In April, the Ontario government announced two major changes to the electricity sector. The first is the amalgamation of four large local distribution companies (LDCs) in the region surrounding Toronto, including the provincially owned LDC, Hydro One Brampton. The second, higher-profile transaction is the sale of up to 60 per cent of Hydro One, the government’s electricity transmission company.

Many of the details still need to be ironed out, but the broad strokes have been outlined:

  • the government will retain 40 per cent ownership;
  • no other single shareholder can own more than 10 per cent;
  • the first tranche of the IPO will be 15 per cent later this year;
  • the Ontario Energy Board will be given additional powers to protect ratepayers from excessive rate increases; and
  • the proceeds will be invested in transportation infrastructure and used to repay Hydro One’s debt.

This is a potentially transformative transaction—both for the government’s fiscal plan and the province’s electricity sector. The biggest risk to the government and the transaction itself is that the government lacks the political support required to see it through. The size and complexity of this transaction create a number of risks that the government, prospective investors and advisers on both sides need to manage:

1. Political

Electricity is the most ‘political’ price in Ontario’s economy. Rates have been rising and will continue to rise for many years, for a variety of reasons unrelated to this potential IPO. Moreover, otherwise sensible privatizations—like the Pennsylvania Turnpike in 2008 or Hydro One itself in 2002 —and politically sensitive mergers and acquisitions—like BHP Billiton and PotashCorp in 2010—have failed to proceed after political pressure became too intense.

2. Valuation

Critics will say that privatization itself is causing higher rates, even though rates are going to increase substantially over the next decade regardless of ownership structure, due to previous investments in green energy and other kinds of infrastructure. The government may feel obligated to take a strong stand to limit rate increases thereby reducing the potential revenue stream to shareholders, thereby reducing the overall value of the asset. The Highway 407 privatization in the mid-1990s allowed the new owners to increase rates (and thus the value of the asset) while creating significant political challenges. These will doubtless factor into this government’s approach to Hydro One.

3. Reputation

The opposition to the sale of shares of Hydro One is already intense. While the criticism—for example, among the NDP, CUPE and a handful of legal experts—is directed at the government and the transaction itself, there is a very real chance that would-be investors and their advisers may become objects of criticism, particularly if they are not seen to be on the side of the public and ratepayers.

Research

We wanted to get a better understanding of some of the risks associated with the Hydro One IPO, so we reached out to our H+K Perspectives Panel. What we found is that Ontarians are skeptical of the motives behind the proposed deal and its impacts. The government’s commitment to using a significant amount of the proceeds to invest in transportation infrastructure has not resonated with people.

Opposition to the partial sale of Hydro One is more than three times higher than support:

This view comes from a well-informed group, where nearly three quarters were aware without prompting (73 per cent), and nearly 8 in 10 indicate prior awareness after prompting.

Feelings associated with the proposed deal tend to be negative, with “skepticism” being the most commonly reported reaction:

Among the Ontarians we spoke to, most do not believe the government will get a fair deal for taxpayers, nor do they think the government will be able to protect families and businesses from higher electricity bills:

In fact, just over three quarters believe electricity prices will go up as a result of the partial sale (76 per cent).

The majority of those we polled feel the risks involved in the partial sale of Hydro One outweigh the benefits of raising money for infrastructure:

This is reflected in the preference of about half we spoke to, who indicated they would prefer that things continue with current government ownership if given the option—which may be related to the fact that most of the Ontarians we polled believe that electricity distribution is a natural monopoly that should be owned by the government:

H+K Perspectives omnibus survey conducted between April 25 and 28, 2015

So what?

In short, the government’s most transformative policy initiative is being built on very shaky political ground. Although the financing and legal requirements to implement this change may be straightforward, the context in which the deal will occur is very complex. Recall that Ontario is the province in which two gas plants were cancelled after construction started. In those instances, public pressure became so intense that the government felt it had to change direction—an admission that it had insufficiently engaged the public earlier in the process. Politics in every jurisdiction can drive sub-optimal financial and economic outcomes.

For the Hydro One IPO, the government and its advisers will need to develop a near-flawless transaction and related public communications that manage the variety of risks that can jeopardize the overall valuation of the asset or the viability of the transaction itself. Hydro One’s largest shareholder now and in the future—the people of Ontario—does not currently support the transaction, nor do they see the trade-off (hydro shares for transit dollars) that underpins the government’s direction. At a minimum, the government and investors need to allay these concerns to reduce risks over the longer term. More likely, the viability of the transaction itself may be in jeopardy without effective public engagement and communication.