Monday, 26 January 2015

WHY WE SHOULD DISMANTLE NALCOR (PART I)

Nalcor is engaging in lay-offs at the Muskrat Falls construction site.  Undoubtedly, it will say this is a normal and recurring process, except it is known in some quarters the project is suffering low productivity amidst a typical Labrador winter, an unfinished “dome”, and inexperience just as its major contractor suffers a veritable turnstile of senior construction management.  

The Oversight Committee won’t acknowledge the fact yet; perhaps it don't even know. But, eventually someone will have to tell us the project is at least a year behind schedule and that cost overruns are worsening.

The saga of bureaucrats masquerading as entrepreneurs, in a business we can ill afford, plays out.  For whom does the ‘bill’ toll? As always, it tolls for thee. 

Having created Nalcor to pursue a foolish 'energy warehouse' mandate using public money, the Williams/Dunderdale Administrations have gotten the Province into a pack of financial trouble, especially by having sanctioned Muskrat Falls. 

Nalcor's mandate, of course, is far wider than even Muskrat implies. At a time when the House of Assembly is being de-constructed, ostensibly to save a few dollars, we ought to be looking for bigger fish; a place where serious money is being squandered.

Nalcor is one of those places.


In this two part piece, I want to discuss the mandate given Nalcor, and how we might begin to change it. While certain decisions are needed now, no one should be fooled that there is an easy fix for the financial problem that is Muskrat. 

Indeed, dismantling Nalcor does not diminish the harm that decision will impose on the Province for decades. But we can stop new commitments of public money being made. We can bring in new management. We can receive an accounting of Muskrat's status with respect to both costs and schedule. 

It is time we had an eye to the future.

Newfoundland and Labrador is not unique for its involvement in state-owned capitalism; still, we ought to have learned from past failures and from experiences world-wide.

Some countries, notably those in Latin America and Europe, largely got out of the business of investing in state owned enterprises (SOES) in the 1980s and 90s (in Great Britain, the Iron Lady could see bureaucrats weren’t for business boardrooms). Even the British post office, headed by a Newfoundlander, has been privatised. Canada divested plenty of its SOES, too. Many other countries that embraced the approach to economic development have paid a high price; lower commodity prices (and corruption) have dramatically diminished SOE balance sheets.

Locally, the lunacy of state capitalism is evident.  Much of the capital given Nalcor will never be returned. The precipitous decline in oil prices and a mega-hydro project, predicated on wild assumptions and over-hyped management capability, have exposed a lie that rhetoric can no longer camouflage.  

At the best of times, large scale investments are a challenge even for private business. Remove the capital risk/ reward equation and put inexperienced people in charge – that is a recipe for failure.  Private business success is often over-rated; profit making and even capital preservation is tough and uncertain, at the best of times.

Entrepreneurship gives rise to winners just as it stakes a claim to losers. When high profits are recorded, due often to cyclicality as much to sagacity, the winners are frequently ready to announce their genius. As to the losers, they will inform you: it was not a case of foolhardiness but bad luck.

The problem, in the case of SOES, is that there is no penalty for those having made poor decisions, as there is for owners of private capital.

Danny Williams is gone.  Ed Martin may retire soon (though he should be pushed and his V-P for Muskrat, too). He will be handed a handsome gift of severance; likely, he will never doubt he is the Magi. But, the public investors, whose money is squandered, are left only with the lesson the benefits of state capitalism were never intended for them.

Nalcor will need billions to complete the now estimated $8.3 billion Muskrat Falls project. 
Already the equity requirement has increased from $1.9 to $3.3 billion.  That represents a 47% increased demand from the provincial treasury. The project has a long way to go before even 1 KWh is produced.

Equity for the second plank in Nalcor's mandate, offshore oil and gas, is vaporizing under our noses. 

Nalcor will soon have capitalized $1 billion representing working interests in the White Rose Growth Project (5%), the Hibernia Southern Extension Project (10%) and Hebron (4.9%); the latter will require far more government funding before it produces oil.

Nalcor also claims a working interest of 99% per cent in two onshore exploration permits in Parson’s Pond on the Great Northern Peninsula. 

Who can recall Ed Martin ‘scrumming’ with the media folk or boasting of that venture?  
Some of the 99% share was gained only after Nalcor drove away junior players whose smaller budgets could ill-afford its high-spending ways.

Nalcor budgeted approx. $27 million for three wells, getting only two for the money (talk about cost overruns!).  The wells were dry and a $5 million road constructed to the site of the third location was abandoned. It never did drill the primary target! Decisions like this are why private investors go bankrupt; in Nalcor’s case they hush up their failures and boast being experts.

Nalcor’s spent another $7.3 on “high-quality seismic data”, ostensibly to encourage exploration.  It is small change for an international oil company; for the government it is a lot of money. 

How are you enjoying private enterprise so far?

There was a time, and it was very recent, when the NL government salivated over nearly $35 million of discretionary spending! Those days have returned. 

That amount, of course is the small money. Don't forget the larger sums squandered offshore and at Muskrat.

All of Nalcor’s investments are high risk. If the capital requirements were sourced from a sovereign wealth fund or some equivalent investment vehicle like Norway, Saudi Arabia and a few other countries use to cushion the effects of oil production or price decline, the investments would still be inappropriate: Nalcor’s investments do not meet any benchmark of diversification.  

Even worse, the Corporation is using the government’s borrowed money; the same money that competes with funding for health care and social services.  This is not low risk capital like that originally invested in Newfoundland and Labrador Hydro. Cat Arm and Bay d’Espoir never represented the capability to financially injure the treasury, as does Muskrat.

The 5-10% equity stake Nalcor has taken in offshore oil investments are not intended to acquire leverage to keep more work here; unlike Hibernia, except for the accommodations and a flare boom, not another module on the Hebron topside structure is being built in this Province.  We will soon find out if we were so well off to have cared less how many jobs went to South Korea. It will be interesting to see how long those returnees from Fort McMurray stay quiet!

While the risks Nalcor has assumed are similar to those of a dot.com, it is acting with the full consent of the provincial government.  That has to change.

Newfoundland and Labrador cannot afford to fund such highly speculative investments.  It is not just irresponsible. It is bad public policy. 

The myth that public investments are appropriate “because they are ours”; a phrase once invoked by Tory spin-doctors to justify Muskrat, is just that. It is a myth. Like all myths, they serve the myth-makers.  Even if the idea was embraced by the Liberals and the NDP, it was never true.

It will not be easy, fast or cheap to dismantle Nalcor. It must be thoughtfully done; the decision cannot be of the kneejerk variety. We can never hope to extract ourselves from all the commitments to which we are held. But, right now, we can and should put a stop to additional investment decisions being made; we should receive an accurate accounting of those commitments to which we are tied. 

Let’s get back to governing, to creating better health care and education policy and running our institutions better.  Let's do the same with all our social programs and our management of basic infrastructure. That should be a government's competitive advantage. When it is allowed to stray, as it has here and elsewhere, the costs are unbearable. 

The next time an unwise Premier visits your wallet in search of a legacy, think of Nalcor and its destruction of public capital. Just know the decision is going to cost you dearly. 


More next week.

5 comments:

  1. There is no justification for completing Muskrat. There is very limited power available and no need here, or in Labrador or for "export" markets, at a sales price that will cover this cost. All in, this project is trending toward 12-14 billion. Astonishing. Simply astonishing.

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  2. You are blinded by petty, narrow-minded, and self-interested political goals.

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    1. suuuuuuure, not like the PC's did any of that. (Danny Billion$). I fully support this page...at least he tells it as it is. Not smoke and mirrors as the current administration is used too. Drink the kool aid much buddy?! or should I call you steve? Paul? or better yet Manning?

      Laughable this province has become.

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    2. "...blinded by petty, narrow-minded, and self interested political goals".

      That's a perfect summation of the rationale behind the Muskrat Falls project.

      Absolutely perfect.

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  3. State Owned Enterprises (SOEs) are a problem but mostly when the old Soviet system of 100% ownership is used.

    State owned utilities can work if they stick to their core mandate and do Request for Proposals for incremental power so there is an element of competition and sometimes innovation in supply. Nalcor did a good job at this in securing a good price for the 55 MW of wind. There is no evidence that NL Hydro has been a good steward of the affairs for the past half century given that we have about the fourth highest cost electricity in Canada even though about 75% of the energy originates from water projects that should have been paid down by now. In other words, the holy grail or where we want to be in 55 years with Muskrat Falls.

    Privately owned monopoly utilities are even worse than state owned ones (e.g. Emera with highest power rates in country) because there is little incentive for a push. Nobody is beating at their heels and all they have to do is a bunch of studies to convince the Public Utility Board and they are away with a higher than market return on investment. The one saving grace is the Public is protected from the large Muskrat deals because they must produce at the rates projected. If there is a large overrun on cost then the equity holders take the hit and their capital structure cannot be as highly debt loaded as government backed one can.

    Statoil, the Norwegian SOE is 40% privately owned and is privately operated. The Norwegian Government ownership is no different than the Ontario Teacher’s Fund large block of ownership in the stock market. The Fund Managers get a seat on the Board except that perhaps they direct that investment goes first into Norway but otherwise it is hands off. It is my understanding that Williams/Dunderdale wanted to establish a large player like Statoil. Unfortunately, that is not what we have in Nalcor.

    If Nalcor was set-up like Statoil, no private investment group would make an investment such as Muskrat when the numbers were so marginal. They may go along the Hebron investment which may not give the anticipated rich return but I think that project will still produce well over a billion barrels of oil and generate at least between $75 and $100 Billion in revenue over the next 30 years based on a $14 Billion investment. At current market exchange rates all it needs is an average world price of $69 US to hit that mark. Hebron is not the problem.

    The junior exploration work on the West Coast could have been done for a fraction of the cost (approximately one fifth of the cost) in partnership with an operating junior company as long as the junior was the operator and Nalcor was only the investor. As an example a junior would never build a $5 M road to nowhere. They would have figured out a much more economical way to get the equipment on site.

    There may be a case for the Nalcor seismic investment whereby it is meant as a form of public pre-investment infrastructure which is perhaps more effective than some of the government line Department’s work in the area of attracting investment.

    In summary, when you look for options to suggest for the wind down Nalcor, consider the Statoil model.

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