What next after Ontario cancels power contracts?

Publication August 9, 2018

Recent headlines have captured the decision of the newly elected Ontario provincial government to cancel more than 700 renewable energy contracts in the province.

For most of these projects, the approval of the Independent Electricity System Operator or IESO — the provincial entity responsible for operating the electricity market and directing the operation of the bulk electrical system in Ontario — had not been finalized.

The provincial government has explained that not all projects were cancelled, but rather the cancelled projects were chosen because they had not met their respective developmental milestones. The government’s view is that the cancellation of the projects will decrease hydroelectric rates in the province by 12%. The provincial Minister of Energy, Northern Development and Mines, Greg Rickford, said that $790 million will be saved.

Here is our dissection of the recent decision and its potential impact on the development of renewable infrastructure in Ontario.

Partnerships between governmental authorities and the private sector for development of renewable energy infrastructure usually see the private partners providing the up-front capital to develop a project and bring it to commercial operation, after which the costs are recouped from payments to the private partner from the government. Such arrangements shift the risk of lengthy and over-budget construction to the private partner.

Policy U-turn

The previous Ontario government enacted a “Green Energy Act 2009” in an effort to source 50% of Ontario’s energy from renewable energy. The previous provincial government underwent several procurement processes, such as the feed-in-tariff (FIT) procurement agreements, which tried to offer stable prices for energy sourced from renewable energy. The procurement strategy used standard-form contracts. Suppliers would apply for a contract with the government.

Another such program, the large renewable procurement — called LRP — was launched in 2014 with the goal of attracting bids from projects of more than half a megawatt in size. The goal of these procurement strategies together was to assist Ontario in meeting its target for renewable energy.

A successful applicant to either program would receive its contract from the IESO. After the applicant (now the supplier) received its contract, but before construction could begin, the supplier would need to obtain the relevant approvals and permits. Once these were obtained and any milestones were met, then the supplier would need permission to proceed with construction. Once the supplier’s facility was built and producing energy, then the IESO would pay the supplier for this energy at the contract price for a term that could reach up to 40 years in some cases.

The monetary incentives provided by the province to promote green energy are seen by some to have contributed to increasing energy prices for Ontario residents. In the lead up to the 2018 provincial election, there was a lot of talk about the increasing price of electricity. During this time, Doug Ford, Ontario’s premier, announced that he would decrease hydro bills by 12% if he were elected.

Affected projects

Following on the promises made during the provincial election campaign, the newly elected Ontario government has cancelled 758 renewable energy contracts. Among the LRP contracts on the list of pending cancellations are hydroelectricity, solar and wind projects. Among the FIT contracts are solar, renewable biomass, biogas and waterpower projects, but the vast majority are solar.

Most of the projects targeted had not yet received their notices to proceed from IESO.

A compensation scheme for one of the cancelled projects has been laid out in a bill that was enacted as the Urgent Priorities Act on July 25. The compensation scheme contemplates paying the developer behind the project for reasonably incurred expenses related to the project (specifically in relation to developing and acquiring the land, employee termination, subcontractor and landowner losses, as well as any decommissioning fees), certain debt and make-whole amounts, and any additional amounts prescribed in the law.

The most recent iterations of the FIT and LRP standard-form contracts contain language that give the IESO a unilateral right to terminate the contracts before projects reach commercial operation.

The change in policy position has some commentators questioning whether international investors in renewable infrastructure will continue to be attracted to investing in Ontario.

Compensation

It will be interesting to see what, if any, compensation will be made available to other developers. It may be that the government intends to compensate the developers to maintain public confidence in investments in Ontario.

As Bruce Pardy, a professor of law at Queen’s University and author of the CCRE commentary “FIT to be untied,” explains, the developer “assumes that legally granted and valid approvals will be honored at any time and also in the event of a change of government. Anything else would send out a fatal signal to the entire economy. The protection of confidence is a great asset and will certainly not be called into question by the new government either.”

The obvious concern for developers and investors with projects in Ontario is the possible chilling effect on entering into contracts with the Ontario government.

A government counterparty is generally seen as attractive, given that as a general rule, they are reliable partners with ample means to pay. It remains to be seen whether the Ontario government’s actions change investors’ views on that. Similarly, contractual confidence is a substantive factor when rating agencies grade investments, and any decrease in confidence typically translates sooner or later into a decrease in rating and an increase in the cost of borrowing.

What next?

The government has to be well aware of the risk that this course of action poses to the private sector’s confidence in the government’s commitment to its contracts and its perceived creditworthiness and, as such, will go to great lengths to ensure that developers in these situations will not be left out of pocket.

The government may be seeking to provide a formula for compensation that fairly represents developers’ efforts and willingness to contract with the government, recognizing that renewable energy is only one of several industries in which private parties enter into development contracts with the government, particularly in Ontario.

Conversely, if the question of compensation is not adequately addressed in the broadest sense, then the risk of wide fallout and a plethora of unforeseen consequences is very real.

The effects of this decision will echo beyond the energy industry. Ontario has a number of public-private partnerships that have long-term contract terms. These PPPs are used to build roads and hospitals and schools within the province. However these agreements are predicated on an ongoing relationship between the government and the private sector.

The industry awaits clarity from the Ontario government as to how it will demonstrate to investors that they can continue to invest confidently in Ontario and the extent to which equity partners in existing LRPs and FIT contracts will be compensated.

It is not clear whether some of the issues will eventually spill into the courts, a process that can take years to reach resolution.


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