THE POWER OF LIBERALIZATION IN THE QUEBEC ELECTRICITY REGIME (Print Version)
by Jean-Luc Migué & Gérard Bélanger*
Le Québécois Libre, February 15, 2009, No 264.
The price of electricity for Quebec residential consumers is one of the
lowest in North America. Relative to price conditions in North America,
the contrast between what Hydro-Quebec charges residents and what it
could get from exporting outside the province is striking. In April
2008, the rate in Montreal was 6.81 cents/kWh, compared to 11.17 in
Toronto, 11.75 in Halifax, 13.45 in Edmonton, 19.12 in Boston and 21.27
in New York. Enormous arbitrage opportunities are obviously missed.
Quebec derives more than 93 % of its electricity from hydro resources.
As in Manitoba and British Columbia, which also get most of their
electricity from hydro resources, prices to residential consumers are
based on the average rather than the marginal cost of production, which
is the cost of producing a kWh of electricity when the capacity of the
monopoly supplier is used. Overabundance of cheap production sites in
the past explains why average costs are low. For instance, the cost of
producing electricity in James Bay has been estimated at 1.58 cents/kWh.
But the era of cheap generation sites is over as shown in Table 1. When
transportation (1.4 cents/kWh) and distribution costs (1.3 cents/kWh)
are added, the marginal cost overall could then rise to over 11
1: Costs of electricity production in Quebec
Unit cost (per kWh)
1. Heritage electricity block
2. Projects under construction
2. • Eastmain-1-A and Rupert
2. • Medium-sized projects
2. Chute-Allard, Rapides-des-Coeurs,
2. • Wind energy
6,0 to 8,0 cents
& 3 cents
3. Large scale projects under study
3. (La Romaine, Petit-Mécatina,
Inefficiencies under Public Monopoly Supply
The first principle to maximize the value of natural resources is to do
what farmers and miners do: sell them to the highest bidder. A second
principle to avoid waste prescribes that every unit of the resource
brings in a benefit as high as its cost. Pricing at marginal cost
translates these rules.(1)
Based on these principles, rents on hydro resources are clearly being
dissipated, primarily by the failure to price electricity at marginal
cost to residential and large industrial users.
In contrast to oil, wheat and metals, electricity is not traded at a
single price in the continental market. Residential Quebec consumers
have little incentive to economize energy by better insulation or other
means. 69.9% of Quebec houses were electrically heated in 2001 (8.0% in
1972). Overconsumption, particularly in periods of peak demand, implies
extra capacity. In the past this has resulted in marginal costs as high
as 47 cents/kWh for the 330 hours of the coldest nights (in 1991)(2).
Peak demand for electricity in Canada occurs in winter, while the demand
peaks in summer in the United States for air conditioning. Regional
comparative advantages have failed to be realized.
Further market integration across North America would also improve
reliability. While resistance to the construction of transmission lines
is real, Bernard(3)
shows that inefficiencies resulting from pricing below production costs
reflect deliberate political decisions in favour of residential
consumers and large industrial concerns, more than a lack of
interconnections already substantial with neighbouring provinces and
with the United States. Part of the rent from water resources is also
dissipated in overemployment of unionized employees who receive far
higher wages (by some 21% in 1991(4))
than those paid to comparative jobs in Quebec and elsewhere in Canada.
That Hydro-Quebec pricing is inefficient clearly stands out from an
examination of the overall return realized by the public utility on its
investment over long periods. While the rate of return recovered after
2002 with the rise in the cost of energy, between 1986 and
2001 the public monopoly realized a return consistently below the yield
on risk-free federal government 5-10 year bonds (Table 2). It should be
mentioned that Quebec practices in that regard do not radically differ
from those of other provinces. Ontario Hydro got a pretax return on
assets of only 2.9% and Manitoba and New Brunswick utilities even lost
money when pure economic profits are considered.(5)
Table 2: Return
on Hydro-Quebec Net Worth Compared to 5-10 Year Canadian Bonds,
Fed 5-10 year Bonds
Source: Hydro-Quebec, Annual Reports, various years; Bank of
Job Creation through Subsidies to Large Industrial
The rationale put forward by the Quebec government to offer electricity
at the high-power rate of 4.5 cents/kWh to large industrial users rests
on the false assumption that the implicit subsidies to energy-intensive
firms create jobs. At first sight, when only the subsidized firms are
considered, jobs are obviously created in the aluminum and
electrotechnology sectors. More than 10% of the world’s aluminum is
produced in Quebec, which accounts for 10 of the 11 Canadian plants.
What this practice means however is that the province chooses to export
aluminum rather than electricity at a great sacrifice in income lost.(6)
Only considering the 2006 agreement with Alcan for the establishment of
a new modern plant in the Saguenay region, the total cost to the
government is estimated at a minimum of $250 millions per year.(7)
This conservative estimate translates into $336,700 per year per job
created with implications stretching over 30 years.
To show how misplaced this practice is, imagine the contribution to job
creations that would follow from selling more electricity to the
American Northeast or to Ontario, even at the average export price of
between 8 and 9 cents, and using the enormous profits thus generated to
reduce income taxes to Quebecers. Defenders of direct or cross subsidies
to firms never include the cost in jobs destroyed in disfavoured sectors
by heavier tax burdens levied to finance the programs. All types of
spending, including by individuals and private firms, generate economic
Redistribution of Resource Wealth
Through taxation on all resources in private hands, a form of
redistribution generally occurs. In that respect, conditions prevailing
in the Quebec electricity market raise another fundamental question:
Should rents from natural resources be also redistributed to the overall
population in provinces rich in resources, such as oil in Alberta or
hydroelectric power and mines and forests in Quebec?
Conventional wisdom often assumes that natural resources are God given
free goods. But to be brought to market, natural resources, like any
other goods, always imply incurring investment and labour costs. Just
because they are “natural” does not mean that they should belong to
provincial governments and be shared with the population as a whole. If
this statist principle were valid, it would apply to agricultural and
urban land, to air, to incomes of talented stars, etc.
Alberta levies high royalties on its energy resources. Until 2007,
Quebec levied no royalty for the use of water.(8)
Quebec’s strategy to spread the hydroelectric rent around is to charge
less than cost to electricity users. In 2007, royalties to the
provincial government will amount to $265 million, and then to $545
million in 2008, based on a rate of 0.328 cent/kWh adjusted yearly to
the consumers’ price index.
One further advantage would follow from protecting private property
rights of resources against arbitrary redistribution. The conventional
basis for instituting equalization payments is that it deters
inefficient migration when the motive for migration is to acquire a
share of a province’s resource revenue. But by a quirk of the
equalization formula, payment calculations to receiving provinces rest
solely on the monetary revenue of provincial governments, at the partial
or total exclusion of the overall rent levied by a province on its
resources. As shown above, Quebec (and Manitoba) devotes a large share
of its resource rents to redistribution in underpricing its electricity.
Yet while Hydro-Quebec profits are included in the Quebec government
budget, this type of resource rent is only indirectly incorporated into
and with little impact on equalization payments. Canadian taxpayers
subsidize Quebec’s (and Manitoba’s) cheap power policy.
Restoring Competition in the Electricity Market
European directives increased competition all across Europe in the 1990s
by unbundling generation, transmission and distribution. By one estimate,
European real prices have declined by 30% for small business users, 15%
for households and 10% for large users since 1997.(10)
After restructuration in the U.S., “publicly-owned plants experienced
the smallest efficiency gains, while investor-owned plants in states
that restructured their wholesale electricity markets improved the most”(11).
Rising investment in new supply in Alberta after the introduction of
competition in the mid 1990s also created downward pressure on prices.
Moving to competitive pricing of electricity with as many private
producers as possible would obviously prove desirable. Less dissipation
of water resource rents would occur and the Quebec government would
share in those rents. But such a radical institutional change is not
conceivable in Quebec where public ownership of electricity has become a
sacred cow. Not only would a majority of voters resist the end of
artificially cheap electricity(12),
but nationalists and various anticapitalist activists would revolt at
the thought of leaving a natural resource at the mercy of “greedy”
Yet deregulation of the North American energy market has enormously
increased Hydro-Quebec’s value. One estimate sets the value at some $130
billion, assuming that private companies would raise residential rates
at the Toronto level, i. e. some 4 cents higher per kilowatt-hour.
Annual profits would rise to about $7B from the 2006 level of $2.8B.
Translated into income tax cuts for Quebecers, it would reduce the
burden by a third.(13)
Marginal cost pricing under public monopoly with greater integration to
the North American market would be a second-best solution. Rather than
using electricity as an inefficient tool of industrial and social policy,
Quebec would gain enormously from market pricing and additional
cross-border trade. Market integration could also mitigate market power
by increasing the number of suppliers. But because Hydro-Quebec is a
political institution, it can hardly be assumed that the price of its
services cannot itself be political.
1. For a more comprehensive analysis of waste resulting from
Hydro-Quebec practices, readers are referred to a specific writing on
the subject by Gérard Bélanger, L’économie du Québec, mythes et
réalité, Éditions Varia, Montreal, 2007, Chap. 6.
2. Jean-Thomas Bernard, “Compétition électricité/gaz naturel au Québec,”
Energy Studies Review, vol. 4, no 2, 1992, p. 117-127.
3. Jean-Thomas Bernard, “Hydro Disconnect,” Financial Post, March
24, 2006, p. FP17.
4. Official Gazette, Parliamentary Commision, Quebec City, No. 103,
March 11 1992, p. CET-4985.
5. Jack Mintz, "Powerful Reforms," Financial Post, August 24,
2006, p. FP17.
6. The CEO of Hydro-Quebec recognized as much in a candid admission
relative to sales to large industrial users in the 1980s: “If
profitability is measured against the supply cost of new installations
at 8 cents/kWh, it is obviously negative. Relative to our average supply
cost for the overall network, yes we make money. Relative to the export
market, no we don’t.” S. Paradis, "Hydro ne perdrait pas d’argent avec
les contrats à risques partagés," Le Soleil, November 2, 2006, p.
7. J. T. Bernard and G. Bélanger, “336 000$ par emploi durant 30 ans,"
Le Soleil, January 15 2007, p. 17.
8. For a more comprehensive examination of present and proposed water
rights in Quebec, see D. Katz & J.-F. Minardi, “Water Rights under
Threat in Quebec,” The Fraser Forum, October 2008, pp. 29-31.
9. In the business income tax base as if a private corporation.
10. Tom Adams, “Privatization’s Power,” Financial Post, March 26,
2004, p. FP15.
11. K. Markiewicz, C. Wolfram and N. Rose, "Do Markets Reduce Costs?,"
NBER Working Paper No. 11001, Cambridge, MA, December 2004.
12. For a specific analysis of public choices in the field of
electricity, see J.-T. Bernard and M. Roland, “Rent Dissipation through
Electricity Prices of Publicly Owned Utilities,” Canadian Journal of
Economics, Vol. XXX, November 1997, p. 1204-1219.
13. Claude Garcia, “Hydro-Québec is Worth $130B―So Sell It!,”
Financial Post, September 19, 2007, p. FP 17.
* Jean-Luc Migué is a Senior Fellow at the Fraser Institute. Gérard
Bélanger is a professor at Université Laval.