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Monday 9 October 2017


Guest Post by David Vardy

Framing the Mandate for a Commission of Inquiry
Premier Ball has announced that an Inquiry into the Muskrat Falls project will begin soon, perhaps before Christmas. Before celebrating this announcement we need to know that the Inquiry will have a broad scope, as well as the necessary resources to do the job.
The Commissioners must have a wide range of expertise, including experience in managing major projects, as well as expertise in energy policy, project engineering and public utility regulation. The panel should include people who operate at an international level as well as Commissioners who understand the environment in which we operate. This mission calls for a broad set of skills and requires more than one  single Commissioner.

The terms of reference for the Inquiry should be framed with public input through a consultation process. I agree with Uncle Gnarley that Nalcor should have no role in writing the mandate of the Commission. The mandate should be as broad as possible and it should allow the Commission to report and recommend on all matters relating to the project. If there are any restrictions they should be subject to public debate. Government should release a draft of the terms of reference and invite public input, perhaps through the good offices of an independent third party. 

The purpose of the inquiry should be to improve public policy and the management of public projects, with particular reference to the completion of Muskrat Falls and the task of placing its future operation on a viable footing. All major public inquiries in the past have had two major components: the first to find out what went wrong and the second to find out how to prevent the problems from recurring. 

The Ocean Ranger inquiry was conducted in phases. The first was to find out why the Ocean Ranger went down in February of 1982 with 84 people on board. The second was to improve safety standards to reduce the risk of future disasters. The mandate for these inquiries included both a retrospective as well as a prospective, or forward-looking, focus.  The same can be said of the Harris Panel on the State of the Northern Cod Stock, the Dunphy Inquiry and the Wells Inquiry into Offshore Helicopter Safety.
The Inquiry should be given all the powers conferred under the Public Inquiries Act, the power to subpoena evidence and cross-examine witnesses, similar to other public inquiries such as the Ocean Ranger Royal Commission and the Cameron Inquiry into Breast Cancer Testing. Government should challenge the Commission of Inquiry to find solutions and to set a new course for the operational phase of Muskrat Falls.

What we demand from the Commission of Inquiry is the unvarnished truth, a rare commodity in the Muskrat Falls world. The Commission must assess the many tainted assumptions and the flawed business model and tell us if the project can be salvaged, despite its sullied provenance. The conduct of a forensic audit will be essential to the process of tracking how decisions were made and determining if professional or legal codes were breached.
In its Report and Recommendations, the Commission must reveal what was wrong and why it was wrong but they must go beyond pointing out the errors and search for solutions, solutions that will replace the flawed components or pillars on which the project was sanctioned. The work of the Commission must balance its work between investigating what errors were made, whether through deliberate deceit or ignorance, and finding remedial solutions.

The balance between the Commission’s investigation of past mistakes in policy and management, versus finding future solutions, should be 50/50, with equal weight between investigating past mistakes and proposing future solutions. If no solutions can be found, the Commission should report truthfully that the project is not viable and advise that further financial commitments should be avoided. 
While 78% of the project may be complete the question remains as to whether the project is viable and whether it can support the increased cost of $800 million each year on top of the $700 million annual cost of running our electricity system on the Island. Indeed, the revenues may not even be able to support the operating costs, estimated for 2021 at $143 million. If revenues do not cover costs the project is doomed, sooner or later to be mothballed, a monument to failure. 

Examination of consumer behaviour tells us that, if rates double, demand will shrink by 40%, eliminating all potential demand for Muskrat Falls and devaluing the assets. Export revenues are unlikely to cover operating costs. The project may have to be mothballed, even if it is perfectly capable of generating power, albeit at a loss.
The joint environmental panel report was ignored and overruled and the PUB was denied the opportunity to conduct a full review or to exercise regulatory oversight over the project and its construction. The project is being carried out without the environmental oversight needed to ensure that the recommendations of the joint panel are implemented. From both an environmental and financial standpoint this project is a disaster of epic proportions.

The Inquiry should be charged with finding out how the fundamental flaws can be corrected. If they cannot be corrected then the project will go into bankruptcy because it will not be able to cover the operating costs, let alone the capital costs.
The Muskrat Falls project was sanctioned without a sound business case. Without fundamental changes the project will founder into bankruptcy. The Inquiry should be mandated to report and recommend on all matters which threaten the viability of the project. The “pillars” upon which the project is founded are built upon sand and not on solid rock. Unless these pillars are reconstructed on a solid rock foundation the failure of the project is assured. If action to correct the fundamental flaws is excluded from the remit of the Commission the project is doomed. I will cite only four examples of such pillars. 

1.                                 The first pillar is the 50-year take-or-pay power purchase agreement (PPA) which requires that NL Hydro purchase power from its parent company Nalcor Energy, regardless of price. This unregulated monopoly situation is intolerable in 2017 and belongs back in the 19th century, when unregulated monopolies ruled the day.  

Consumers will find ways to avoid contributing toward the cost of Muskrat Falls when rates double, leading to a reduction in demand from 7,000 GWh to 5,000 GWh or less. Revenues from rate increases may increase slightly or possibly decline, depending on whether the elasticity of demand (in absolute value) is less than one or greater. If the latter (greater than one or >|-1|)  then revenues will actually fall when rates rise, leaving no contribution toward the estimated $800 million in incremental cost arising from Muskrat Falls, other than meagre export revenues. 

2.                             The second pillar is the water management agreement to which Quebec has
refused to become a signatory, leaving the project without the ability to optimize production and to achieve its capacity (824MW) and energy (4,900 GWH) production targets. When the Quebec Superior Court ruled in 2016 that the rights given to Hydro Quebec under the first 40 years of the 65 year power contract continue intact into the final 25 years (the Renewal Contract) it struck a blow at a fundamental pillar of the Muskrat Falls project.  

3.                            The third is the agreement with Nova Scotia to provide power at rates below 
the rates offered to consumers in this province. This is an unsustainable pillar of the Muskrat Falls project.
4.                                The fourth pillar is the back end loading of the costs, which imposes an 
intolerable burden on future generations. This is illustrated by Nalcor’s estimates of capital cost recovery for generation assets, rising from $170 million in the first full year of operation to $1067 million in year 50.

In addition to these four pillars there are many assumptions that must be challenged by the Commission, including the following: 
i.                    The contrived cost estimates, which have risen from $6.2 billion to $12.7 billion and are likely to rise further; 

ii.                 The assumption that oil prices would continue to increase beyond the level prevailing at the time the project was announced;

iii.               Load growth projections, rising from 7,000 GWh to 10,000 GWh by 2030, along with the assumption that rate revenues will always increase in lock step when rates increase;

iv.                The assumption that Nalcor should be given extraordinary powers, including exemption from compliance with the Public Tendering Act and removed from oversight by the PUB;

v.                  The assumption that Nalcor was capable of managing a project of this magnitude; and

vi.                The assumption that the North Spur has been fully remediated and is now safe. This poses intolerable risks upon people close to the generation site. There must be a technical review of the science and remedial action to avoid a disaster of epic proportions. While the Commission may not have the expertise to conduct the necessary technical review they can assess the need for such a review and recommend it be undertaken before the project is completed.
The  Commission must be given a broad enough mandate to allow them to examine all the pillars, including the contrived cost estimates and the neglect of the effect on demand when prices double and remain high. Only by inviting the Commission to bring forward recommendations based upon their analysis of the failed business model and contrived assumptions can we hope to make this a viable project.

We know we cannot make a silk purse out of a sow’s ear but we have to strive at least for a “polyester purse”, for a project which covers most of its costs, without plunging the province into bankruptcy, or else making it a dependency of the federal government.

The Commission must be able to make recommendations which will strengthen the project’s viability. These may include legislative changes to place Nalcor under full regulation by the PUB or the merger of all of Nalcor’s electric power assets into a fully regulated NL Hydro. They may include abandonment of the take-or-pay contract as well as the unconscionable energy sales agreements with Nova Scotia. They may include recommendations concerning the flawed business practices and lack of transparency of Nalcor. 
The Commission should be asked to provide interim reports, reports which will enable government to introduce changes in project management and in the business model under which Muskrat Falls will be operated. With at least three years remaining before full power there is ample opportunity to make improvements in the project, particularly in the way it will operate after construction. If the Commission discovers that the business model is beyond remediation they will have no choice but to recommend termination, in order to avoid digging us deeper and deeper into a hole from which there is no escape other than declaring provincial insolvency.
David Vardy