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Thursday 14 December 2017


Guest Post by David Vardy


The “Good Faith” Argument
Finally, the Supreme Court of Canada (SCC) is hearing the argument that the Churchill Falls contract is inequitable. The SCC hearing began on December 5, 2017. This is an appeal to a decision of the Supreme Court of Quebec, which was in turn an appeal of a decision rendered by Judge Joel Silcoff on July 24, 2014. CFLCo had sought the following declaration (Silcoff, p. 2):

CFLCo lost in both tribunals and are now asking the SCC to overturn the decision of the Quebec courts. Their position is that the profits enjoyed by Hydro Quebec were unforeseen in 1969 and Hydro Quebec has a duty to renegotiate. Lawyers for the Churchill Falls Corporation (CFLCo) argued that Hydro Quebec has not acted “in good faith”.

CFLCo is basing its case in part on the fact that Quebec civil law recognizes that “long-term, interdependent, collaborative contracts contain implicit good faith duties of loyalty and collaboration that require parties to adjust and adapt over the long life of the contract to maintain the contract’s relevance for both parties. (Appellant’s Factum before the SCC, p.4).”

In framing its case before the SCC CFLCo is arguing that there is a concept of partnership in play which calls for the SCC to make a judgement as to whether the sharing of the profits from Churchill Falls is fair and equitable. Whether the SCC accepts this argument remains to be seen.
David Vardy
Renegotiating with Nova Scotia
This poses the question as to whether we will soon be heading back to the SCC once again to seek redress on our agreements with Nova Scotia, which have become unbalanced in their favour?  We will not be able to invoke the Quebec civil code, as we have with Hydro Quebec but we may have another, better card to play.

Lawyers for CFLCo have been searching in vain in the power contract and other documents for a statement of the intended sharing arrangements, to deal with unforeseeable events which have arisen over a 65 year contract. In the case of our agreements with Nova Scotia concerning the Maritime Link we do have such a statement, embodied in the Term Sheet, signed by the parties.  Does this place us in a stronger position to deal with inequities, in the event we have to go to court with Nova Scotia?

The deal with Nova Scotia was announced November 18, 2010, based on the “20 for 20” principle and enshrined in the famous Term Sheet announced by Premiers Danny Williams and Darrell Dexter. Before adding the cost of capital financing, the Newfoundland and Labrador share of the project was valued at $5 billion, while the Nova Scotian component, the Maritime Link, was valued at $1.2 billion, or 20% of the cost, for a total of $6.2 billion. When financing costs are added the NL component alone was estimated at $6.2 billion and the Maritime Link was estimated at $1.4 billion for a total of $7.6 billion. The “20 for 20” principle set out in the Term Sheet provides for Emera to absorb 20% of the capital investment for 20% of the power from Muskrat Falls.

In exchange for building the Maritime Link, and allowing Nalcor Energy to export power at no transmission cost over the Link, Emera was to receive 20% of the power for 35 years. This represented a commitment of 980 GWh annually, at no energy charge. At the end of 35 years the Link was to be transferred to Nalcor. On top of this Nalcor was to supply 240 GWh of “supplemental” power each year for five years. The “Nova Scotia block” was therefore 1,220 GWh for five years and then 980 GWh each year for 30 years. This will begin in 2020, three years later than originally planned.

This Nova Scotia block was intended to enable Nova Scotia to decommission some of its coal plants and to comply with federal emission standards. This was accepted as “green power” coming from Muskrat Falls. Nova Scotia’s participation was essential to make the project “regional” in scope and therefore secure the federal loan guarantee for the full project.

The Role of the UARB
The Term Sheet contained a catch. The Utilities and Review Board (UARB) of Nova Scotia had to approve this deal before it was accepted. This was a smart move for Nova Scotia. In this province there was no similar role mandated in the Term Sheet for the Public Utilities Board. Indeed, the project was exempted from the jurisdiction of the PUB.

When the UARB ruled on this Term Sheet in July of 2012 they turned thumbs down on the deal. They wanted more power at spot market prices, then estimated at five cents per KWh and rising to nine cents. The UARB insisted on a better deal and Nalcor capitulated, knowing that the federal loan guarantee was on the line and that the province could not finance this project without a federal guarantee. This capitulation took the form of an Energy Access Agreement (EAA) under which Nalcor must supply a minimum of 1,200 GWh of “market energy” over the period up to 2041, initially intended to cover 24 years.

To sweeten the deal Emera was allowed to acquire a 29% share of the Labrador Island Link, with a guaranteed rate of return linked to rates allowed to other regulated utilities.
Emera had no equity share in the generation component, nor was it required to share in cost overruns at the Muskrat Falls site. Nalcor, on the other hand, was required to share in cost escalation on the Maritime Link.

Where does this agreement now stand? The cost of the Maritime Link has risen from $1.4 billion to $1.7 billion (including financing costs) while the generation and transmission costs borne by NL have risen from $6.2 billion to $12.7 billion (including financing costs). The overall project costs have gone from $7.6 billion in 2010 to $14.4 billion. Nova Scotia’s share is now 11.8%, and not 20%. This is due to the more extreme cost escalation for the NL components, particularly at the generation site, than that experienced by Nova Scotia in building the Maritime Link, which remained within the escalation margin allowed by the UARB.

New sharing arrangements
Because of the Energy Access Agreement, demanded by the UARB, the minimum energy commitment to Nova Scotia has risen by 1,200 GWh. For the first five years Nova Scotia’s share of the energy output from Muskrat Falls will be at least 2,420 GWh. Taking account of line losses the amount of Muskrat Falls power delivered at Soldier’s Pond will be 4,600 GWh, below the 4,900 GWh average production for which the plant is rated. Further line losses can be expected when this power is wheeled on to the Mainland but these will be ignored for now. The share of the 4,600 GWh committed to Nova Scotia becomes not 20% but 52.6% The 20% for 20%  principle has gone out the window!

When first announced in November 2010, and again on sanction in December 2012, it was clearly stated that Muskrat Falls was being developed to meet the needs of NL, particularly the Island of Newfoundland. A full 40% or 2,000 GWh was to be used at the outset. With reduced demand projected it is likely that displacement of Holyrood will absorb only 1,500 GWh or maybe much less, if demand collapses, due to doubling of power rates on the Island. 

Emera’s share of equity in the Labrador Island Link has risen from 29% to 63%, expected to “true up” at 59%. This will be an attractive return producing more revenues for Nova Scotia than intended.

What about the prospect of lucrative export revenues? Can we count at least on the five cents per KWh (rising to nine cents), which was the initial forecast presented to the UARB? Look at Nalcor’s return on the export of 1,600 GWh of Recall power as reported in its 2016 Business and Financial Report, which yielded a mere $43.5 million, or 2.7 cents per KWh! Wheeling fees accounted for about half of this amount or 1.3 cents. If we sell the additional 1,200 GWh at this price it would yield only $32 million, assuming no wheeling fees need to be paid.

We cannot impose an energy charge on the “Nova Scotia block” which, for the first five years, amounts to 1,220 GWh. The 1,200 GWh in sales under the EAA will bring the total to 2,420 GWh. The EAA provides for 1,200 GWh to 1,800 GWh, with 1,200 GWh as a minimum. If Nova Scotia buys 1,800 GWh then its share of energy will be 3,020 GWh or 66% of the total, making it by far the principal beneficiary!

Impact of doubled power rates
If the doubling of power rates on the Island creates a large scale substitution effect then Island demand will collapse, as people substitute other forms of energy or redouble their energy efficiency. Not only is demand for power likely to plummet but so will revenues from sales. Does the agreement with Nova Scotia offer any solace? Not in the least.

In that event we will have 2,180 GWH (4,600 GWh less 2,420 GWh) to sell elsewhere if Nova Scotia takes 1,200 GWh under the EAA (rather than 1,800 GWh). If Nalcor sells the power to Mainland users other than Nova Scotia then there will likely be wheeling fees to pay. Using the recent experiences of Nalcor in marketing surplus Recall power as a guide and taking the spot market price as 2.7 cents less wheeling fees in the amount of 50%, produces a net yield of 1.3 cents per KWh. Based on this amount the export revenues would be $31.5 million, yielding total export revenues in the order of $63.5 million. In this scenario the $63.5 million would be the totality of the revenue available to repay $800 million in incremental costs due to Muskrat Falls.

This is less than half of the 2021 operating and maintenance costs and certainly not enough to cover the additional $800 million in revenue requirements triggered by Muskrat Falls. When faced with this prospect what should we do? If a better deal cannot be renegotiated should we simply renege and face the penalties? Under this scenario mothballing of the assets may be the best option.

A Bargaining Chip?
What are our prospects of renegotiating? Are they better than our chances of renegotiating the Churchill Falls contract using the “Good faith” argument? Clearly there are benchmarks that can be invoked, going back to the Term Sheet. The agreements with Nova Scotia, as currently structured, do not align with the Term Sheet. We have abandoned the 20/20 principle. Instead, for less than 12% of the capital cost (compared with 20% originally) Nova Scotia has access to as much as 66% of the energy. Instead of 29% equity in the Labrador Island Link Emera has 59%, privatizing a large share of the transmission infrastructure in our province.

Why did we give away our bargaining position by allowing Nova Scotia to insert the UARB into a critical bargaining role? Why did we weaken our position by emasculating our own PUB? These will be questions that those in charge will have to answer when they appear before the Muskrat Falls Inquiry Commissioner.

When the province appears before the SCC to argue that Emera should renegotiate we will have benchmarks in place, benchmarks included in a Term Sheet announced by Premiers who quickly disappeared from the scene. Will this Term Sheet empower us to argue that the intent of the agreements was not to make Nova Scotia the principal beneficiary of the Muskrat Falls project, assigning them at least 52% of the power and as much as 66%, for less than 12% of the capital cost? Can we argue that the agreements can be renounced for failing to align with the intended goals?

What seems abundantly clear is that these agreements with Nova Scotia do not create the basis for a mutually beneficial partnership.

Where is the strategy that will rescue us from the mistakes we have made and direct our efforts toward more productive outcomes? Nalcor is digging us further and further into a financial hole from which no escape appears visible. Government has failed to prompt an informed debate in the future of Muskrat Falls. Surely the Commission of Inquiry has a role to play in seeking solutions to the fundamental flaws of Muskrat Falls, the flawed water management agreement, our inability to recover costs, our disregard for the dangers of the North Spur and our reckless agreements with Nova Scotia.

Would our “Good Faith” case with Quebec be strengthened if we had a Term Sheet, like the one with Nova Scotia? Nova Scotia is reaping all the benefits and has become the principal beneficiary rather than NL, as was intended. Nova Scotia is positioned to have access to all the power it can use and perhaps more besides, for export. Nova Scotia is deriving numerous secondary economic benefits from low-cost energy, considerable savings on fossil fuels, environmental benefits, and profit on selling whatever surplus it cannot use. They have become the principal beneficiary, if not the entire beneficiary.

The Term Sheet provides a framework for renegotiating the agreement. The fundamental principle is that the allocation of costs should equal the energy shares enjoyed by each party. Does this mean that Nova Scotia’s contribution should be increased to at least 52% of the cost?

Will we be in a better position when we appear on the steps of the SCC yet once again? Will the Term Sheet convince the nine Justices that the agreements with Nova Scotia do not comport with the original intent and must be renegotiated or renounced?

Must all paths lead to the steps of the Supreme Court of Canada?

David Vardy