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LDC Growth, Merger and Service Diversification in Ontario

Most of you have heard about Hydro One and the semi public offerings and divestiture the Ontario government made. There have also been at least a dozen other Local Distribution Company (LDC) mergers that have occurred over the past 5-10 years. Its often confusing for a rate payer to understand who their electricity provider is and why their name has changed. There were over 300 electricity distributors in Ontario in 1998 at the time of the Electricity Act. Now there are less than 60. Why is this happening?

First, lets clarify between a merger and a sale. A sale is when a municipal owner sells their LDC to a larger entity. They receive an influx of cash, but no future rights to dividends or even a say in the operation. A merger or consolidation on the other hand, involves no sale, but rather it legally combines various entities together with board seats and dividends still flowing back to the municipal shareholders per the merger terms and conditions. So while a larger LDC may come to be, the backend ownership hasn’t really changed from the original structure.

The way LDCs are governed means they only can make money off capital assets. There is a lot more complexity to it than this, but in short, there are few options to earn profit and thus a dividend back to the shareholder(s), so its difficult to remain viable without growth. If a municipality is growing, that means electricity needs will grow and thus assets will grow. This provides financial relief to an LDC, but when growth slows or other political winds change, there is pressure to sell or merge in order to be sustainable. This is why we have seen such consolidation over the years since its the quickest way to achieve dividend goals and remain viable – either from an outright sale or from a merger. But there are other options available to LDCs, each requiring planning, financial resources, and time.

First, there are rules that allow up to 10% non-governmental ownership of an LDC. This is a way to get an influx of cash into the LDC without divesting, which in turn can be used for other growth opportunities. Examples of this include past ownership by OMERS in Enersource, as well as the recent investment by Enbridge in OEC (a previous employer of mine).

Another approach over the past 10 years has been for LDCs to embark down a path of unregulated revenue diversification. Unregulated services are those that are not regulated like the electricity distribution portion of the business. While there are many examples of this diversification and many LDCs are actively looking at this strategy, two examples of this strategy would be Oakville Hydro and Erie Thames Powerlines. These two have diversified to such a degree that they are now known by other names, OEC and ERTH respectively, with their respective LDCs acting as an affiliated business within the broader parent company structure. We can dig deeper into this approach separately, but the reality is that outside of merger or sale, the strongest path to longer term sustainability is diversifying beyond the LDC whether it be acquiring assets or deploying new revenue-generating services. This takes a considerable commitment by the shareholder(s) and also an investment in people, assets, and financing to be able to expand like this. Managing a growth path like this in the face of tight municipal budgets and public perception can be the biggest challenge of all. A clear strategic plan combined with transparency and buy in from the shareholder are key to making this a reality. Remember, structure follows strategy!

The pressure for LDCs and municipal shareholders to continue to consolidate will only get stronger over the coming years. The end goal is for a more streamlined approach to electricity distribution and continued reliability. Unfortunately, history has not always shown clearly that sales and mergers offer the strongest long term value creation, so outside asset and service diversification are additional options to increase and maximize shareholder returns and ensure the LDC remains sustainable.

Visit Enertia’s website for more info on how we can help with your growth and diversification strategy: