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Thursday 12 October 2017


Guest Post by PlanetNL

PlanetNL3: New Nalcor PPA Information Confirms Massive Revenue Problems

In PlanetNL2, Nalcor’s 50-year Dividends forecast was assessed along with the assumed costs of the 50-year Muskrat Power Purchase Agreement (PPA).  At the time, a revised Nalcor PPA cost forecast was not available, therefore some general guesstimates were made in the absence of specific numbers.  The preliminary analysis predicted huge subsidy requirements from Government to mitigate Nalcor losses and bankruptcy.

On October 3, 2017 Nalcor responded to a citizen’s Request For Information to issue the up-to-date forecast of PPA costs.  A full analysis is presented here using Nalcor’s own exact PPA and Dividend numbers, in combination with the Premier’s expressed 17 c/KWh rate cap, and the PlanetNL prediction that energy sales will fall by 30%.  The results are indeed as frightful as feared: Government debt is going to rapidly mount and crush program spending.

The most efficient way to convey this highly technical analysis is with charts showing the cash flows.  All are based on Nalcor’s 50-year payback period from 2021-2070. 

First is Nalcor’s forecast (data released Oct.3, 2017) of the massive PPA costs to be paid by NL Hydro to the various combined Muskrat entities.  These costs are due on a take-or-pay contract basis regardless of the anticipated drop in energy consumption.  These costs will get worse if the project capital cost increases or if Operations and Maintenance budgets prove to be higher than is presently included within Nalcor’s predicted costs.

In the next chart, it can be inferred that a large part of the PPA revenue is clearly intended to be delivered to the Province as Dividends (data released Aug.31).  These substantial cash flows are supposed to be available to pay back Government its equity investment and provide the promised future earnings.  Export revenues – sales to Nova Scotia or beyond – are included.

The difference between the PPA and Dividend was essentially supposed to be paid by Newfoundland isolated island ratepayers through increases of their billings.  Here, the Nalcor plan is in for a major stumble as ratepayers will balk at extreme electricity rates. 
Premier Ball has even admitted as much when he stated 17 c/KWh was the highest rate consumers might bear – he appears to acknowledge that anything higher is desperately unaffordable.

What Nalcor and the Premier have yet to acknowledge though is the certainty that electricity consumers will substantially reduce their consumption as rates rise.  An energy sales drop of 30% is easily predicted if rates hit 17 c/KWh or higher.  A rate cap combined with the energy sales drop, for all it’s troubles, will prove to not increase total revenue much at all.

Nalcor’s next major stumble is their never-ending belief that energy sales are always going to increase.   Newfoundland is facing a long-term substantial population decline which alone will cause long-term electricity demand to drop.  A declining economy – a key side effect of non-competitively high electricity rates – is also probable.   Global technology development is also resulting in increasingly energy efficient products such that automatic growth of household and business energy demand is no longer realistic. 

The following financial projections cannot recognize Nalcor’s energy sales forecast.  This model will hold sales flat, neither increasing or decreasing.

The chart below predicts Newfoundland (isolated island only) ratepayer sales revenue based on NL Hydro selling 5000 GWh/yr in 2021.  The bulk of it, 4300 GWh/yr is for the residential and commercial markets sold at 17 c/KWh as suggested by the Premier.  The industrial market is expected to buy 700 GWh/yr at 7 c/KWh.  The model allows rates to increase by 2% annual inflation (ie. all the revenue growth in this chart is simply due to inflation).

Nearly all the sales revenue is needed to pay Hydro’s non-Muskrat costs plus Newfoundland Power to maintain the isolated island system that exists today.  The chart below removes what is expended on the non-Muskrat costs.  The remaining portion shown is the net ratepayer contribution toward Muskrat PPA costs: a tiny fraction of Nalcor’s PPA needs even at a high electricity rate of 17 c/kwh.

Premier Ball intends for Government to subsidize Muskrat but he is yet to acknowledge the extent of such a subsidy.  The next chart calculates the requirement.

Government will first decline to collect and use the Dividends; however, alone this is insufficient:   Government will have to inject additional cash starting with over $500M in 2021.

For those who thought there was an upside to Muskrat some years down the road, it’s impossible to find it in these numbers.

Compounding of Government Debt
Government’s $4.0B in Muskrat equity contributions is being carried as Government debt and bears interest charges every year.  Up to and beyond 2021, interest charges will accumulate and compound as zero Dividends are available to pay off any interest or debt.  Government, already deep into repetitive budget deficits, is realistically only going to post bigger deficits and will borrow more money to subsidize Muskrat.

The following chart combines the original $4.0B Muskrat debt, adds the new capital injections and adds the powerful force of compounded interest expenses.  The borrowing cost used in the calculations is a conservative 5% which assumes only a mild bond rating decline which might well be in effect by 2021.  The Muskrat Net Debt is shown both with and without inflation (2%/yr).

The last column at the right indicates the total net present value of the Muskrat project to Government: a $48B loss.  An additional 2% interest hike – quite possible if the bond raters more aggressively downgrade the Province’s credit rating – would increase the loss to $108B (50-year financing terms are very rate-sensitive and this is a huge risk going forward).

Those who feared that the project is adding $12B to the public debt need to consider this cataclysmic range of numbers instead.

Stark Reality
While preparing this post in recent days, two new reports surfaced highlighting the Province’s debt predicament.  The Federal Parliamentary Budget Office released its 2017 Fiscal Sustainability Report and found that Newfoundland is the most unsustainable province.  The Province also released its Public Accounts Report for the last fiscal year showing Total Net Debt has jumped to $13.6B: some Muskrat equity debt is included with more noted to come.  Neither report recognizes the potential long-term subsidy costs of Muskrat.

The analysis of this post reveals the Province racing towards a fiscal cliff at far greater speed than most authorities are aware. The numbers calculated to 2070 are irrelevant: a financial collapse is likely imminent before 2030.  Immense taxation and embarrassingly poor Government services may be just a decade away.

How is it the Government does not recognize or acknowledge the overwhelming evidence of energy demand compression resulting from ballooning rates in combination with the province’s negative demographic and economic growth forecasts – all factors certain to make Muskrat energy completely unnecessary to this province’s needs?

How is it that Government does not recognize the enormous peril that endless subsidies, needed to operate a grotesquely uneconomic project, threaten to effectively bankrupt the Province in the next decade?

The frightening economic realities of the Muskrat Falls project, easily laid out here, must not go unanswered.  Time is of the essence and cowering behind a planned Inquiry is no excuse for the Premier and top officials to not address these critical issues now.  Not only will the Inquiry cost many millions, inaction by Government until after an Inquiry threatens to carelessly add billions more to the public debt.

Additional Assumptions and Risks
The financial modelling behind this post relies heavily on Nalcor’s numbers presented as-is while integrating the Premier’s rate cap.  The only serious modification was to reduce Nalcor’s energy sales forecast.  The Nalcor data carefully excludes rate information: it focuses entirely on costs and revenues as rates are something that would be determined later using cost-of-service utility system principles as practiced in this jurisdiction. 

The year 2070 drops down in nearly all the charts as it is not scheduled to be a full year of PPA payments or Dividends. Also, while payments are actually scheduled to begin in late 2020, even Nalcor doesn’t fully tabulate for cash flows in that year, therefore 2020 has been uniformly excluded.

Nalcor Oct.3 data includes a 10-year forecast (2021-2030) of total Hydro costs that allowed determination of their expected NL Hydro isolated island costs.  This simply requires removal of Labrador market revenues and the isolated diesel community revenues which are known to be presently well under $40M total.  Beyond 2030, a 2% inflation factor is added to all non-Muskrat business costs and revenues.  Likewise, Newfoundland Power is conservatively expected to require $240M beginning in 2021 with 2% annual inflation thereafter.

Many assumptions in the model are conservative and leave more potential for losses to increase rather than decrease.  Among the concerns are:

      1.      Additional increase to Muskrat capital cost.  Apparently Nalcor is already over 80% spent and has 3 years work left to do on the less than 20% budget remaining which seems like a very low burn rate for a 3-year period.  Perhaps a budget overrun of another billion or two is imminent and the Inquiry shall provide useful political cover to “discover” these findings.

      2.     Any increases to the Muskrat system’s Operations and Maintenance Budgets will be over and above the PPA costs and would increase Government subsidy.  Major risk issues lurk throughout the project that could add huge expenses: geotechnical instability, lack of water management rights, transmission system complexity and various design, construction and material quality concerns.

      3.     The energy sales drop may be steeper than the 30% reduction used in this analysis and/or long-term negative growth due to population or economic decline could be realized beyond 2021.  With a rate cap in place, revenue declines and Government subsidy must increase.  The scenario prepared in this analysis might be cautiously considered high.

       4.     Nalcor’s Oct.3 data for the 2021-2030 non-Muskrat Hydro costs (the total required revenue minus the PPA) appear to be lowballed: these costs are presented as decreasing over a 10-year period instead of increasing with at least a nominal inflation factor.  If actual costs climb by inflation through the period, Government subsidy would increase by $90M in 2030.

      5.     The Premier’s 17 c/KWh rate suggestion is surely too high for a great many low-income consumers.  Government will be under tremendous pressure to fund a low-income subsidy program that will further increase Government debt.  An amount around $50M/yr could be ballparked as a form of necessary social assistance through power bill rebates.

      6.     The sector that will have the hardest time adapting to high rates and enacting efficiency improvements will be Provincial Government buildings.  Government’s own power bill increases will add millions in new annual debt or their energy improvement capital projects will add new debt.

       7.     The analysis excludes consideration of the Rural Deficit program which presently collects $60M+ of over-payment from Newfoundland Power customers that is redistributed to rural markets.  When reassessed, rural diesel rate areas, presently subsidized on average 75%+, may be in for a substantial rate increase.  The added revenue may be under $10M and political opposition may partially neutralize their increase.

These concerns could easily wipe out the net ratepayer revenue amount available to put toward Muskrat costs or turn it negative.  Numerous other issues are available to critique.  The Dividend assumptions may be over-optimistic, Hydro and Newfoundland Power costs may escalate at greater than inflation, and more.  None of these items should need much discussion, however, as the business case for Muskrat is so remarkably dead it’s not worth whipping any further.

Next Post
This posting was an unscheduled follow-up resulting from Nalcor’s Oct.3 release of the PPA costs forecast.  In the next post, to appear later this month, the cancellation of the Muskrat project will be presented as the most rational and economic solution to meet Newfoundland isolated-island energy requirements.

Key References
Nalcor RFI responses are on their website here:
-        Select PB-651 for the Oct.3, 2017 response with detailed PPA costs 2021-2070
-        Select PB-555 for the Aug.31, 2017 response with detailed Dividend projections 2021-2070

About PlanetNL
Frustrated by the continuing lack of honest and credible information from Nalcor and Government, PlanetNL, having a suitable analytical background, is presenting independent research and calculations.  This is a spare time activity outside of regular professional commitments.  All key information used to develop the views and analysis are publicly available.  The analysis cannot avoid entering public policy space: if Government or Nalcor wish to refute the analysis, they are welcome to present an open and honest rebuttal.