Global Adjustment: A political Time Bomb in Ontario

Prior to April, 2009, most Ontario electricity consumers probably paid little attention to the "Provincial Benefit" line item on their electricity bills. They had little reason to. Since its inception in 2005, the Provincial Benefit, known in Ontario's electricity industry as the Global Adjustment, was a relatively small adjustment on their electricity bills.

A drastic drop in market prices for electricity and increased governmental payment obligations have made this overlooked price adjustment a powder keg of political resentment and consumer backlash. In April 2009, for the first time ever, the Global Adjustment charged to Ontario electricity consumers exceeded the market price of the electricity they purchased. In every month since then the Global Adjustment has been significantly greater than the market price for electricity purchased by these consumers

The Global Adjustment is the difference between the rates paid by Ontario governmental authorities to regulated and contracted electricity generators and the spot market prices for electricity consumed in Ontario. If the amount paid by Ontario governmental authorities for the generation of the electricity is higher than the market price for the electricity, a positive Global Adjustment is charged to Ontario electricity consumers. If the amount paid by Ontario governmental authorities for the generation of the electricity is lower than the market price for such electricity, a negative Global Adjustment is credited to Ontario electricity consumers.

The amounts paid by Ontario governmental authorities that are factored into the Global Adjustment fall into three categories: (1) amounts payable for nuclear and baseload hydroelectric generation by Ontario Power Generation Inc. (OPG), (2) amounts paid for non-utility generation administered by the Ontario Electricity Financial Corporation (OEFC), and (3) amounts paid under agreements between the Ontario Power Authority (OPA) and electricity generators and suppliers of conservation services. Each of these three categories of governmental payment is explained in more detail below.

In the case of OPG's regulated hydroelectric and nuclear generators, a fixed price for electricity is set by the OEB. If the net revenue earned from the sale of electricity produced by these regulated baseload generators is less than the regulated price, the difference is charged to electricity consumers as part of the Global Adjustment. If the net revenue from OPG's sale of this electricity is more than the OEB's fixed price, the excess is credited to consumers.

Non-utility generators (NUGs) are generators that are not owned by the former Ontario Hydro. These generators provide electricity at set prices under power purchase agreements with what is now the OEFC. As is the case with the OPG base-load regulated generators, the difference between the OEFC's net revenue from the sale of this electricity and the amount that it pays to the NUGs under power purchase agreements is charged to electricity consumers as a component of the Global Adjustment.

The final component of the Global Adjustment arises under OPA contracts for generation and demand management projects. Some of these projects were setup through the OPA's former "Request for Proposals" process while other projects resulted in power purchase contracts without recourse to the RFP process. The OPA provides guaranteed revenue to electricity suppliers under these agreements. If the project earns net revenue that is less than the guaranteed amount, the difference is made up from a charge to the Ontario consumer through the Global Adjustment.

April 2009 saw an unprecedented change in the Global Adjustment. Until then the Global Adjustment had never exceeded 1.44 cents per kWh, and in the vast majority of months it had been less than 1 cent per kWh. In April, 2009 the Global Adjustment shot up to 3.020 cents per kWh and has remained above 3 cents per kWh each month since, except for June 2009 when it dipped to the still relatively high amount of 2.79 cents per kWh.

By covering the gap between the market price for electricity consumed in Ontario and the amount Ontario governmental authorities contract to pay out in the categories outlined above, the Global Adjustment reduces the volatility of electricity prices and passes the cost of new generation projects on to consumers. This procedure enables the Ontario government to offer price certainty to new generation and demand management projects, spurring the development of new electricity supply projects in Ontario.

However, consumer resentment may be growing now that reduced economic activity, particularly in Ontario's flagging manufacturing sector, has contributed to a steep decline in spot market electricity prices. The Global Adjustment has prevented the benefits of low electricity market prices from being passed on to the Ontario consumers, many of whom badly need it, particularly in light of the rising Canadian dollar.

Hardest hit are consumers who signed retail contracts at locked-in prices before the electricity market price crashed. Retail contracts provide the consumer a fixed price for electricity, subject to the floating Global Adjustment. Consumers that locked into fixed rates under retail contracts before the market prices crashed have experienced a double whammy - locked-in fixed rates that exceed the current market price, plus a drastically increased Global Adjustment.

The guaranteed rates being offered by the OPA under its new Feed-In-Tariff program will put continued upward pressure on the Global Adjustment, by producing a source of new governmentally-guaranteed pricing for electricity generation.

As a result, it appears Ontario electricity consumers are not going to experience relief from high electricity bills in the foreseeable future.

Peter Murphy (416) 369-4674 peter.murphy@gowlings.com

The Sale of New Brunswick Power to Hydro-Québec

On October 29, 2009, the Premiers of Québec and New Brunswick signed a memorandum of understanding (MOU) to sell substantially all of the assets of New Brunswick Power (NB Power) to Hydro-Québec (HQ). Subject to the approval of both provincial legislatures, the deal is scheduled to close on March 31, 2010, with a separate closing date of January 1, 2011 for the Point Lepreau nuclear generating facility.

Although primarily an asset purchase, the proposed arrangement under the MOU would also see changes to New Brunswick's regulatory framework and provide HQ with greater access to the New England market. With respect to the assets to be sold, HQ would agree to acquire and operate most of NB Power's distribution, transmission and generating assets (including Point Lepreau following its refurbishment) for $4.75 billion, an amount estimated to be equal to NB Power's current debt. NB Power would continue to own and operate the Belldune (coal) and Coleson Cove (oil) generating facilities, though HQ would have the option to shut down those facilities upon one year's prior notice. NB Power would also retain ownership of three other generating facilities, which would be de-commissioned following the closing of the transaction.

The arrangement would also alter New Brunswick's current regulatory framework in a number of ways. First, New Brunswick would commit to establishing alegal and regulatory structure that reflects the structure that is currently in place in Québec. Second, the New Brunswick System Operator would be merged into an HQ subsidiary. Third, under the terms of the MOU, HQ would freeze the rates charged to residential, commercial and wholesale customers for a period of five years. HQ would also lower the rates charged to industrial customers to match those in Québec, which are currently the lowest in North America. The savings to ratepayers in New Brunswick over the five year period is estimated to be $5 billion. Fourth, the arrangement would also see the creation of a "heritage pool" of electricity equal to 14TWh. Following the expiry of the five year period, rates for electricity within the heritage pool would be adjusted in accordance with the consumer price index, and any electricity needs beyond the heritage pool would be supplied through a market-based competitive process.

At the time that this article was prepared, Prince Edward Island was reported to have joined the inter-provincial power negotiations between Québec and New Brunswick.

Neil McCormick (613) 786-0274 neil.mccormick@gowlings.com

Executives Fined Under Books and Records Provision of the Foreign Corruption Practices Act as "Control Persons"

On July 31, 2009, the U.S. Securities & Exchange Commission (SEC) settled an enforcement action in which a company's COO and CFO had been charged under the U.S. Foreign Corrupt Practices Act (FCPA) and the U.S. Securities Exchange Act for violations of anti-bribery, books and records, and internal control provisions under these Acts. The SEC alleged that the company had made over $1 million in improper payments to customs brokers and subsequently falsified the company's books and records to conceal these payments. The CFO and COO were charged despite the fact that they had no personal knowledge of the payments being made or of the falsification of the company's books and records. The case is significant because of its application of statutory strict liability provisions under which "control persons" can be held personally liable if they fail to exercise sufficient supervision over employees responsible for accurate accounting or fail to provide an adequate system of internal controls. The company was required to pay a civil penalty of $600,000 and the CFO and COO received a penalty of $25,000 each.

Control Person Liability

Under the Securities Exchange Act (Exchange Act), an issuer is required to maintain records, books and accounts that accurately and fairly reflect the transactions and dispositions of the issuer's assets. Furthermore, the Exchange Act requires issuers to have in place a system of internal accounting controls sufficient to ensure that books and records are accurate and that transactions are taken pursuant to management direction. Every person who directly or indirectly controls any person responsible for maintaining accurate records is liable jointly and severally with and to the same extent as the person maintaining the records, unless the control person acted in good faith and did not directly or indirectly induce the acts constituting the violation.

The COO and CFO in this case held supervisory responsibilities over all members of senior management who were responsible for keeping accurate books and records and for the proper maintenance of an internal control system to ensure accurate record-keeping. In other words, all senior management reported directly or indirectly to the COO and the CFO. While there was no indication that the COO and CFO had personal knowledge of the illegal cash payments, the SEC found that the COO and CFO both failed in their supervisory duties mentioned above. The SEC argued that there were strong indications that senior management ought to have been aware of the improper payments and subsequent improper accounting treatment of those payments.

The Future of Control Person Liability

This case raises the possibility of strict liability for corporate executives. Where in the past, the SEC typically required evidence that individuals knowingly evaded or failed to implement internal controls or falsified books and records, it may be that no such evidence will be requiredin the future to impose liability on "control persons". Here, liability was found even though there were no allegations that the COO and CFO participated in or had personal knowledge of the bribery and subsequent falsification of books and records. The SEC's finding of control person liability will shift the burden to company officers to prove that they acted properly and did not directly or indirectly induce or assist in the improper activity.

U.S. companies or U.S. subsidiaries of Canadian companies, and Canadian companies that are SEC-registered or dual-listed, are subject to the books and records provisions of the FCPA and the Exchange Act. To reduce the risk of liability, companies should ensure that they have in place a robust code of conduct and ethics as well as underlying policies and procedures addressing payments to public officials and integrity in financial books and records. "Control persons" should ensure that they are basing certifications on information obtained through a variety of independent source, that they are exercising meaningful supervision over individuals with direct responsibility for books and records and that robust internal controls are in place and are being adhered to. In addition, companies should adopt rigorous training for all employees, particularly those in controller or accounting functions.

The Gowlings International Business Ethics and Anti-Corruption practice group will be pleased to offer advice on whether these statutes apply to your business, and to provide assistance in developing and implementing practical measures to mitigate these risks.

Kristine Robidoux, QC (403) 298-1817 kristine.robidoux@gowlings.com

Christine Yick (403) 298-1856 christine.yick@gowlings.com

Alberta's ERCB Orders Interim Shut-In of 158 Gas Wells

Effective as of October 31, 2009, by Decision 2009-061 Alberta's Energy Resources Conservation Board (ERCB) has ordered the interim shut-in of production from 158 gas wells licensed to Canadian Natural Resources Limited (CNRL), Paramount Energy Operating Corp., and EnCana Corporation until a full-scale hearing can be held in 2010.

Earlier this year, applications were made to the ERCB by Sunshine Oilsands Ltd. (Sunshine) and Total E&P Canada Ltd. to address the issue of whether natural gas production from 228 intervals in 158 natural gas wells would pose a risk to the future recovery of bitumen in the Athabasca Oil Sands Area.

In circumstances where production of natural gas threatens the potential recovery of bitumen, the ERCB has authority to shut in natural gas wells pursuant to section 3(5) of the Oil Sands Conservation Regulation which states:

Where it appears to the Board that the ultimate recovery of crude bitumen in the oil sands strata may be affected by gas production, the Board may, onits own initiative or on application by an affected party, make any order or directive it considers necessary to effect the conservation of the crude bitumen in any particular case.

The ERCB concluded that production of natural gas from the 158 wells may pose a significant risk to future bitumen recovery, and therefore ordered the shut in of the wells pending the outcome of a full hearing to be held in 2010.

The Test Applied to an Interim Shut-In Application

One of the issues addressed by the ERCB was the appropriate legal test to be used in an application for interim shut in. In cases of civil litigation, Courts will grant an interim injunction only if the applicant satisfies a three-part test articulated by the Supreme Court of Canada in RJR MacDonald Inc. v. Canada (Attorney General), [1994] 1 S.C.R. 311:

• Is there a serious issue to be tried;
• A demonstration by the applicant of irreparable harm; and
• Weighing the "balance of convenience", or in other words, which party suffers the greater harm by either granting or not granting the application.

In reaching its decision for the interim shut in of wells, the ERCB affirmed previous rulings that it will not apply the three-part test used in civillitigation for interim injunctions to applications for the interim shut in of wells. The ERCB stated that it did not require irreparable harm to be conclusively established, and that it was not required to conduct an analysis of the balance of convenience. Rather, the focus of the ERCB is on the potential for significant waste of bitumen during the period between the interim application and the main application to shut in the wells.

Commercially Recoverable Bitumen v. Potentially Recoverable Bitumen

CNRL argued in its submission that there should be evidence of commercially recoverable bitumen in an application of this nature. The ERCB, however,was of the view that, since interim applications are not the appropriate forum for detailed debate respecting the resource, the appropriate consideration was whether bitumen is potentially recoverable, not commercially recoverable.

Technical Aspects of the Application

As part of its decision, the ERCB found that there was communication between the natural gas intervals and the bitumen intervals (i.e. that production from natural gas intervals could create a low pressure zone above the bitumen interval and when steam is injected as part of Steam Assisted Gravity Drainage operations, or SAGD, the steam can escape into the low pressure zone, reducing the ability to heat up bitumen for recovery from asecondary production well). SAGD simulation models presented by CNRL and Sunshine yielded conflicting results on the question of whether reduced pressure in the gas zone would lead to an increase in steam-oil ratios or reduced recovery of bitumen. The ERCB concluded that there needed to befurther review of these issues at the full hearing to resolve these conflicting modelling results.

There was also disagreement as to whether solution gas (natural gas which is dissolved in liquid hydrocarbons while in the reservoir but is ultimately produced in gaseous form) was being produced from the wells. The presence of solution gas is a factor to consider in determining whether there is communication between natural gas intervals and bitumen intervals. Again, given the complex nature of this issue, the ERCB held that it should be determined at the full hearing.

Conclusions

The ERCB emphasised that this application was interim in nature and not conclusive with respect to the issues raised. With that in mind, there are several principles that can be taken away from the ERCB's decision until such time as there is a full hearing with more substantial evidence and argument such that the ERCB can comprehensively assess the issue:

• The ERCB will not shy away from exercising its broad jurisdiction under the Oil Sands Conservation Regulation to prevent the potential waste of bitumen.
• The ERCB focuses on the potential recovery of bitumen, not commercial recovery.
• The ERCB will not apply the more onerous three-part test used in civil litigation in deciding whether to grant an application for interim shutin-of wells.
• Decisions on complex technical questions, while occasionally entertained during an application for interim shut-in, will normally be deferred until the full hearing.

Clark Schow (403) 298-1807 clark.schow@gowlings.com

Alberta Court of Appeal Ruling on Standing Causes ERCB to Correct Errors in its Sour Gas Safety Parameters

On October 28, 2009, the Alberta Court of Appeal held that the Energy Resources Conservation Board (ERCB) had misstated the test for standing on applications for sour gas well licences, and had wrongfully denied standing to two persons who resided in the vicinity of proposed wells. In response to the Court's ruling, the ERCB temporarily suspended issuing licences for sour gas wells. Shortly afterwards, on November 13, 2009, the ERCB announced that it had made an error in calculating the emergency response modelling parameters that applicants must comply with, and immediately lifted the temporary suspension on the issuance of sour gas well licences.

The ERCB has the statutory responsibility for considering applications to drill oil and gas wells in the Province. Section 26(2) of the Energy Resources Conservation Act requires the ERCB to give a person notice and an opportunity to be heard where it appears that its decisionon an application "may directly and adversely affect the rights of [that] person ...".

Industry applications to drill "sour" gas wells have long attracted concern and opposition among people who live in the area of the proposed well and among environmental groups. Sour gas wells contain hydrogen sulphide (H2S), a gas which is potentially lethal even in very low concentrations and which has been alleged to have long-term impacts on the health of people and livestock.

Over the years, the ERCB has enacted a number of directives concerning sour gas wells. One of these, Directive 71, creates an Emergency Planning Zone(EPZ), defined (as its name suggests) as a "geographical area surrounding a well, pipeline, or facility containing hazardous product that requires specific emergency response planning ...". The ERCB has long followed a practice of according standing on sour facility licensing or approval applications to persons who live or own property within the EPZ or within "setback distances" which the ERCB has established for sour gas facilities. Another directive, Directive 56, prescribes sour facility "set-back" distances and radii for notification and consultation.

In July, 2008, an amendment to Directive 71 created another type of geographic area called a Protective Action Zone (PAZ), defined as "an area downwind of a hazardous release where outdoor pollutant concentrations may result in life threatening or serious and possibly irreversible health effects on the public".

An application by Grizzly Resources Ltd. (Grizzly) to drill two sour gas wells was among the first to be considered after the amendment to Directive 71 which created the PAZ. According to Directive 71 as originally worded, the geographic area covered by a PAZ could be significantly larger than the area of an EPZ. Whereas the EPZ for Grizzly's proposed wells had a radius of only 2.11 kilometres from the wellhead, the PAZ for the wells appeared to extend to a maximum of 9.25 kilometres. A PAZ's exact boundaries fluctuate and depend, at any given time, on which way the wind is blowing.

The appellants were individuals who lived outside the EPZ but within the boundaries of the apparent PAZ for the Grizzly wells. The ERCB dismissed objections the appellants had made to the drilling of the wells on the basis that the appellants were not directly and adversely affected by drilling of the wells.

The ERCB stated that residence within the PAZ for the wells, by itself, was not sufficient to establish that that the resident had rights that may be directly and adversely affected by the ERCB's approval of the Applications.

If an objecting party … does not own land or reside in a setback area or notification or consultation radius as prescribed in ERCB Directive 56, or the calculated EPZ for the facility, the onus is on an objecting party … to establish that he or she has legal rights that may be directly and adversely affected by a decision by the ERCB to approve an application. The impact must be specific and the objecting party must establish that he or she may be affected in a different way or to a greater degree than members of the general public ...

[b]eyond residing in the PAZ and the general concerns raised in the Review Application, you have not provided any substantive evidence that your rights may be directly and adversely affected by the Approvals ...

The Court of Appeal held that the ERCB had mis-stated the test for standing and had failed to properly apply either branch of the two-part test forstanding set out in Dene Tha' First Nation v. Alberta (Energy and Utilities Board), 2005 ABCA 68, 363 A.R. 234, [2005] A.J. No. 158 (leave to appeal to the Supreme Court of Canada dismissed [2005] S.C.C.A. No. 176). In that case, the Alberta Court of Appeal had described two tests for standing before the ERCB as follows:

First is a legal test, and second is a factual one. The legal test asks whether the claim, right or interest being asserted by the person is one known to the law. The second branch asks whether the Board has information which shows that the application before the Board may directly and adversely affect those interests or rights. The second test is factual.

In the decision under appeal, it was held that the ERCB had failed to apply either aspect of this test properly. Concerning the first test (the legal test), the Court considered that rights were in fact created by the ERCB's own Directives. This included not only the amended Directive 71, which required Grizzly to develop emergency planning for its sour gas wells which extended to residents of the PAZ, but also Directive 60, which required Grizzly to provide notice of flaring to residents within three kilometers of a well (within which one of the appellants resided).

In relation to the second part of the test, the Court held that the ERCB had erred in stating that, in order to have standing to be heard "... the objecting party must establish that he or she may be affected in a different way or to a greater degree than members of the general public". The ERCB, it was held, was wrong in faulting the appellants for failing to lead evidence of possible adverse effect. Quoting from the definition of PAZ found in ERCB Directive 71 ("an area downwind of a hazardous release where outdoor pollutant concentrations may result in life threatening or serious and possibly irreversible health effects on the public."), the Court held that this definition alone indicated that those wholive in a PAZ could have their rights directly and adversely affected as a result of a hazardous release.

The ERCB responded to the Court ruling by suspending the issuance of sour gas well licences until it had had the chance to formulate a response. The ERCB did not wait long to do this. On November 13, 2009 (16 days after the Court's ruling) it announced that it had made what was obviously a basic error in its Directive 71 respecting the manner in which the PAZ should be calculated. In the case of Grizzly's application, the parties had all interpreted the PAZ to cover a significantly larger area than the EPZ. To correct the error, the ERCB changed the end points in the models used to calculate PAZ's such that the PAZ is now always contained within the EPZ. The ERCB stated that it was never intended, nor was it necessary, for any PAZ to exceed the size of a corresponding EPZ.

The Court of Appeal's ruling had appeared to open up the process of sour gas facility applications to a great many people who would not previously have been accorded standing. On its face, the ERCB's response to the Court's has minimized this possibility.

Paul Edwards (403) 292-9815 paul.edwards @gowlings.com

Gloria Kang (403) 298-1841 gloria.kang @gowlings.com