Canada’s New Regulatory Paradigm – Least Cost of Net Zero

Electricity Canada: The Grid 2022

Alex Kent

Manager, Regulatory Affairs & Grid Infrastructure, Electricity Canada

Canada’s regulatory construct for electricity, the so called “least cost of service”, has reached the end of its useful life. This doesn’t mean that least cost of service wasn’t good, or that some value cannot be saved, but it is time to consider what comes next. Electricity Canada believes that “least cost of Net Zero” is the answer. Least cost of Net Zero is a new construct that says it is the responsibility of provincial and territorial energy regulators to make decisions based on Canada’s Net Zero targets.

Least cost of service rules exist because, as regulated monopolies, utilities have a duty to serve those in their service area and they are restricted to charge those customers a determined amount. In turn, utilities have a guaranteed rate of return based on the assets they own and operate (i.e., the rate base). Utilities must prove to their regulator that they are meeting an investment requirement with the lowest cost option or "least cost of service." These rules ensure that utilities don’t abuse their monopoly nature and overcharge for their services, or recklessly build and demand compensation for overly expensive work.

In principle, least cost of service ensures customers receive electricity at a reasonable cost and that utilities are fairly rewarded. However, this regulatory construct is not up to the challenge before it, namely that Canada, and much of the world, have pledged to reach Net Zero by 2050. Canada will only achieve its goal of Net Zero carbon emissions by 2050 if we meet our energy needs without adding carbon to the atmosphere. As we currently add over 730,000,000 tonnes of CO2 to the atmosphere every year, this is an Everest of a goal.

Zero-net-carbon electricity is the energy source that is going to allow us to scale the Net Zero mountain, but we are going to need a great deal more of it than we have today, and that is the crux of the

Electricity Canada: The Grid 2022

challenge before Canada. The Government of Canada reported in “A Healthy Environment and a Healthy Economy1” that our national electrical supply will need to double or even triple for us to reach our Net Zero goal. This estimate was further confirmed by the International Energy Association (IEA) in their 2022 report on Canadian energy policy2. While a requirement to at least double Canada’s electricity supply is daunting, it is a reasonable estimate. To illustrate why, in 2018 Canada’s transport sector consumed 2,844.2 petajoules of petroleum based energy3 which is equivalent to 790.06 terawatt hours of electricity which is 123% of the energy generated in 2018 by the entirety of Canada’s electricity system4 . Because electric vehicles are 2-45 times more energy efficient than their internal combustion counterparts, the fully electrified transport sector may only require one quarter as much energy to operate. However, even one quarter of 123% is still a 31% needed increase over the amount of electricity that Canadians generate today.

Other areas that will also need significant new electricity supply are building heating (which can benefit from energy efficiency retrofits) and industrial processes (which can benefit from green hydrogen). When electrification in all these sectors are considered, a doubling of electricity supply is a large and reasonable estimate, but it is achievable, just not under least cost of service model for four fundamental reasons.

First, to double Canada’s electricity supply over 28 years requires 2.5% compounding growth per year. When you factor in Canada’s estimated population growth6 between now and 2050, the needed electricity supply growth becomes approximately 3.1% per year7 . Some regions may need more electricity supply, and others less. But, regardless, electricity companies will struggle to supply Canada with the needed zero-net-carbon electricity to make this average 3.1% growth because they are held to least cost of service rules that require them to base their growth on historical norms. Norms that are no longer relevant because Net Zero demands that electricity must grow to replace other energy sources, instead of merely increasing in proportion to Canada’s population.

Second, there is no justification to increase investment in electricity today as there is enough electricity and electricity infrastructure to meet Canada’s current needs. However, we will soon be presented with increases in electrical demand and if we don’t start building today, meeting this demand will be too great a challenge. Third, regulators are concerned with costs when assessing a utility's rate base investment proposal. The regulator may be bound to make decisions that do not align with Net Zero goals as it is not their role to consider environmental impacts, including carbon emissions. If a regulator is presented with two options, a more expensive zero-carbon option, and a cheaper carbon emitting option, the regulator will accept the latter.

Finally, regulators do not usually allow utilities to be compensated for investments made outside of the traditional definition of utility rate base. A utility can only be compensated for infrastructure and assets it owns and operates, not the work it does to meet the needs of its customers. Some critical solutions that fall outside of that framework include energy efficiency retrofits, behind-the-meter energy storage, solar panel maintenance, trading emissions credits between provinces, or anything else utilities could do to reduce electrical demand and/or increase electrical supply in a Net Zero carbon way. These outside rate-base solutions, if they are at a reasonable cost to the customer, should be allowed and utilities should be compensated for them in rate-base.

It is because of these reasons that Electricity Canada proposes that we move from least cost of service to “least cost of Net Zero”. Under a least cost of Net Zero regulatory construct, each utility would be tasked with finding least cost solutions to grow the electrical supply at a manageable but consistent pace (approximately 3.1% per year) needed to make it to Net Zero by 2050. Provincial/ territorial regulators would also have clear guidance on whether new projects meet the provincial/territorial Net Zero targets. With least cost of Net Zero, regulators would be allowed to consider long-term energy needs, as well as environmental impacts, and utilities could be creative in how they meet those long-term energy needs.

The risk imposed by least cost of Net Zero to the consumer is low. This is because the cost of growing the electricity system would be primarily paid by other groups electrifying their energy consumption. Money that would have gone toward gasoline and other emitting energy would instead flow to electrical companies because they are supplying the energy.

Least cost of Net Zero would also be a flexible system whereby each provincial/territorial regulator will set their own targets and consider solutions as they are brought forward. There is no prescriptive action that each province should take; the Net Zero path for Alberta will be different from Nova Scotia’s. The federal government would also play an important role by assisting the provinces and territories.

Electricity Canada: The Grid 2022

This proposed change in the regulatory construct is not intended to upend how the Canadian electricity market works, rather it is intended to allow both electricity companies and regulators to recognize that new goals and tools are necessary to reach Net Zero by 2050. If Canada expects to meet its climate ambitions, then our governments, and our energy regulators, have to say a respectful goodbye to the least cost of service construct and welcome least cost of Net Zero.

1 Page 20 of the report reads “In order to accelerate the electrification of its economy, Canada will need to generate even more affordable, clean energy than it does today. By 2050, Canada will need to produce up to two to three times as much clean power as it does right now.” That statement is derived from a 2016 analysis done by the Trottier

Energy Future Project “Challenges and Opportunities for Canada: Transformations for Major Reduction of GHG

Emissions” https://iet.polymtl.ca/wp-content/uploads/delightful-downloads/TEFP_FinalReport_20160425.pdf

2 Source: International Energy Association (IEA), https://iea.blob.core.windows.net/assets/7ec2467c78b4-4c0c-a966-a42b8861ec5a/Canada2022.pdf, retrieved on Jan 25, 2022.

3 Source: Natural Resources Canada https://oee.nrcan.gc.ca/corporate/statistics/neud/dpa/ showTable.cfm?type=CP&sector=tran&juris=ca&rn=7&page=0 , retrieved on August 17th 2021.

4 The electrical sector generated of the 641.1 terawatt hours in 2018. Source: Natural Resources

Canada https://www.cigre.org/userfiles/files/Community/National%20Power%20

System/2020_National_Power_System_CANADA.pdf, retrieved on August 17th 2021.

5 Source: US Dept. of Energy https://www.fueleconomy.gov/feg/atv-ev.shtml retrieved on August 17th 2021.

6 Canada’s population today is 38 million, Source: Statistics Canada https://www150.statcan. gc.ca/t1/tbl1/en/tv.action?pid=1710000901 retrieved on August 17, 2021.

Canada’ population which finds a total population of approximately 45 million in 2050. Source Statistics Canada: https://www150.statcan.gc.ca/n1/pub/91-520-x/2019001/sect02-eng.htm, retrieved on August 17, 2021.

7 The full calculation to find the yearly growth rate is ((45,000,000/38,000,000)*2)^(1/28) = 1.031.

The system must grow at 3% per iteration to achieve a total 2.37 size increase over 29 compounding iterations. Here those iterations are years and 29 years is selected as it is 29 years till 2050.

Accelerate Net Zero

State of the Canadian Electricity Industry 2022

More. Faster. With action on climate desperately needed, the Canadian government has indicated its desire to work toward a Net Zero grid by 2035. The clock is ticking.

This year’s State of the Canadian Electricity Industry examines the impact Net Zero is having on the industry and offers an overview of necessary industry actions and specific recommendations to help Canada’s electricity industry continue to provide safe, secure and sustainable electricity for all Canadians in the face of rapid transformation.

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