Table 1: Costs of electricity production in Quebec

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, 1986-2007 (%)

Job Creation through Subsidies to Large Industrial Users

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 spinoffs.

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 the calculation(9) 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” entrepreneurs.

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.

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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. 43.
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.

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* Jean-Luc Migué is a Senior Fellow at the Fraser Institute. Gérard Bélanger is a professor at Université Laval.