While the global push for cleaner energy systems and lower emissions is accelerating, oil, natural gas, and coal remain the primary source of the world’s power consumption, which means the costliest investments to reduce greenhouse gas emissions are still to come. With focus intensifying on this transition, governments pushing for new decarbonization targets and policies, and billions of investment required to facilitate the journey, one question looms: who will fund the transition?
Industries across the spectrum are all taking steps to reduce emissions: power grids are evolving, the auto industry is going electric, energy firms are expanding investment in renewable sources - new technologies and other developments are paving the way for change.
As governments establish new rules and standards, questions around how these projects will be funded, long-term consumer affordability, and the impact on the energy transition journey all need to be addressed.
In some cases, it is clear that consumers are paying a premium for a specialized product – an electric vehicle or a residential solar battery storage system, for example. But not all transition efforts are this tangible. Utilities sector executives, in particular, are increasingly concerned about how to facilitate the move to a cleaner system, the cost of this transition, and the burden it may have on consumers, particularly those who cannot afford significant price increases for electricity.
The affordability challenge
Utilities are a front-line essential service, where consumer safety, reliability, and affordability are paramount. They are natural monopolies, with regulatory oversight conducted most often under a cost of service model. Customers are charged an amount that pays for service provided and a reasonable return for the business. When utility bills rise, consumers associate the higher rates with the company’s operations, and not with the costs of investing in greener technology.
Meanwhile, utility regulators – typically appointed crown agencies or elected state run organizations – are often viewed as part of the government, but also independent and immune from intervention. Their role is to govern the utility to ensure the essential service the utility is providing meets crucial benchmarks, namely safety, reliability and affordability while ensuring the utility is not making outsized returns. Regulators protect consumers while ensuring utilities invest the necessary capital to provide safe and reliable power at an affordable rate.
When governments set their energy transition targets, the financial impact on end consumers should be factored in. At the same time, the economics of meeting longer term climate objectives and the impact on a utility’s ongoing business or regulatory environment should be considered. The regulatory process should remain free from any government intervention.
This conundrum remains the greatest challenge facing the utilities sector in the coming years. Already, consumers are contending with an inflationary environment, which translates into more expensive gasoline, higher food prices, steeper housing costs, among other expenses. Against this backdrop, tolerance for higher electricity rates will be low, so how will utilities cover the necessary expenditures required to meet carbon emission targets in a timely manner? Negative outcomes could mean years of delay, or worse, failing to reach the targets of the energy transition journey altogether.
What might utilities do if backed into corner?
Political interventions to help consumers can have unexpected consequences. In Canada, the head of Nova Scotia Power recently cautioned that new legislation passed by the provincial government limiting the company’s ability to raise rates over the next two years will impede the province’s accelerated plan to phase out coal by the end of the decade. Nova Scotia Power, which provides 95 percent of the province’s generation, transmission and distribution services, recently warned it would be unable to make immediate power grid investments that would help pave the way for transitioning to renewable sources.
Since the provincial government’s legislative action, discussions with Emera on the proposed $5 billion Atlantic Loop – an energy corridor that would link hydroelectricity between the four Atlantic Provinces – have slowed, even as discussions with other provinces, utilities and Ottawa continue. The Atlantic Loop would help facilitate efforts to reduce the region’s reliance on fossil fuels, particularly coal.
Additionally, this intervention by the province into a proven independent regulatory process will in fact harm consumers in the province. One immediate impact has been the downgrade of Nova Scotia Power’s credit ratings by S&P Global and DBRS Morningstar credit rating agencies. S&P is concerned the intervention will “significantly increase NSPI’s stand-alone business risk” and “increase the uncertainty for its utilities and stakeholders.” The result is that the cost of capital to finance existing operations and invest in the clean energy transition have increased for Nova Scotia Power and their parent company Emera.
As a result of this type of intervention, utility companies will be incentivized to redirect capital to other regions or projects with better rates of return. The dilemma is clear – a government may choose to address consumer affordability by intervening in an independent regulatory process, but in so doing, they may fail to create an environment that will attract investment in the transition to a net zero economy.
Nova Scotia is not alone in facing this predicament. In Europe, government revenue caps and new taxes on utility companies are fostering an environment of uncertainty for energy investors that critics say is hampering investment in greener power sources.
These short-sighted interventions raise a number of questions. What is the broader impact on investments in renewable power sources? Does this mean energy transition efforts will be deprioritized or halted altogether due to prohibitive costs? Will utilities scale back spending to strengthen the power grid? Will focus be directed to current essentials related to safety and reliability, instead of meeting future carbon emissions goals?
Working together for a viable solution
Governments need to be mindful of the full cost of setting net zero targets and work with both regulators and utilities to manage together the pace of that journey. A thoughtfully laid out blueprint crafted in partnership with all stakeholders is a much more prudent approach to a successful energy transition than unilateral, short-term decisions that ultimately harm long-term climate goals.
The $970 million low-cost financing provided by the Canadian Infrastructure Bank (CIB) to Ontario Power Generation to help build a new, 300-megawatt small modular nuclear reactor is a positive example where working cooperatively achieves results. This type of agreement helps mitigate risks that capital markets are averse to or hesitant to accept, and provides stable financing that also ensures affordability for electricity consumers over the long term. It is also crucial to meeting Canada’s Paris Agreement targets to reduce greenhouse gas emissions, and will create an estimated 2,500 jobs over the course of the project’s development, manufacturing, construction, and operations.
Other potential solutions include financing through tax dollars or providing subsidies to support the build-out of non-emitting resources. Regardless, it is essential that mechanisms allowing utilities to recover costs of investing in a decarbonized electricity system, developed in conjunction with the regulator, are allowed to be implemented without government intervention. Without an appropriate strategy, we will collectively fail to reach our climate goals or risk making an essential service unaffordable for many consumers. Both are unacceptable outcomes.
Decision makers need to recognize that energy transition efforts have a price tag. Governments can help by filling gaps that investors are reluctant to take on. A comprehensive partnership and ongoing dialogue between regulators, the government, and utility companies is the best way to address affordability concerns, alongside energy transition initiatives, targets, and timelines. A balanced approach together is the most effective way to reach net zero while keeping essential services affordable.
