COST OVERRUNS: IS MUSKRAT FALLS IMMUNE?

The Economist, February 18, 2012 edition, contained an article referring to America’s “…30 year itch” with nuclear energy, manifested by its inability to move beyond the 1979 accident at Three Mile Island. The item held my interest, not for any reason related to nuclear energy, though the lengthy period required to pay for the Muskrat Falls scheme had me thinking of the “half-life” terminology of that industry.

The article contained two references with a local context; one where a nuclear plant under construction in Georgia, by a company called Votgle, experienced a spike from its original estimate of $660 million to a “cool $8.7 billion with electricity costs spiking as a result”.  (Thinking the Economist to be an error, the final cost was confirmed by a secondary source).

Fortunately for the Georgia, it has a population of just under ten million people; twenty times the population of NL.  Although, that State’s population will pay for the Votgle’s project cost overruns through their electrical bills, it is a private company, so the tax payer is shielded from bankruptsy.  Nalcor, on the other hand, is playing with our dime.

A second comment, in the same Economist Article, quoted the head of America’s largest nuclear utility, John Rowe of Exelon.  Said he: “…this was not the time to build new nuclear plants, the main reason was not political opposition or even the threat of cost overruns, but the low price of natural gas.  “Shale (gas)”, Rowe said, is good for the country, bad for nuclear development”. 
Cost overruns and arrival of the shale-gas “era” represent only two of the problems threatening the viability of the Muskrat Falls project. But they are two critical issues. The cost problems of the nuclear industry may be disproportionate but the issue is all too familiar.

When the Muskrat Falls project was first announced, it was heralded as having a price tag of $6.2 billion. 

Now, that figure has been acknowledged by the Government as having increased.  Construction has barely begun.  When it does, design problems and other issues will start to emerge.

Perhaps people think that NL will be spared the consequences of a trend that continues to drag on the viability of all large scale projects.  Let’s look at some Canadian facts:

• The CNRL Horizon Project in Fort McMurray:  Original authorized cost $6.8 billion. (Source:  CBC February 12, 2008). According to Albertametal.ca, final project cost: $9.7 billion.
• Imperial Oil Limited, Phase 1 of its Kearl project, $10.9 billion, about a third more than the original estimate of about $8B (Source: Albertametal.ca)

The next three examples come from the National Post Business Magazine:

• Syncrude’s Upgrader Expansion 1:  $4.1B project (originally estimated at around $3.5B), was started in 2000, came in at $3.7B over budget and two years late. Cost overrun of 90%.  The final cost may have actually been higher.
  
• Suncor’s Millenium Project started in April 2000 with a projected cost of $2B. Fourteen months later costs jumped 70% to $3.4B.
  
• Majority owner Shell estimated in December 1999 a cost of $3.5B for their Athabasca Oil Sands Project. It came in at $5.7B, 63% over budget. 

 

• How about a hydro project for even greater relevance, say, one constructed by Manitoba Hydro, which also circumvented its own PUB.  The Wuskwatim Hydro project had a  forecast cost of $900 million, says Tom Adams, in an opinion article published in the Winnipeg Free Press.  Manitoba’s Clean Environment Commission (CEC) which reviewed the project, concluded, "with a 90 per cent confidence level, costs will be within minus eight per cent to plus nine per cent of the estimated cost." The final cost of the project…is now estimated by Manitoba Hydro at $1.67 billion. (Source: Wuskwatim Under Water - and Sinking, Winnipeg Free Press).

How about projects closer to home.  Let’s see:

• CBC recently ran a story that Vale’s Long Harbour Nickel Smelter has experienced cost overruns of 66% from $2.17 billion to $3.6 billion. Vale’s DG-2 cost estimate was $800 million.
• The cost of Hibernia went from $5.2 billion to at least $6.2 billion when it was finished in 1997.
• The Terra Nova Production Platform started out at $1.9 billion, went to $2.5 billion; in March 2009, The Globe and Mail confirmed a final price tag of $2.9 billion.

Neither Hibernia or Terra Nova Platforms were constructed in the overheated labour environment that has characterized construction at Vale Inco in Long Harbour.

In addition, there is a fundamental difference between these projects and Muskrat Falls, but probably not in the way you are thinking.

Both oil and other commodities, like nickel, benefit from a booming world economy, especially double digit growth in China and India (less so now, but oil is still frothy on a relative basis). Increasing prices, if your timing is fortunate, can justify the huge cost overruns.  But, high oil prices also drive exploration for alternative energy sources, like “shale gas”.  Shale gas is now the chief substitute for coal in the U.S. as that country tries to reduce its carbon footprint; old coal plants are replaced with gas fired electricity. The trend is just getting started, but it is only one of the reasons for declining power prices.

Electricity is experiencing a paradigm shift, as lower demand caused by a less robust U.S. economy, smart grid technology, energy conservation programs and the shale gas revolution, conspire to demonstrate the fickleness of trends.  Adds Tom Adams in the same Winnipeg Free Press article: “Where a kilowatt-hour of electricity earned Manitoba Hydro 6.422 cents in 2003, last year it was worth only 3.09 cents”.

Most importantly to residents of this Province, NL is about to make a huge investment on a trend, that, for the foreseeable future, is not just over, but suffering rapid decline.  It is one that, even in the face of overwhelming evidence, Nalcor and the Government still refuses to recognize. 

Declining electrical prices in the export market magnify the impact of cost overruns and real life consequences for fiscal policy planners; in contrast, increasing (oil) prices and cost overruns constitute a recipe for survival.  Little wonder big oil is doing just fine, thank you.    

SNC Lavalin is Nalcor’s engineering, procurement and construction head on the MF project.  It will prepare the DG-3 estimates for Nalcor; SNC will also handle MF design and other issues as they arise.  It has a cost plus contract with no vested interest in how well or how poorly things turn out. 

The ten projects cited and their cost overruns:  couldn’t happen to Muskrat Falls, could they?