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.
