Monday, 2 December 2019


Guest Post by David Vardy
In August of 2018 Premier Dwight Ball told us that ratepayers would not have to pay for Muskrat Falls. Recent news reports indicate that the Premier has met with the Prime Minister and further federal support will be announced in January.  Does this mean that Nalcor CEO Stan Marshall was wrong when he told the PUB the cost was inescapable? The PUB heard little in the way of proposals to lighten the burden other than the shifting of costs from ratepayers to taxpayers. This offers little comfort because for the most part we are all both ratepayers and taxpayers.

When presenting to the PUB on October 8, 2019 Nalcor’s CEO Stan Marshall said the cost of Muskrat Falls was “hard wired” or inescapable: “you got a hardwired cost, the regulator can’t do anything about that, I can’t do anything about that. The Provincial Government can’t do anything about that” (page 110). He said the PUB can exercise no control or oversight (page 112), nor can the Auditor General.

No Oversight by PUB
Legal counsel for the PUB asked (page 144) if there was an oversight role for the PUB including the right to deem certain costs to be imprudent and therefore disallowed. “Hard wiring” seems to preclude such oversight.  Are the financial arrangements as immutable as CEO Marshall claims they are? What are the arrangements currently in place?

The revenue requirements which must be paid, either from ratepayers or taxpayers, are enormous. In a presentation by Stan Marshall dated February 15, 2018 and entitled "Understanding Muskrat" he said that the project would add $808 million to the cost of the Island Interconnected system.  Another Nalcor document (IC-NLH-017,   attachment 1,LUEC tab) calculates that over the 50 year supply period, which begins when the project eventually comes on stream, the undiscounted costs will amount to $74.6 billion.  There will be some offset from fuel savings, export revenues, potential cost savings and electrification (e.g., electric vehicles) but the remaining burden will still be enormous.

MFI Terms of Reference
The report of the Muskrat Falls Commission of Inquiry will be released at the end of the month. How will it deal with the impact of the Muskrat Falls project on the financial obligations of the province? The Commissioner’s terms of reference, section 5(e), call upon him to consider: “the need to balance the interests of ratepayers and the interests of taxpayers in carrying out a large-scale publicly funded project”. As a minimum one would expect that the Commissioner will estimate and measure how the burden will likely be distributed between ratepayers and taxpayers.

We would expect as well, drawing upon 4 (a iii) of his terms of reference, that the Commissioner will attempt to estimate how much of an excess burden over least cost power resulted when government  empowered Nalcor to undertake this project and conferred monopoly powers by statute upon Nalcor. As Tom Baird pointed out in 2012 if the Muskrat power was least cost Nalcor would not have needed monopoly protection nor would the PUB be exempted from its normal regulatory role.

 In his interpretation of his terms of reference the Commissioner states: “At this stage of the Inquiry, I take this to mean that the Commission must look to how to balance or apportion the financial costs of an electrical generation project like Muskrat Falls as between power consumers and all of the Provinces' taxpayers.” (paragraph 49, ). I take no issue with this statement.

Non-recourse: What does it mean?
The project was sanctioned on the basis that 100% of the costs would be paid by ratepayers. Some of the legal documents speak to “non-recourse” to the province and its crown corporations, other than those corporations actually borrowing federally guaranteed money. In other words the taxpayer will be shielded from bearing the burden. This means that there were to be no financial obligations imposed other than those imposed on the four crown corporations, subsidiaries of Nalcor, identified in section 1.4 of the loan guarantee of November 30, 2012. However the legal issues are more intricate and will need to be weighed by the Commissioner, along with the economic forces, which cannot be ignored. Let us look at the legal obligations.  Full disclosure: I am not a lawyer.  
David A. Vardy
Province disavows obligations of Nalcor/Hydro
In late 2012 the  province enacted changes to the legislation governing Nalcor Energy and NL Hydro, specifically section 3.1 of the Energy Corporation Act and 3.1 of the Hydro Corporation Act.

Section 3.1 of the Energy Corporation Act includes the following: “the Crown shall not be liable as principal in contract, tort or otherwise at law or equity for the liabilities of the corporation created directly or indirectly by those contracts or arrangements.” If the Cabinet has approved the contract and if the contract explicitly makes the corporation an agent of the Crown then the Crown can be bound. A similar revision was made to the Hydro Corporation Act except there was no exception identified where the Crown could be bound or obligated to assume obligations from the Corporation corresponding to that in the Energy Corporation Act.

PPA leaves NL Hydro unshielded?
The power purchase agreement dated November 29, 2013 calls for NL Hydro to pay all revenue requirements when billed. The Power Purchase Agreement at Muskrat Falls Inquiry Exhibit P-00457, between NL Hydro (NLH) and the Muskrat Falls Corporation (MFC), signed November 29, 2013, provides for a return on equity and a return of equity. Section 1 of Schedule 1 includes the following Definition:

“Base Block Capital Costs Recovery” or “BBCCR” means the recovery over the Supply Period of the following costs, without duplication:

(a) Development Capital Costs, which shall provide for the repayment of principal under

the Financing and the return of equity capital to the equity holder;

(b) Development Financing Costs; and

(c) Distributions to equity holders sufficient to enable Muskrat to achieve its Assigned


Section 14.4 of Schedule 1 to the Power Purchase Agreement defines an “event of default” for NLH. The Grant Thornton Report prepared for the MFI, at Exhibit P-00454, on page 38, makes the following statement:

“The PPA provides specific remedies if Base Block Payments are not made.  In particular, if NLH fails to make the necessary Base Block Payments while MFCo  continues to be in compliance with this agreement, MFCo may provide notice to NLH it is invoking their rights under the PPA which requires that within 10 days of providing such  notice, if NLH has not paid the outstanding payment, NLH is required to pay a lump sum  amount equal to the full repayment of the debt financing (including principal, accrued  interest and any premiums) plus any associated costs (including legal, advisory, transaction  and administrative costs).”

The PPA is backed up by the Exemption orders, also issued on November 29, 2013. Order-in-Council 2013-343 orders that the PUB include as costs, expenses or allowances “without disallowance, reduction or alteration of those amounts, in Newfoundland and Labrador Hydro’s cost of service calculation in any rate application and rate setting process, so that those costs, expenses or allowances shall be recovered in full by Newfoundland and Labrador Hydro in Island interconnected rates charged to the appropriate classes of ratepayers.”

Do these statutory amendments and Orders-in-Council, in concert with the infamous power purchase agreement between two subsidiaries of Nalcor, relieve the province of any financial obligations? If NL Hydro, the province’s largest utility, goes into default and cannot pay its bills can the province walk away from the obligations? This leaves a huge gaping question as to who will make the payments when ratepayers can pay no more. 
Loan guarantee agreement-undertakings by province
There is another side to this story, one which raises questions about the immunity of the provincial Treasury from the obligations from Muskrat Falls. Let us go back to the November 29, 2012 loan guarantee agreement, which was confirmed a year later in an intergovernmental agreement dated November 29, 2013. Section 3 of Schedule B of the intergovernmental agreement places the following obligation upon the province  with respect to the Muskrat Falls Corporation: “Ensure that, upon MF achieving in-service, the regulated rates for Newfoundland and Labrador Hydro (“NLH”) will allow it to collect sufficient revenue in each year to enable NLH to recover those amounts incurred for the purchase and delivery of energy from MF, including those costs incurred by NLH pursuant to any applicable power purchase agreement (“PPA”) between NLH and the relevant subsidiary or entity controlled by Nalcor that will provide for a recovery of costs over the term of the PPA.”  This places an obligation upon the province but it is not clear what the limitations are or if it breaches the provincial shield created by the statutory amendments to the Energy Corporation Act and the Hydro Corporation Act.

There is a “Whereas Clause C”, in the same intergovernmental agreement, which refers to a “condition precedent” that “NL agreed to indemnify Canada for any costs that it may incur under the Federal Loan Guarantee as a result of a regulatory decision or regulatory change (including through legislation or policy) that prevents the Project Entities from being able to recover Project Costs and fully service the debt guaranteed by Canada under the Federal Loan Guarantee;”

Full Rate Recovery Unacceptable
In his presentation Understanding Muskrat, Nalcor CEO Stan Marshall showed that, in order to achieve full cost recovery, power rates would need to be set at 22.89 cents/KWh. Nalcor probably understood that such a dramatic increase in rates would not only be unaffordable but was also completely unachievable, due to consumer resistance and ratepayer switching to alternative forms of energy.  To establish such rates would create a utility death spiral.

Such a high rate would have been unacceptable to ratepayers. Government responded by announcing a rate mitigation plan which would keep rates at 13.5 cents per KWh. This was based on  revised revenue requirement of $726 million for 2021, down from $808 million, even though  the capital cost estimate has not been reduced).  Is this a “policy change” which “prevents the Project Entities from being able to recover Project Costs”, namely the policy decision to keep rates at 13.5 cents and not force the system to the limit at 22.89 cents/KWh? Is it an event of default?

In calculating the $726 million in revenue requirements for 2021 Nalcor included dividends on Emera’s investment. This investment is shown in the consolidated financial statements of Nalcor as a liability, with a cost to Nalcor of 8.5%. The latest Nalcor estimate (from PB-519-2019) of Emera’s investment is $865 million. Government’s rate mitigation plan, by accepting the $726 million as the target for mitigation, takes responsibility for these payments. The question this provokes is whether government has now accepted the full 50 year revenue requirements of $74.6 billion as a financial obligation of the province, including debt repayment? 

Did the government understand that such an intervention by the province might trigger financial obligations under the provisions of the loan guarantee agreement? Or did they seek legal advice to confirm that the statutory amendments, the regulatory exemptions and the power purchase agreement would continue to shield the province from liability? Or was the shield against financial exposure simply a façade from the beginning?

Did the federal loan guarantee place the province squarely on the hook not only for providing a “completion guarantee”, including all necessary equity funds to complete the project, but also for ensuring that all revenue requirements are paid? Does this mean that the taxpayer is fully obligated to make payments to cover any shortfall? Our net debt is currently $15.7 billion. If Muskrat fails then could this potentially add more than $12.7 billion to our net debt?

Will the legal shields erected by the province stand up against the storm of financial pressure which Muskrat Falls brings upon us, with costs continuing to escalate and as the target date for first power passes by without notice. The latest Oversight Committee report dated October 15, 2019 shows the date for first power from Muskrat Falls as October 15, 2019, the same date (page 49/52).  This target has come and gone as have others. Further delays will add to the capital cost which will in turn raise the revenue requirements over the 50 year supply period. The recent Liberty report warns of further delays because of problems with transmission software and additional problems with synchronous condensers.

The Muskrat Falls Concerned Citizens Coalition raised a number of questions at the Inquiry to determine the financial obligations falling to the province. Unfortunately many of the most probing questions remain unanswered. The challenge facing the Commissioner is a daunting one. The fiscal impact of the project remains the elephant in the room and must be addressed sooner rather than later.

David Vardy