Your Class A Decision: Approach With Caution

Electricity / 03.28.20

Your Class A Decision: Approach With Caution

How Global Adjustment (GA) costs are determined and how they are allocated means that electricity demand – both Ontario demand and your own facility’s demand – have important impacts on your future GA costs.

Uncertainty about electricity demand over the coming months is an important risk factor for those who are considering their option to be Class A for GA purposes under the Industrial Conservation Initiative over the coming adjustment period. Distortions in electricity usage resulting from shut-downs due to COVID-19 are likely to be felt for several months longer and could impact Global Adjustment costs and the allocation of those costs into 2022.

Impact of Lower Demand on GA Costs and Cost Allocation

The level of demand for electricity in Ontario has an important impact on the size of the Global Adjustment cost that must be paid for by consumers in the province each month. Ontario demand and a consumer’s own demand will, in turn, have an impact on the share of those GA costs that are borne by that consumer. The severe shock to economic activity caused by the COVID-19 pandemic has already changed electricity demand in Ontario – and profoundly, for many individual consumers.

Those facing a decision on whether to elect Class A or Class B for the period starting July 1 need to consider how these demand impacts could skew the economics of Class A and Class B before making an election to the local utility or the IESO prior to the June 15th deadline.

How Demand affects the Monthly GA Cost

The bulk of the costs within the Global Adjustment represent monthly revenue or price guarantees to generators. A generator’s contract with the IESO will guarantee that the generator will receive $x per month to cover fixed costs and return on investment. The generator has an opportunity to earn this revenue firstly by selling electricity into the market and being paid the Hourly Ontario Energy Price (HOEP). To the extent this sales revenue does not cover the monthly revenue requirement, the balance is paid by the IESO and those costs are recovered from consumers through the GA.

In high demand conditions, more generators are running, producing more power, and the Hourly Ontario Energy Price is generally higher, so more “sales” revenue is earned, and the generator-related revenue supports to be recovered through the GA are lower in that period.

In a low demand period, the opposite is true. Fewer generators are running, those that are running often have lower output, and HOEP is also lower. Generators are earning less market revenue, so GA costs in these periods are higher.

The IESO is reporting that the economic shut-downs and work-form-home conditions currently imposed due to COVID-19 have so far increased residential demand about 14% during daytime hours, but that overall, Ontario demand is down 7-14% due to reduced commercial and industrial activity. Peak Ontario demand which is used to establish the ICI peak contribution factors has also been reduced by 8-14%.

The IESO projects that electricity demand will be 4.6% lower than “normal” over the remainder of 2020 and 4.1% lower than “normal” in 2021. Monthly peak demands are expected to be 6.6% lower than “normal” through 2020 and 3.2% lower in 2021.

If demand is lower as the IESO expects, the result will be higher total GA costs to be borne by consumers.

Also noteworthy, the reduction in peak demand in 2020 is expected to be most profound during July-September, a period when the coincident peak demand “high 5” hours often occur that establish a Class A consumer’s “peak demand factor” for the following adjustment period. Thus, the impact of COVID-19 on peak demand this summer could affect the peak demand factor and therefore the GA costs paid by Class A consumers for the period July 1, 2021 to June 30, 2022.

If the allocation of GA costs to Class A customers is distorted by unusual peak demand factors as a result of COVID-19 demand impacts, then that will have a knock-on effect on Class B GA costs, since Class B consumers pay whatever GA costs are not recovered from Class A.

Impact of reduced demand on GA Cost Allocation

We can expect lower demand to result in more GA dollars that have to be paid. But lower demand will also affect how those dollars are allocated, impacting individual consumers in different ways. The choice of Class A or Class B is one tool some consumers can use to minimize this impact.

Consumers must consider changes to Ontario’s aggregate demand, but also the changes they are experiencing in their own operation, to make sure that they have carefully assessed their choice of Class A or Class B. They also need to be aware that uncertainty about those demand conditions creates an added risk in making their decision.

Effect of Demand Uncertainty on a GA allocation to a Class A consumer

The allocation factor that determines a Class A consumer’s share of monthly GA costs for the period from July 1, 2020 to June 30, 2021 will be set based on conditions that existed in July 2019. That allocation factor, commonly referred to as the Peak Demand Factor is fixed if the consumer chooses to be Class A for the future period. It does not adjust for consumption that is lower in the future period. In the extreme, if the consumer shuts down its operation for 12 months from July 1, 2020, it will have the same monthly GA invoice as if it were running at 100% over that period.

For Class B consumers, on the other hand, GA costs are allocated volumetrically each month. A Class B consumer with no consumption in a month will be allocated no GA costs in that month.

The implication is clear for Class A consumers who face uncertain demand in the coming months. Most consumers who are eligible for Class A have routinely found that it offers them cost avoidance (unless they have very high peak demand relative to their average consumption). However, there is a level of future usage below which Class B may become more attractive than Class A for some consumers. It is important to explore that threshold and how likely it is to be encountered, given that many are now operating under “unprecedented” conditions.

The depth and duration of the economic shut-down is uncertain, and it is affecting different organizations differently. Some organizations that have not yet been hit significantly may find a material impact emerges later as effects ripple through the economy if the downturn persists. Some that have been hit hard fast may also be among the quickest to rebound. Each organization must explore for itself the range of possible demand scenarios it faces to ensure it is making a good choice regarding Class A.

Effect of Demand Changes on GA allocation to a Class B consumer

Changes in electricity demand across consumers in Ontario will affect GA costs allocated to a Class B consumer in several ways.

If a material proportion of former Class A consumers anticipate their electricity use will be considerably reduced in the coming period, they may elect to be Class B consumers going forward. This will reduce the share of GA dollars allocated to Class A consumers and increase the share allocated to Class B consumers. But since those prodigal Class A consumers returning to Class B would be bringing low consumption with them (that is why they are coming), the effect could be an increase in the GA costs allocated to currently existing Class B consumers.

Whatever the GA costs that are payable by Class B, they are allocated to each consumer based on that consumer’s consumption in the month divided by total consumption by Class B in the month. If Class B consumption is down 5% across all consumers, the unit cost of GA allocated to Class B consumers will rise by about 5% (a given amount of GA dollars must be spread across fewer units of consumption).

A consumer whose consumption is down 2% when the market is down 5% will see their share of Class B GA costs increase from what it otherwise would be. Only the consumer whose consumption is down more than average will see a reduced share of Class B GA costs.

These scenarios reflect the fact that there are certain fixed costs in the GA that must be paid, and those costs get allocated in Class B to where the consumption is. If some consumers shrink or disappear for a time during the economic downturn, those still in operation will pay a higher share of these cost obligations.

The depth and duration of the economic impact of the COVID pandemic is uncertain. Clearly one impact will be a reduction in Ontario electricity demand right now, and for some time to come. The depth and duration of the impact on individual consumers will vary widely. Global Adjustment costs are the largest component of costs for many electricity consumers. Ontario demand is a significant factor in the magnitude of GA costs, and each consumer’s demand determines what share of that cost burden falls on them. Current demand uncertainty introduces a significant risk factor for electricity consumers to assess in considering their Class A election this year.

1 Independent Electricity System Operator: Electricity System Impact of COVID-19 (May 20, 2020)