QUEBEC NEITHER ENEMY NOR BENEFACTOR SAYS FORMER HYDRO-QUEBEC EMPLOYEE

Guest Post Written by Bernard Lahey

I am a Quebecer, currently retired, having spent most of my career in the Quebec public sector - including two stints at Hydro-Québec.  From my point of view, most discussions of Newfoundland and Labrador’s dealings with Quebec ignore several important factors. 

At the outset, it might be a useful reminder that those who ignore history are destined to repeat it.  The danger in the demonizing of Quebec is that it avoids drawing any lessons from Newfoundland’s own role in the saga of Churchill Falls and prevents Newfoundlanders and Labradorians from considering further cooperation with Quebec. 

In this blog, I want to offer some food for thought.  I don’t speak for Hydro-Quebec. I had nothing to do with Churchill Falls. However, I am concerned about what is happening on the Rock.  

From afar, it seems that the province is betting its economic future on a single project - Muskrat Falls.  The financial and operational challenges of the initiative appear to be almost insurmountable, especially for a small Province already facing a major economic crisis. Thanks to the federal loan guarantees, this is no longer Newfoundland and Labrador's problem.  We are in this together whether we like it or not.  Call me naïve if you please, but I wonder: if Newfoundlanders and Quebecers can achieve a better mutual understanding, perhaps we can discuss cooperation more constructively.  

My goal is to present, as best I can, the other side of the Upper Churchill story – the dark side if you will. 

It is easy to forget the context in which the Upper Churchill project was realized. The foundations of the deal were actually laid in 1953.  Hydro-Quebec's involvement came much later, in the mid 1960’s following the nationalization of Shawinigan Light and Power, which held a minority interest in Brinco.  Premier Joey Smallwood, motivated by his fervor to develop Labrador at all costs, granted exclusive water rights to Brinco, a private Anglo-Canadian consortium for a period of 99 years, renewable thereafter under the same conditions for another 99 years (until 2151).  No doubt Smallwood was anxious to please the shareholders of Brinco who represented the elite of Anglo-Canadian high finance. An article from the New York Times, in 1964, provides an interesting description of Brinco. These are the people who negotiated the Churchill Falls deal: Rothschild, Falconbridge, Bowater, Rio-Tinto, Anglo-American - to name a few of the major Brinco shareholders.  They are not the type of investors who can easily be fooled or intimidated.

Having control of the immense hydro-electric potential of Labrador for a period of 198 years, Brinco was able to offer Churchill Falls energy to contingent buyers at long-term prices based on production costs plus an annuity. The catch was that the project was far too big, even for Brinco. The project  needed financing and in order to secure financing; needed was a guaranteed customer with a reliable credit rating. That was easier said than done. 

Churchill Falls is between 1,000 and 2,000 km from the major markets of Ontario  and the United States.  In the 1960's, Ontario and the Americans were still enamored with the magic of nuclear energy.  There was precious little interest in such a bold plan involving the long-distance transportation of energy over an inhospitable climate.  In any event, the transportation of electricity over such distances was unheard of and indeed, technologically unfeasible prior to the development of 735 kV transmission lines by Hydro-Quebec in the mid-60's.   

The popular narrative is that Quebecers were able to hold Newfoundland hostage by refusing to allow the transmission of electricity through its territory.  The truth is a bit more complicated. Granted, Quebec was not interested in ceding thousands of kilometers of its land for the construction of high-voltage transmission wires to allow Churchill Falls corp (CFLco), Brinco’s newly minted subsidiary, to compete with Quebec in its export markets.  Go figure.  Moreover, a few thousand kilometers of high voltage transmission wires are not a pretty sight.  How would you react if your neighbour asked you to run them through your back yard?

There is also the question of who would pay for the construction, maintenance and operation of the lines.  Transmission costs totalled $500 million, roughly equal to half of Newfoundland’s annual GDP.  Clearly Brinco did not have the financial means to undertake such a project on its own. Meanwhile, the federal government had no interest in intervening in a sector of provincial responsibility to finance a massive electricity transportation grid when neither Ontario, nor the Americans had any interest.

When CFLco required further injections of capital, HQ was the only partner willing to increase its investment.  Much is made of the last-minute, 25 year extension accepted by CFL co given its precarious financial condition.  Much less is made of the fact that Quebec had guaranteed the financing rate of the entire project.  As interest rates rose, Quebec was forced to subsidize the interest cost of the entire project.  Could it be that Quebec’s demands for further concessions were related to the deteriorating economic benefit of the project?  

Those who know don’t talk and those who talk don’t know.  I suppose people will believe what they want to believe.  In any event, lets be clear about one thing:  Hydro-Quebec drives a hard bargain and they assume that their counterpart will do the same.  HQ’s job is to maximize the gain for the Quebec tax and ratepayer, full stop!

When CFL co found itself on the verge of bankruptcy, Newfoundland could have stepped in and nationalized the private sector share of the company - as it eventually did a few years later.  Why the inaction?  Well one reason was that Premier Smallwood was smitten with the project.  Without Hydro-Quebec as a partner, Smallwood wrote in his diary, the project never would have been completed.  Hydro-Quebec was the only entity willing and able to put its money where its mouth is.

One other common misconception relates to the pricing formula, which declines over time.

Recall that the proliferation of nuclear energy meant that the real price of electricity had been trending downward for decades.  At the time, there was no particular reason to expect that to change. Meanwhile, Hydro-Quebec had no shortage of interesting projects within the Province.  In the case of the Churchill Falls deal, Hydro-Québec assumed the same economic risks as it did in projects completed in Quebec.  HQ therefore insisted on benefits and conditions, including a very long-term fixed price of electricity, that was lower than the price it could anticipate from its own facilities.  Most commentators like to point out the dramatic difference between the current price of electricity and the price included in the Churchill falls contract.  However, the same dramatic difference exists for all of Hydro-Quebec facilities completed in that era, such as Manic 5.  Moreover, the point is that if Brinco had insisted on some type of price escalator clause, HQ would have proceeded with projects within Quebec and Churchill Falls would not have been built in the first place.  At the end of the day, CFLco shareholders settled for a guaranteed long-term return with essentially no risk. A win-win!

It is easy to forget how huge the original Upper Churchill project is: just over 5 times the size of Muskrat Falls.  The total cost of the project was about equal to the annual GDP of Newfoundland.  In other words, CFL co, was in no position to assume the risks associated with such a massive project.  To find financing for the Upper Churchill, HQ had to supervise the project and assume all construction risks.  As Nalcor is now realizing, these risks are huge in a project such as this.  Indeed, something as simple as the choice of suppler and quality control on inputs is an art unto itself: experience counts.  

HQ guaranteed and eventually had to subsidize the interest cost of the project.   Since most of the project was financed in US dollars, Quebec was forced to take on a large foreign currency risk which, in those days, could not be hedged.  Finally, HQ alone paid for the transmission of the energy through Quebec, a cost equal to about half the cost of construction of the production facility.  By the way, many of the aforementioned costs are conveniently ignored in any evaluation of relative gains from the project.  

Meanwhile, Newfoundland’s financial risk was limited to its small equity share in CFL co.  It is common to hear that HQ has garnered the lion’s share of the profits from Churchill Falls.  The fact that HQ assumed essentially all of the financial and operational risks of the project is not mentioned quite as often.  Nor is it mentioned that other projects within Quebec such as James Bay were delayed in anticipation of the completion of Churchill Falls.

After years of negotiation, presumably with the full knowledge of Premier Smallwood, after a massive investment in long-distance electricity transportation, and following the completion, on schedule and within budget, of one of the largest hydroelectric projects in the world, it took Newfoundland no more than 2 or 3 years before attempting to renegotiate the 70-year fixed rate agreement and embarking on a series of legal challenges aimed at declaring the contract null and void.  Hydro-Quebec was not amused.  By the way, if you think the contract with Hydro-Quebec was one-sided, wait until Newfoundlanders digest the full implications of the recent agreement with Nova Scotia.

What is the point of this blog?  Well, past is prologue.  Muskrat Falls is in trouble and something has to be done.  We have to stop whistling past the graveyard.  The problem is not simply a question of cost.  The technical and operational risks are equally daunting.  Finally, the power deal with Nova Scotia is almost certain to constitute a major financial burden for Newfoundlanders for a generation.  I happen to think that Newfoundlanders’ future is at stake.

So here is my two cents worth:

·       An independent review of the Muskrat Falls project by a panel of experts should be undertaken immediately to decide whether to continue and if so, what is the plan. 

·      This project was facilitated by the federal government.  They bear the ultimate responsibility for this project and sooner or later, will have to assume a significant share of the cost.  Debt guarantees will not be enough to save the Newfoundland tax and rate payer.

·       So far, there is precious little evidence that Nalcor has the necessary experience to complete a project of this size.  The inconvenient truth is that Hydro-Québec is perhaps the only entity in the world with extensive experience in the construction of massive hydro-electric projects in a sub-arctic environment.  Newfoundland and Labrador’s distrust of Quebec is a major stumbling block to cooperation.  In my view this distrust is unwarranted.    

     If Muskrat Falls ever gets completed, some degree of cooperation may be required to maximize energy production.  Moreover, it would be nice if we could talk to one another sometime before expiration of the current Churchill contract in 2041. HQ has a constructive business relationship with all its neighbours, except Newfoundland and Labrador.  However, Hydro-Quebec is a business.  Any deal would have to entail an economic advantage for Quebec.  That is how these things work.  Quebec is not your enemy but isn’t your benefactor either.

·       The deal with Nova Scotia represents a major financial burden for Newfoundland.  This deal has to be renegotiated.  I would say the federal government should recognize their responsibility for this debacle by assuming the cost of the Maritime Link. 

I hope that Newfoundlanders and Labradorians will understand that this was written in good faith and is meant to spur debate on a subject that is critical for your future, and perhaps ours.

Good luck

Bernard Lahey

Montreal 

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About Bernard Lahey

Bernard Lahey holds a Bachelor's degree in Economics from the University of Toronto and a Master's degree in Economics from the University of Western Ontario.  After starting his career as a member of the Research Department at the Bank of Canada in Ottawa, Mr. Lahey joined the ministère des finances du Québec where he held various positions in the area of finance.  In 1997, Bernard Lahey joined Hydro-Québec where he worked in various capacities ranging from trading, to debt management and gradually rose through the ranks to be named Assistant Treasurer in 2005. Between 2007 and 2009, Mr Lahey oversaw operations on the currency desk at the Caisse de dépôt et placement du Québec. He returned to Hydro-Québec in 2009 as CIO of the pension fund and has been retired since 2014.