Editor's Note: When David Vardy released the essay entitled “Making Best Use of the Lower Churchill: The Muskrat Falls Development”, which he had prepared
as a brief for the Action Canada Fellowship in 2011, it constituted the first sceptical
appraisal of the many claims of the Williams Administration regarding the
project.
It took six more years before then Fortis CEO and current Nalcor CEO Stan Marshall got around to describing the project as a “boondoggle”. But Vardy was there, at the starting gate, absent any but the public interest, to warn of that likely outcome and to replace hyperbole and falsity, often issued under the guise of patriotism, with objective analysis.
It took six more years before then Fortis CEO and current Nalcor CEO Stan Marshall got around to describing the project as a “boondoggle”. But Vardy was there, at the starting gate, absent any but the public interest, to warn of that likely outcome and to replace hyperbole and falsity, often issued under the guise of patriotism, with objective analysis.
It can rightly be said that Vardy not just wrote the primer on
the Muskrat Falls project; he was the "first responder" sounding the alarm, demanding notice of Muskrat as
ill-considered, possibly injurious, public policy.
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| David A. Vardy |
It was in response to his
alarm that this Blogger, and a handful of others, began asking questions and
writing, first about government’s shift to secrecy and opacity over the
business case for the project (exemplified by its refusal to deal even-handedly
with the PUB) and later, when the main stream media (except the Telegram's Wangersky) wouldn’t or couldn’t,
provide exposure to the entrails of an emerging – now a full-blown - debacle.
When David Vardy ought to have been welcomed by politicians and officials as a source of sound analysis and common sense, giving him a full
airing of his concerns – and those of others – he received only
the title “naysayer” and the opprobrium of Danny Williams and his adherents.
Vardy still works daily addressing questions to Nalcor and to the
Government - and to dozens of others who might assist or give clarity on some issues - writing articles for this Blog and the Telegram and appearing in
the mainstream media. He is an unrelenting “town crier” determined to raise the
profile of Muskrat issues as the project – slowly, but surely - is recognized by
the public as a serious threat to the province’s solvency and many other elements of our
social cohesion.
In British Columbia, a new government is reappraising a hydro
project of its own, known as “Site C”, which it fears is also a boondoggle. It has mandated
an Inquiry to review the project and to determine if it should be continued.
Drawing on his analysis and experience with the Muskrat Falls
project, Vardy submitted a 48-page Paper to the British Columbia Utilities Commission entitled "Site C and Muskrat Falls Compared". Based upon that work the Commission invited the former senior public
servant to appear in person and to make an additional – oral - presentation. Vardy summarized his far lengthier tome for this purpose - which he delivered in B.C. on Saturday,
October 14th. The verbatim text of his oral submission is available at this LINK at page1511 and his draft comments follow. - Des Sullivan
PRESENTATI ON
TO THE BCUC INQUIRY INTO THE SITE C PROJECT – Vancouver, October 14, 2017
By David Vardy
My name is David Vardy and my submission to the
Commission is a comparison of Muskrat Falls with Site C. I am an economist who
served for most of my career as a senior public servant in the government of
NL.
Earlier in my career I was a member of the Economics
faculty at Queen’s University and worked in the federal departments of Finance
and Fisheries. I did my graduate training in economics at the University of
Toronto and at Princeton University.
Within my home province I served as Secretary to the
Cabinet, Chair of the Public Utilities
Board, President of the Institute of Fisheries and Marine Technology and Deputy
Minister of Fisheries.
My full submission of August 30, 2017 is on the BCUC
website.
In both NL and BC hydroelectric power reigns supreme. In
BC 90% of capacity is hydroelectric while in NL 64% of Island supply is hydro
power and for the province as a whole hydro power is higher than 90% of the
total supply, when the giant plant at Churchill Falls is included.
The power capacity of BC Hydro is 10,000 MW while that of
Nalcor Energy is 7,500 MW, including Churchill Falls, which is rated at 5,428
MW. Nalcor is the majority shareholder in Churchill Falls, with Hydro Quebec
holding 34%.
Most of the energy produced at Churchill Falls is sold to
Quebec leaving Island capacity at about 2,000 MW which compares with 10,000 MW
in BC.
Unlike BC Hydro Nalcor Energy is not regulated, even
though its fully owned subsidiary, NL Hydro, is regulated by the Public
Utilities Board.
Muskrat Falls will add 824 MW and 4,900 GWh to the
provincial system. While Muskrat Falls is similar in size to Site C its impact
on the province is much greater than the impact of Site C on BC. Site C
represents 3.5% of your province’s GDP and 21% of your net debt, while Muskrat
Falls represents 42% of our GDP and 85% of our net provincial debt.
The Muskrat Falls project includes a number of components,
additional to the generation plant itself. The generation plant accounts for
54% of the cost while transmission lines represent 46%, a much higher
transmission component than that for Site C. Also included in the project is a
sub-sea cable crossing under the iceberg infested Strait of Belle Isle. The TL
connecting the Island with Nova Scotia is known as the Maritime Link.
The impact of Muskrat Falls on power rates will be
enormous, with rates doubling to 22.9 cents per KWh in 2021, the first year of
full power. My understanding is that Site C will not trigger large rate
increases when it comes on stream in November 2024.
I will highlight some key issues that I think are
relevant, relating to the following matters:
1. Planning time frame and intergenerational
equity;
2.
Underestimation of costs;
3.
Overestimation of consumer demand; and
4.
The business case for Muskrat Falls.
Planning
time frame and intergenerational equity
Nalcor selected a planning horizon of 50 years and
advanced the Muskrat Falls project as a long term solution to a perceived
energy problem. If we did have an impending energy shortage it would be
relieved by 2041 when the Churchill Falls contract with Quebec comes to an end
and we have access to its full 5,428 MW production instead of our current
access of 525 MW.
In presenting the Muskrat Falls project Nalcor ignored
the availability of Churchill Falls power. The time frame for the review in NL
should have ended at 2041, without adding further generation costs from 2041 to
2070.
The project required a long payback period to build any
kind of business case. Such a long time frame permits costs to be shifted into
the future through various devices. Both BC Hydro and Nalcor have used
different techniques but the result is the same, namely to reduce current rates
and increase future rates and thereby to avoid rate shock.
In the case of Nalcor they have chosen to backend load or
defer payment of the costs of generation assets over the 50 year period, while
adopting normal cost of service accounting for transmission costs. This means
that capital costs expensed for generation assets in the last 20 years (from
2050-2070) are enormous.
With rapid technological change large power plants may be
rendered obsolete. In 2069, Muskrat Falls may be superseded by more efficient
energy sources but ratepayers will continue to be burdened with the cost of the
project. This results from the “backend” loading of generation costs while unit
energy costs are levelized over time, in real terms. Will the same be true of
Site C where the planning horizon is 70 years? Is it fair to future generations
to impose these costs upon them?
Underestimation
of cost
Underestimation of cost has been a huge problem at
Muskrat Falls. Since the Muskrat Falls project was announced in 2010 there have
been seven cost revisions. Including financing costs, but excluding the
Maritime Link, the cost estimate went from $6.2 billion when announced by
Premier Danny Williams in November 2010, to $12.72 billion in June of 2017. The
following table comes from the June 2017 report of the Oversight Committee. The
increase from $6.2 billion in 2010 to $12.72 billion was an increase of 105%,
with the largest increase announced by the new President Stan Marshall in June
of 2016 at which time he announced that there would
be a slippage in the schedule by two years, delaying full
power to the second quarter of 2020. The increase amounted to $2.48 billion,
which included a variety of escalating costs including those for the
powerhouse. The delay in schedule created a major increase in financing cost
from $1.3 billion to $2.3 billion. The delay was the result of problems by a
major contractor who had been awarded the contract to build the powerhouse and
associated civil works. This large contract was awarded to an Italian firm
which had no previous experience in the Canadian north and had vastly underbid
the competition.
In December of 2016 Nalcor’s CEO announced that the contract with Astaldi had been renegotiated, raising the contract from $1.1 billion to $1.83 billion, an increase of 66%.
In December of 2016 Nalcor’s CEO announced that the contract with Astaldi had been renegotiated, raising the contract from $1.1 billion to $1.83 billion, an increase of 66%.
Nalcor also underestimated the operation and maintenance
costs. Their June 2017 update revealed that their earlier cost estimate had
been revised from $39 million to $109 million, growing to $143 million in 2021.
How does the operating and maintenance cost of Site C compare?
There are many complex reasons for the cost escalation. A
former Nalcor employee has stated that cost estimates were falsified in order
to secure project sanction. The anonymous engineer said:
“I could not put up with falsifying information
anymore.
To begin with, the original cost of $6.2 billion on
which the project was approved was a complete falsification. The estimate was
deliberately kept low — below $7 billion, so as to appear favourable relative
to the cost of thermal power generation.
The likely costs were known about three years ago,
but Nalcor Management kept it a secret, steadfastly denying that there were
major schedule delays and cost overruns, until it was no longer possible to
hide the true status with the election of a new Provincial Government.”
This led to calls for a forensic audit and a public inquiry. The provincial government will soon be appointing a public inquiry into the escalating costs to determine the reasons. However it is likely that part of the problem stems from the inexperience of Nalcor, a crown corporation created in 2007, whose expertise in the electric power business resides primarily in NL Hydro and which has had no experience in a project of this size and complexity.
With the Upper Churchill project, completed in 1974,
ahead of schedule, the project manager was Acres Canadian Bechtal, who brought
the project in on budget. Nalcor ought to have similarly engaged an experienced
project management firm, rather than taking on the lead
project management role itself.
Overestimation
of Demand for Power
While costs were vastly underestimated the converse
applied to the demand estimates. In the 20 years prior to 2010 energy demand
had risen and fallen back again, largely due to the closure of two paper mills
and the downsizing of a third. This loss of industrial load was offset by
continuation of a trend toward increasing penetration of electric space heating
in the residential and commercial sectors. At the beginning of this 20 year
period consumption was about 7000 GWH and at the end it was at the same level. Nalcor
forecasted (2012) that energy consumption would reach almost 10,000 GWh by
2030. This stands in stark contrast with the June 2017 update from Nalcor which
shows energy use falling initially after interconnection and then rising slowly
to only 7200 GWh by 2030, as shown below.
It is questionable whether Nalcor has sufficiently
measured the impact of rising rates upon demand. Using an elasticity of demand
of -0.4 we would expect energy use to drop over time from 7,000 GWh to 4,200 if
rates double by 2021 to 22.9 cents per KWh, as forecasted by Nalcor (see chart below
from June 2017 update from Nalcor). This would wipe out demand for Muskrat
power.
2011-12
Review by joint environmental panel and by PUB on Reference from NL government
The Muskrat Falls project was exempted from the
jurisdiction of the PUB but in 2011, as a result of an intervention to which I
was a party, the government made a limited reference to the Board. The
reference asked the Board to decide between Muskrat Falls and the Isolated
Island option, a combination of small on-Island hydro sites and thermal
generation. The cost estimates presented to the Board were based on 5-10% of
the engineering work and were Class 4 estimates. The demand projections were
unrealistically high, in a province which had lost 80,000 people because of the
collapse of fish stocks. The consultants to the Board were Manitoba Hydro
International (MHI) who were persuaded by Nalcor and its consultants to endorse
the project, as was the Consumer Advocate.
In the Board’s report to government the following quote
is made from testimony by my colleague Ron Penney and me:
The Board concluded it could not render a recommendation
based on the incomplete information filed in the hearing.
The PUB did not reach a conclusion and remained agnostic
on the options. The joint environmental panel on the Lower Churchill reported
in August 2011 and was equally unconvinced of the merits of the project. They
stated as follows:
Is there any similarity between the situation faced in 2012 by the NL PUB and that faced by the BCUC today?
Marc Eliesen, who was at the helm of BC Hydro from 1992 to 1994, outlined why he believes the
only financially responsible course of action is to cancel the $8.8 billion
project and remediate the Peace River site in order to minimize Site C’s
negative impact on BC Hydro customers
and taxpayers.
“There never was a business case for the start-up of construction of Site
C, and there is not a business case to support its continuation or postponement.”
This is similar to comments made by former Fortis CEO Stan Marshall
after he took on the role of CEO of Nalcor Energy in 2016. When asked whether
Muskrat Falls was a “boondoggle” he confirmed that it was and said that he
never supported the project because it was speculative, overbuilding capacity,
instead of increasing capacity incrementally to meet demand.
In my written submission to the BCUC I made 14 recommendations and I remain
committed to all of them but will conclude, for brevity, with only three.
1.
The BCUC must be vigilant to reflect the
interests of present and future generations. The present generation has an
obligation to protect our assets, including our environment, for future
generations. We also have an obligation to pay for the services we consume,
including electric power, and not to foist our costs upon future generations
through byzantine financial arrangements which amortize costs well beyond the
lifetime of people living today, as epitomized by the 70 year time horizon in
BC for Site C and the 50 year horizon adopted in NL for Muskrat Falls, combined
with backend loading of costs.
2.
Do not overbuild the system; build according
to your need. This is particularly appropriate in an era of rapid technological
change when we need to design a system that is adaptable to change. For NL,
Muskrat Falls was far too large for our needs and far too expensive.
3.
Ensure that project costs and schedules are
tightly controlled. As noted earlier the cost estimates for Muskrat Falls have
been revised seven times to date. The largest project, for the powerhouse and
other civil works, was awarded for $1.1 billion and has been renegotiated to
$1.83 billion. The original contract was not a lump sum contract. Instead it
was cost plus, the more labour used the higher the cost.
Thank you for the opportunity to make this presentation. My
full submission is on the record and I will be pleased to answer your
questions.
David Vardy
St. John’s, NL