HYDRO ONE’S FAKE CAPITALISM.

From out of the great shambles of Ontario’s electricity system — soaring electricity prices, closing windmill plants, rising debt — a Phoenix rises, a Canadian corporate champion that apparently will turn the shambles into a miracle of state capitalism. Hydro One Ltd., the government-controlled Ontario holding company for the province’s electricity distribution monopoly, is to acquire another regulated monopoly holding company, Avista Corp., located a convenient 3,720 kilometres west of downtown Toronto.

According to Hydro One Ltd. ( HOL), the $ 6.7- billion equity and debt deal will create one of the largest regulated utilities in North America, increase stable earnings through fully regulated utility operations, generate efficiencies and increase the growth profile of the newly merged operation.

Mayo Schmidt, CEO of Hydro One, said “This is a proud moment for Canadian champions as we grow our business and become a North American leader.”

What can go wrong? Corporate mergers are a dime a dozen. Some work out, some don’t. With regulated utilities, when things go wrong the pieces often have to be picked up by ratepayers. One certainty is that the success of monopoly mergers depends on the constant flow of cash from ratepayers who are required to produce rates of return to shareholders.

For all Ontarians and customers of Avista across five U. S. states — Washington, Oregon, Idaho, Alaska and Montana — the first thing to know is that this is a financial/investment deal that has little connection with the actual operations of either company.

The merger takes place at the holding-company level, with the U. S. company that owns Avista bought by the Canadian holding company that owns Hydro One. At the end of the deal, there will be one holding company, Hydro One Ltd., and two operating subsidiaries, Hydro One Inc. in Ontario and Avista in Spokane, Wash.

The resulting Canadian corporate champion may or may not prove to be great for investors. One thing is certain: over the last decade in which the Ontario government sent electricity prices soaring to save the environment, ratepayers were never informed that they were in the business of creating international corporate players by turning Hydro One into an international bonanza for investors.

A new study from the Fraser Institute reports that the average Toronto resident pays more than $200 a month for electricity, the highest in Canada. One way or another, ratepayers are funding Hydro One’s new status as an international regulated utility.

The official version of the proposed relationship between Hydro One in Toronto and its new, distant corporate sister in Spokane is tricky to decipher and somewhat contradictory.

First, the companies say ratepayers will not be hurt. “Hydro One and Avista customer rates will not be impacted by any of the costs associated with the transaction.” Furthermore, the managements of the two operating companies will remain in place.

On the other hand, the deal is expected to generate efficiencies “through enhanced scale, innovation, shared IT systems and increased purchasing power (that will) provide cost sharing opportunities.” Under regulatory frameworks, such benefits should be passed on to ratepayers, not shareholders.

Whether large cost and efficiency synergies are available remains to be seen. Maybe they’ll find a way to store Ontario’s overflow of waste electricity into little batteries and ship them by rail to Spokane. Is it really possible to generate large volume discounts on copper wire and other buyingpower activities — carried out without merging managements?

The Hydro One/Avista financial deal at the top is clearly dependent on the continued monopoly regulatory regime at the bottom. A Dominion Bond Rating Service review put it clearly: “DBRS expects that the quality of the regulatory regime in Ontario will continue to remain supportive, providing the regulatory ring- fencing for the utility and allowing the company to earn a fair rate of return while covering costs on a timely basis.”

Hydro One CEO Schmidt pushed the shareholder benefit. “Our shareholders will see stable, strong, forward- looking returns on equity. For the people of Ontario, who are also shareholders, this means a growing income stream to help fund public programs like hospitals, schools and transit.”

What this means is that Ontario’s electricity regulator will continue to maintain electricity prices at a level that will support the earnings of the Hydro One operating company. Those earnings, in turn, will provide the dividends necessary to support the Hydro One Ltd. holding company and revenues for the Ontario government. But since the government of Ontario is the principle Hydro One shareholder, a massive conflict of interest exists.

In this, Hydro One is a model for state capitalism: the government sets the prices paid by consumers to a government corporation so that the government can collect more money to funds its operations. Along for the ride are a flock of investment players in the game of fake capitalism.

WITH REGULATED UTILITIES, WHEN THINGS GO WRONG THE PIECES ARE OFTEN PICKED UP BY RATEPAYERS.