EPCOR: Risk and the Best Interests of the City

This post is a follow up to a previous post on the decision to spin off the power generating wing of EPCOR as the new Capital Power Corporation, and to authorize the sale of shares in that new company to the market. The proceeds of this sale of shares will be used by EPCOR to build the water, wastewater and electricity distribution and transmission businesses.

It’s now possible for me to say more about the rationale for the decision since the Initial Public Offering (IPO) of shares is complete. During that 90-day period it was critical that the City not act as a ‘promoter’ of the IPO, so we couldn’t talk plainly about the risks and strategic assumptions. Remaining neutral on the promotion of the IPO was part of the motivation for taking the decision in private – becoming a promoter has legal risk attached to it, and the City could be an attractive target for shareholder litigation.

It has been argued by critics of the decision that the dividend (which is forecast by the city to be $133 million this year) will fall because of this sale. This argument makes an assumption that the dividend would have continued to grow steadily as it has for many years, or at least remain constant. This should not be assumed. The first bit of fine print on every risk-bearing investment is ‘past performance does not guarantee future results’.

There is also regulatory risk to consider: if and when stronger environmental regulations & pollution pricing come to bear on high emissions industries, the power business could change significantly – and the kinds of strong, growing returns EPCOR has seen from that line of business could at the very least become more volatile, which would not be in the city’s interest.[I’ve quoted the relevant paragraphs from the prospectus below.]

The investment risk is lower in the water, wastewater and electricity distribution and transmission businesses, all of which are regulated and provide a stable return. Truthfully, EPCOR was becoming generating-heavy and as an investment, EPCOR needed to be rebalanced toward lower risk. This decision, I think, was in the best interests of the city from a risk management perspective.

I believe the main concern, however, is the way in which the decision was made. The legality of the process in the Capital Power decision is now before the courts. In ruling on an application for interim injunction to stop the IPO, Justice Hawco’s of the Court of Queen’s Bench made some widely reported remarks to the effect that some of the reasons for privacy displayed ‘a lack of faith in the intelligence or common sense of the citizens’, (as reported, p11-12 of the ruling) but he also ruled that there did appear to be “valid concerns by EPCOR about going public before the prospectus was filed.” Justice Hawco also indicated, and this also was not widely reported, that “The sale of the electrical business of the city as managed by EPCOR could have been more transparent, but the sale was made in the best interests of EPCOR and the best interests of the citizens of Edmonton.” [I’ve uploaded a PDF of the full ruling here: CQB decision Pidruchney vs. COE et al.] I understand this litigation is continuing.

I am on record saying that that I reluctantly supported taking the decision in private. I am also bringing a motion to Council on the 22nd of July designed to ensure that any decision to sell any former city-owned assets, or EPCOR asset that directly serves Edmontonians (i.e. the water and wastewater plants, water pipes and electrical distribution and transmission infrastructure) cannot be sold using the same process. I’ve been accused of inconsistency in pushing for this but supporting, albeit reluctantly, the behind-closed-doors process for the Capital Power decision. However, the complications I described in my previous post do not apply with the regulated parts of EPCOR. I hope my motion will pass and provide reassurance that these municipal services will remain with EPCOR.

The Capital Power prospectus includes the following about environmental risks:

“Many of the Company’s operations are subject to extensive environmental laws, regulations and guidelines relating to the generation and transmission of electricity, pollution and protection of the environment, health and safety, GHG and other air emissions, water usage, wastewater discharges, hazardous material handling, storage, treatment and disposal of waste and other materials and remediation of sites and land-use responsibility. These regulations can impose liability for costs to investigate and remediate contamination without regard to fault and under certain circumstances, liability may be joint and several resulting in one contributing party being held responsible for the entire obligation.

“On April 29, 2009, the Canadian Environment Minister announced in a media interview that the Canadian Federal Government is planning new climate change regulations aimed at coal-fired power in Canada’s electricity sector. The regulations would purportedly require all newly constructed coal generation plants to use technology to capture GHG and inject it underground for permanent storage. Compliance with this and other known and unknown environmental regulations may require material capital and operating expenditures and failure to comply with such regulations could result in fines, penalties or the forced curtailment of operations. Further, there can be no assurances that compliance with and/or changes to environmental regulations will not materially adversely impact the Company’s business, prospects, financial conditions, operations or cash flow.

“The Company’s business is a significant emitter of CO2, NOx, SO2 and mercury and is required to comply with all licenses and permits and existing and emerging federal, provincial and state requirements, including programs to reduce or offset GHG emissions.

“EPLP’s wood waste plants may also be subject to SO2 and mercury reduction requirements within the next five to seven years. In addition, the decreased availability in waste heat used by EPLP’s Ontario plants may lead to increased emissions and decreased allowances being allocated with respect to these facilities. There are a number of uncertainties associated with the estimated cost of compliance with these existing and emerging requirements. It is not yet clear as to the form in which the new carbon and GHG regulations will be implemented or whether such regulations, when implemented, will reflect the proposed regulatory aims. In addition, the Company is not able to determine the extent to which future compliance costs will be recoverable from customers or whether such costs may be shared among emitters, customers and stakeholders. Other unknown factors include the future composition of the Company’s generation assets, the future production of electricity from the Company’s generation assets, the extent and timing of the development of carbon offset markets, whether economically feasible emission-reducing technology will emerge, the market price for carbon offset credits and other measures that the Company might undertake to reduce its emissions. Compliance with new regulatory requirements may require EPLP to incur significant capital expenditures and/or additional operating expenses.”