REFLECTIONS ON THE MUSKRAT FALLS PROJECT

Guest Post by David Vardy

Introduction

The sanctioning of the Muskrat Falls project in December of 2012 was a huge mistake, one which has spiralled into a major economic and environmental catastrophe. 

The warnings of the joint federal provincial panel were ignored, as were those of the Public Utilities Board. These warnings relate to the lack of a business case for the project, the high risk for a small province, the adverse demographic factors, the lack of export markets and the high unit cost.

A Gamble that failed

In a Telegram article dated May 25, 2013 the Honourable John Crosbie said that “Muskrat Falls is worth the risk”, quoting T. S. Eliot on the subject of risk: Only those who would risk going too far can possibly find out how far you can go. Since then we have sailed on a sea of risk and reaped the whirlwind. 

David A. Vardy

The challenge now is to prevent the risks from destabilizing the provincial economy. The risks of operating the project may prove to be just as daunting as those of building it, due to the impact of high power rates. The incidence of these power bills is likely to be placed on those with the least ability to avoid the burden, namely residential customers, whose only recourse will be to leave the province.

The project was based on speculation that known risks would not turn against the project, risks of escalating costs, declining oil prices and decreasing demand for electricity. Cost estimates were contrived to ensure project sanction, by using unrealistic numbers, cost estimates that were known to be too low. It has been alleged they were deliberately falsified to encourage sanction by government in December 2012.

Nalcor substantially reduced its demand forecast in 2016, indicating that the load forecast used to justify the project was as questionable as the cost estimates. A more cautious approach would have built capacity incrementally rather than incurring the large capital cost of overbuilding, taking the risk that lucrative markets to recover costs could be found for power surplus to domestic needs.

Risk borne by ratepayers

It was a fundamental mistake for the province to embark on this project, placing all the risk on ratepayers. The “take or pay” power purchase agreement will place the majority of the burden on residential customers. By sanctioning this project government ignored the huge demographic transformation, with more senior citizens, declining working age population and shrinking overall population.

Projections of demand ignored the first law of economics, the law of demand and price elasticity, which rules that people will substitute other alternatives when prices rise. Demand will decline rather than grow in the face of surging power rates. Government and Nalcor relentlessly insisted that we “need the power”, failing to recognize that unaffordable rate increases will likely result in such drastic reduction in demand that no Muskrat Falls power will be used within the province.

Bargaining Position with Quebec

It was also a mistake to believe that Muskrat Falls and the Anglo-Saxon Route would strengthen our position with Quebec. The two submarine crossings and the relationship between Nalcor and Emera have not helped us. We became prisoner to Nova Scotia in our quest to finalize a loan guarantee agreement with the federal government, who demanded an interconnection with the rest of Canada across the Cabot Strait, as a precondition.

The Maritime Link is sized around Muskrat Falls and offers no redundant capacity to carry either Churchill Falls power after 2041 or power from Gull Island, which continues, inexplicably, to be the Crown jewel for ambitious politicians. The unnecessary investment in high cost Muskrat Falls power precludes us from benefiting fully in 2041 from access to low cost Churchill Falls power, because Muskrat Falls more than satisfies our needs for the medium and long term.

False Premise

Reliance on Muskrat Falls ignores the fact that most of the demand is located on the Avalon and that we will still need emergency power based at Holyrood. It was a huge mistake to think that Holyrood could be shut down and that our emergency power would be supplied from Nova Scotia. We cannot depend on 1500 km of transmission lines crossing a variety of climatic zones where icing and high winds will knock out lines and iceberg scouring in the Strait of Belle Isle will threaten the submarine cables. We could never choose between Muskrat Falls and Holyrood because Holyrood, or its replacement, will continue to be needed.

The reference question put to the PUB in 2011 posited a choice between two complementary projects which were never alternatives. This false premise was compounded by precluding the PUB from examining other alternatives, such as wind, solar power, energy efficiency and demand side management.

The Brinco Model

Muskrat Falls began with an integrated management structure, with SNC Lavalin taking the lead in engineering, procurement, construction and management (EPCM). This changed over time with a downgrading in the role of SNC Lavalin and with Nalcor assuming the lead, relying on SNC Lavalin for engineering design, but with Nalcor officials signing off on procurement, contract awards, change orders and disbursements. This departs from the way Brinco built the Churchill Falls project and Muskrat Falls has suffered from the departure from the Brinco model.

Brinco knew it needed to bring in outside expertise and they retained Acres Canadian Bechtel (ACB) to undertake construction at Churchill Falls, bringing it to completion within budget for $946 million and ahead of schedule. (See https://www.ieee.ca/millennium/churchill/cf_history.html)

The Acres Canadian Bechtel (ACB) consortium acted as agents for CF(L)Co, charged with responsibility for engineering and construction management. The construction organization in the field had ultimate responsibility for contract administration, inspection and construction coordination.

All work on the project was carried out by contractors. More than 180 construction and services contracts were awarded, ranging widely in value, but with a maximum of $75 million for a single contract.

Note that the Astaldi contract began at $1.1 billion and has risen to $1.830 billion, without explanation. Along the way they built a canopy or dome for $120 million but subsequently discarded it as junk. Brinco and Acres Canadian Bechtel had a limit of $75 million for any single contract. The limit in Hydro Quebec is $50 million for a single contract. Smaller contracts allow for more competition. We should at least have pre-qualified the bidders, probably removing Astaldi from consideration, due to its lack of Canadian and northern experience. Instead we opted to maximize the risk.

Public Tendering and Cost Plus

The tendering process has been byzantine, anything but transparent, and outside of the public tendering rules followed by the rest of government. Nalcor has never provided convincing evidence why it could not operate through public tendering nor have they explained why they did not place a cap on the value of large contracts, as was done for Churchill Falls. The Astaldi contract was essentially a cost plus contract, despite the statement by Ed Martin at the 2015 Nalcor AGM that it was a “lump sum” project, fixed in terms of the projected amount of concrete to be poured. This point was confirmed by EY in their April 2016 report when they said that the payment mechanism is based on person-hours expended rather than m³ of concrete poured. This mechanism did not capture the potential for poor contract management labour and the consequent decoupling of labour paid from work completed. It was Nalcor, namely NL ratepayers, who took the risk, and not Astaldi!

Hydraulics and water management

One of the big advantages of Churchill Falls, apart from the large reservoir, was the hydraulic head of 312 metres, compared with 35 metres for Muskrat Falls, 100 metres for Gull Island and 176 metres for Bay D’Espoir. The head is how far the water falls from the reservoir to the tailrace.

Of course Muskrat Falls shares the reservoir with Churchill Falls and that is a major advantage. However the lack of an effective water management agreement with Hydro Quebec makes it quite impossible to achieve the 824 MW of capacity that has been touted. The Quebec Superior Court decision rendered by Justice Martin Castonguay last August confirms that Nalcor’s solution to the problem, approved by the PUB in 2009, is not practical or realistic. Resolution of this problem requires either a negotiated settlement with Quebec or winning our appeal of the Castonguay decision to the Supreme Court of Canada. This is another unresolved risk.

Sensitive Clays at the North Spur

The April 2013 risk report from SNC Lavalin confirmed the high risks, risks which should have been mitigated in advance of sanction. We now know that this report did not get the attention it merited. One of the high risk areas identified was the North Spur and the potential for sensitive clays to liquefy, due to water pressure, when the dam is impounded.

Sadly the PUB missed an opportunity to deal with this issue as part of its hearing into supply issues and reliability of power. This hearing began with DarkNL and is continuing. The PUB accepted Nalcor’s argument that consideration by the PUB of the risks of the North Spur and of the ineffective water management agreement was outside the scope of the hearing. They also contended it would have defied the Exemption Order which prevented the Board from exercising its normal regulatory authority over the Muskrat Falls project. The PUB allowed the filing of evidence relating to the reliability of the transmission line but disallowed evidence concerning the generation project itself, including the North Spur and water management. These inexplicable decisions of the Board left these two issues bearing enormous risk unresolved.

We continue to lack independent validation of the safety of the North Spur. A recent thesis by a graduate student at the Lulea University of Technology in Sweden confirms that safety is a huge problem. An article written by his thesis supervisors, Dr. Lennart Elfgren and Dr. Stig Bernander, adds credence to the argument that the remediation at the North Spur must be reviewed by a panel of eminent geo-scientists. 

The unresolved risk of the North Spur places people in danger, along with the capital investment, demanding appointment of a review panel.

Will Muskrat Falls be mothballed?

We continue to dig a hole for the province as we pour money into this money pit. The surging rates will knock electricity demand back to the point where no demand for MF power will exist. Export markets will return only two cents per KWH, making a negligible contribution to rate mitigation. Vital equipment is being sourced in China and may be unreliable. The 2013 SNC Lavalin report on risk said, based on past experience “quality, performance, warranty service and schedule problems can be anticipated with these Lump Sum turnkey packages (i.e., major claims and delays.") Quality control is a problem because Nalcor does not have the experience to manage a project of this magnitude.

The incremental costs will be around $800 million annually and rising. Between $120 and $200 million of Bunker C might be displaced but the economics of replacing $200 million of oil with $800 million in capital costs again defies economic logic. The $800 million is the same order of magnitude as the tax increases and other revenue measures introduced in the 2016 budget, many of which were rolled back because of public resistance. This is likely to become a big white elephant, one we cannot afford to operate, as consumer resistance to high rates stifles demand.

Transparency

The promise “to open the books” on Muskrat Falls has not materialized. EY produced only an interim report. The Muskrat Falls Oversight Committee has failed to produce the quarterly reports which were issued prior to the election, attempting to fill the void by posting a serious of vacuous monthly reports. The Oversight Committee was too close to government (and to Nalcor) to be effective, being solely comprised, until recently, of government officials.

The so called “Independent Engineer” (Montgomery, Watson and Harza, MWH) was taken over more than a year ago by Stantec, a big Nalcor contractor, without remedial action to correct the conflict of interest. These oversight bodies were far too reliant on data supplied by Nalcor, without critical testing. The PUB remains neutered while Nalcor continues as an unregulated government-owned utility, with unusual powers (e.g., exempt from public tendering) exceeding those of other crown corporations.

Provincial Fiscal Situation

Our fiscal situation is desperate, more precarious than that of Puerto Rico, which is now under a federal board of supervision. Nova Scotia is running a surplus, without the high oil royalties we continue to enjoy. Our public sector is far too large, as shown by a recent AIMS report. 

Forum for Debate

The House of Assembly has not been seized with the problems. No emergency sessions have been convened to avert a growing crisis. Nor is the provincial Cabinet focused on the issue of Muskrat Falls. Oversight mechanisms are mostly inactive. Minimal information has been released by the new Board and Nalcor’s CEO.  No explanation has been given for the burgeoning cost of the Astaldi contract or whether the flaws in the original contract have been corrected. Citizens are left in the dark and this is not acceptable.

The latest monthly report shows that in May of 2017 expenditures were $154 million dollars. At $500,000 per person year this project cannot be rationalized as a make work project nor can it be explained as part of a rational energy strategy or economic development plan. It is simply a fiasco and one which poses an existential threat which many citizens have yet to perceive.

Is it normal for a society in crisis to be so blasé about its future? Are our institutions serving us well, including the provincial and federal governments, Nalcor Energy, Newfoundland Power and the PUB? Memorial University appears to be punching well below its weight in failing to encourage public engagement on this issue and the fundamental economic and fiscal crisis of which the Muskrat Falls fiasco is a part? They have failed to respond to the challenges issued by Edsel Bonnell and others to create a new forum to bring forward possible solutions

Conclusion

The government seems to be impervious to rational thought, having taken refuge in the wisdom of Stan Marshall. Stan refuses to seek an independent review of the North Spur and government will not overrule or rile him. Stan has failed to deliver a rethinking of this project or even a change in the management team.

Is there a further role for the federal government? We could not have sanctioned the project without the loan guarantee of $5 billion, which has now been increased to $7.9 billion. Should we commend or condemn the federal government for their role in enabling us to embark upon this risky undertaking? The loan guarantee agreement was designed to ensure that the ultimate responsibility and financial risk was deflected back to provincial ratepayers, minimizing the risk to the federal government. The province is obliged under the 2012 agreement to ensure after the project is completed that “the regulated rates for Newfoundland and Labrador Hydro (“NLH”) will allow it to collect sufficient revenue in each year to enable NLH to recover” costs incurred.

Ultimately the risks came back to the ratepayers in NL. Should we now ask the federal government to reactivate the inactive Lower Churchill Development Corporation (LCDC) and to share in the financial risks of both construction and operation? It is clear that the federal government will be called upon to take a larger role, beyond simply raising the cap on the loan guarantee. It is also questionable that we as a province are going to be able to operate the facilities on our own and to bear the full cost burden.

Will a renewed federal provincial corporation, bearing 49% of the risks, be the best vehicle to finish the project and to operate the facilities once completed? Or will we take the far greater risk of going to Quebec for a comprehensive agreement which will enable us to complete the Muskrat Falls project, as part of a package involving water management, Gull Island and extension of the Churchill Falls contract beyond 2041? This might offer short term gain but a mountain of long term pain.

David Vardy