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Playing games with electricity prices

Timmins lost 670 Xstrata jobs because Quebec has lower electricity prices than Ontario. Cliffs is making noises about refining in Manitoba because Manitoba offers cheaper electricity rates.

Timmins lost 670 Xstrata jobs because Quebec has lower electricity prices than Ontario. Cliffs is making noises about refining in Manitoba because Manitoba offers cheaper electricity rates. Industries in Manitoba and Quebec pay under three cents per kilowatt hour, plus distribution costs, while in Ontario they pay a spot market rate that can be double that. Should we lower the price of electricity for industry in the North?

The price of electricity is actually a very political topic. Quebec and Manitoba offer low prices to attract businesses. Much of that business comes from Ontario. We call this a 'beggar-thy-neighbor policy' because it makes one province richer by making another province poorer. But it does work, and southern states in the U.S. use the same strategy to attract Ontario’s car plants by offering tax holidays and anti-union legislation.

So we are caught in a dilemma. If we, in Ontario, keep our price high, our neighbours steal our jobs. If we cut prices, we end up subsidizing power, encouraging waste and even hurting the environment.

Faced with this dilemma, electricity prices are set by politicians. Mike Harris tried to change this, hoping that a market model would do better. About then, Enron’s California debacle showed that markets for electricity are easy to monopolize and manipulate. Unregulated markets didn’t work. Dalton McGuinty tried to solve that problem by creating a hybrid model – part-politics, part-market. Some of the political decisions are good – like encouraging alternative energy – others are strange – like adding a debt retirement charge to the price of electricity. Market-driven firms normally can’t get away with charging today’s customers for yesterday’s mistakes.

Some of the political decisions are just dumb – like charging the same price for power in Northern Ontario as in the south. The policy was supported by a 2006 report from Navigant Consulting that argued the price difference between south and north should be nearly zero. The report’s handling of the technical pricing issues could be questioned, but the main flaw lay in a failure to understand economic development and interprovincial price competition. When you are playing political games, price isn’t a technical issue.

Northern Ontario is one place where we need more, and not less, politics in electricity pricing. We need our government to be as clever as Walmart and Future Shop. We need it to start playing hardball with the competitors that are undercutting our prices.

Everyone has seen the ads that say, “We will not be undersold.” Walmart and many others promise to match the price of any competitor. Future Shop goes one better: “We will beat any advertised price by 10 per cent of the difference.” Customers are supposed to think that these promises guarantee lower prices. The truth is these ads are a way to reduce price competition. Since we want to reduce inter-provincial price competition, these ads can show the way.

Look at what happens when Company X considers offering a lower price than Future Shop. With the 10 per cent guarantee, Company X knows that trying to undercut Future Shop will actually drive customers to Future Shop. The Future Shop promise actually lets Future Shop set a higher price and reduces competition. Zhiqi Chen at Carleton University published a version of this result in the Canadian Journal of Economics in 1995, if anyone wants details. It is a well-known lesson from game theory. You can find other references on the web by searching: Game theory lowest price guarantee.

Now let's apply the same principle to electricity prices in Northern Ontario. What happens is Rick Bartolucci, our minister of northern development and mines, announces that he will beat any electricity price in any jurisdiction bordering Northern Ontario by 10 per cent of the difference in contract price offered. Other provinces would lose business and revenue by keeping prices so low. No company would go to Manitoba or Quebec to get lower electricity prices. Provinces would have the revenue needed to upgrade their aging electricity infrastructure.

And Rick would be recognized as a brilliant minister who applied modern game theory to solving a major problem in Northern development. The Bartolucci Promise would put him in the history books.