Ontario and particularly in the GTA as the GTA evolves. In fact, public-private partnerships with the right partners have a great deal of potential in general, perhaps even in the energy business.

Of course, the energy business is our forte. We're evolving there as well. You may have heard that energy forms are "converging," and wondered what on earth that meant. Well, gas is becoming an important fuel for electricity generation and gas and electricity will trade more freely as substitute commodities in the near future.

An integrated (or "converged") market is closer than most think, but it has to start with the fundamentals. Cogeneration of electricity and steam with gas is one fundamental. Basic partnerships on electricity and gas distribution is another fundamental. We've formed an alliance with Mississauga Hydro initially on joint-metre reading. Since it was announced, every single utility in the GTA has approached us to grow the partnership. North York is next.

In order to expand our capabilities for providing excellence in energy management (not just gas or electricity management), we've set up a joint venture with TransAlta Energy Corporation of Alberta. It's Canada's largest and most successful private electricity supplier and it's the company which is showing the leadership for deregulation in Canada's electricity sector. The TransAlta-Consumers partnership has been created to provide service to municipal electric utilities in Ontario. Our first project is with St. Catharines hydro-electric commission. We are going to significantly reduce their

bulk-electricity costs through more effective commodity purchases, and through better use of gas and electricity in standby power situations. This is a win-win project for St. Catharines Hydro, their customers, and Consumers Gas.

Those are a few examples of how Consumers is changing and growing. We believe we are building on our core competencies and the strengths of our people. We also believe we are leading the way in our industry. If I judge by the requests to have our executives speak across North America and Europe, we are leading.

What's driving the changes is a genuine desire to serve the customer even more effectively than we did in the past and to put systems in place which enhance front-line decision making. Consumers Gas has come a long way in realising our visions of being "a fully integrated utility and energy services company." To do that, we need competencies all along the energy value chain--some from alliances, and some through IPL Energy, the owner of Consumers. We also need the flexibility to respond quickly to changes in the energy marketplace as North American competitors come into Ontario. The Ontario government has been instituting some of the necessary changes. It has been assessing how to reduce the regulatory burden to allow Ontario companies to be more competitive globally and it is certainly on the right track in this area.

But the biggest change in the energy sector, and one that is coming without question, is the way in which the electricity industry operates here. Change must take place. The electricity market is North American, not provincial and structural change is occurring everywhere else, which is driving rates down for electricity customers. The reality is that major power consumers will migrate to where the rates are stable, secure, and low. They've made that clear with their words and their actions. Ontario can't lag behind the rest of the continent in restructuring the electricity industry or we'll all suffer. The Ontario government commissioned the Macdonald Committee to report on how to improve competition in Ontario's electricity industry and the committee reported last June. In my view, Macdonald provided a good blueprint for restructuring the Ontario electricity industry and the blueprint has been endorsed by a broad cross section of energy consumers, competitors, distributors, manufacturers and business associations.

Even the President of Ontario Hydro, in a speech at the Conference Board of Canada said: "I was delighted that the committee concluded that the status quo was no longer an option, and recognised the need for competition, including retail access, which would allow for an electricity market that is truly driven by customer choice. The report is a call for change and one that should prove valuable to move the yardsticks forward." I concur wholeheartedly!

There are considerable risks in doing nothing--including higher than necessary electricity prices, loss of economic competitiveness and reduced ability to eliminate Ontario Hydro's outstanding debt, not to mention the impediments on the rest of us in the energy industry. We will all be impacted. Change, and significant change, is very much in the public interest.

Based on our own experience, we believe that the introduction of competition in electricity markets is a first priority. As I said earlier, competition was introduced into the natural-gas industry over 10 years ago and has--as Macdonald pointed out--brought with it unquestionable benefits for gas customers. We firmly believe that competition within the electricity sector will produce similar effects.

The truth is that competition in electricity is already being implemented in the United States and some other Canadian provinces. Ontario's electricity system now is basically a vertically integrated, unregulated monopoly. It cannot remain a protected island in the increasingly competitive North American industry, especially if it wishes to compete for sales in a bigger market. If Macdonald's blueprint isn't followed, then an alternative plan must be proposed. Inaction will only make Ontario Hydro, and its Ontario competitors like Consumers, less competitive in North America.

We're not talking about privatisation of Ontario Hydro here. Restructuring for competitiveness can proceed quite independently of privatisation; in fact it probably should. Trying to do both at the same time would be an almost insurmountable task. Legislation must be put in place which will permit the electricity industry to respond competitively and which by its very nature will level the competitive playing field between gas and electricity. Some of the cross-subsidisation techniques which the electricity industry is forced to apply now are only exacerbating the problems.

In the gas industry, we've seen that competition drives innovation and efficiency. In fact, Ontario really has led the world in this area. The number of customers we currently have buying gas according to their own terms here is more than five times greater than in the rest of North America! (And I've already told you how it has dropped gas prices!) This is an area of deregulation leadership that we shouldn't relinquish. But other jurisdictions are progressing much faster than Ontario is now. I am concerned that they could catch, and pass, us.

There are fundamental structural changes that will have to be made in our energy industry, and our electricity industry in particular. Implementation of these changes will take time and the creativity of all stakeholders. Ontario Hydro will be a key contributor.

But we firmly believe that the regulators, the legislators, and other key stakeholders including the natural-gas industry, the major power consumers, the municipal electric utilities, the Boards of Trade and the customers must work together on this important process. Speaking for the gas industry, we have to! We're bound by the same legislation and regulations.

Let me re-state our position. Fair competition must be introduced now and be encouraged to flourish between the public electricity system and shareholder-owned, natural-gas companies. While we're encouraged by the initial response of the provincial government to the recommendations made in the Macdonald report, what we'd like to see now is action. We would like to see governments proceed as quickly as possible towards implementation, because the implementation will be complex.

We firmly believe that, based on our own experience, the introduction of competition in electricity markets must be a first priority. Restructuring is essential, privatisation may follow where it can be shown to provide financial benefits and be in the public interest.

The natural-gas industry has a stakeholder interest in these matters. We speak not only as a competitor but also as a partner with the electricity industry in meeting the energy needs of our end-user customers. If we can't sort out these complex issues, we'll all lose our customers to global competitors and this is not in anybody's interest.

All stakeholders must recognise that the convergence of electricity and natural gas into integrated energy markets is very much a realistic prospect. Just look at the Hydro-Quebec-Gaz Metropolitain deal concluded recently. Gaz Metropolitain is the gas distributor in Quebec. Hydro-Quebec is, of course, the power supplier to the province. Sometimes it's a bit tough to distinguish between the private sector and the public sector in Quebec, but Hydro-Quebec is now the biggest shareholder in Gaz Metro. The two companies, though ostensibly separate entities, are combining forces to make a concerted push into the United States where de-regulation is leading rapidly to the converged energy market I have described.

While not supporting that particular model, we also see real opportunities lying outside our provincial boundaries--opportunities for companies like ours to provide customers with excellent service in energy management, not just gas or electricity management. So do others! There have been several other energy industry acquisitions, alliances and mergers announced recently.

But, for us to capitalise on those opportunities--indeed, for us to continue to be major players in this business--it is vital that there be as much symmetry as possible in the changes happening here with the changes happening elsewhere. And most importantly, that they take place quickly.

I've already said that Consumers Gas hopes to invest well over $3 billion in Ontario over the next five years in the gas business alone, and that we will pay taxes of a half billion dollars over that same time-frame. Those investments will be dictated first by Ontario's investment climate, secondly by the performance of Ontario's economy, and thirdly by the establishment of fair competition in the energy business, continent-wide.

On the first two conditions, we have seen tremendous progress. We're concerned about the third, here at home. What we need is provincial leadership on policy, along with a specific action plan and timeline, because the aptitude for. change is the currency that's driving the energy sector today. Ontario's companies are leaders in that sector now. We can't be hamstrung. We need a level playing field so we can react to the market.

Who will benefit the most? There's no question about that. It's the customer and the community. No one knows that better than Consumers Gas. Since 1848, when our company was founded to supply gas to Toronto's street lamps, our highest priority has been to provide excellent service to our customers, and to the cities and towns where they live. Who knows, as I sometimes say to our employees these days, we started out in the water and street lighting businesses and we may end up there again. They're a great "fit" with the gas business.

Our dedication to customer and to community has served us well. We look forward to the next 150 years. Thank you very much.

The appreciation of the meeting was expressed by Ann Curran, Principal, Lewis Companies and a Director, The Empire Club of Canada.