FORENSIC AUDITOR CONFIRMS NALCOR UNDERSTATED COST ESTIMATES FOR MUSKRAT

This post co-authored with David Vardy

The Forensic Auditor's main conclusion was that based upon its “findings and observations, at the time of sanctioning” a “combination of…potential misstatements may have resulted in the Interconnected Island Option (the Muskrat Falls project) no longer being considered the least cost option at the time of sanctioning.”

In coming to this conclusion, Grant Thornton has confirmed long held suspicions that Nalcor planned to advance sanction of the MFP regardless of the consequences. Essentially, the Forensic Auditor chronicles a narrative that suggests recklessness on the part of Nalcor Energy. The Forensic Audit was made public by the Commission of Inquiry September 21, 2018.

GT reports that there was:

1. A potential overstatement of the Cumulative Present Worth (CPW) for the Isolated Island Option; and

2. A potential understatement of the CPW for the Interconnected Island Option.

Presumably GT’s use of the qualifier “may” is intended to defer final determination to the Inquiry Commissioner.

At the outset of the project, Nalcor claimed that the Interconnected Island Option had a $2.4 billion CPW advantage over the Isolated Island Option  (a phased approach using wind, Island Hydro, and upgrades to the Holyrood GS).

The Forensic Auditor confirms that Nalcor not only misstated the figures for the two options; it also misapplied the advantage to claim Sanction for the Muskrat Falls project.

Does anyone still dispute the need for the Commission of Inquiry?

Nalcor’s "misstatements" were many and substantial which is what makes the Forensic Audit a profoundly important piece of work. GT's forensic analysis and conclusions contain extensive implications bearing on the integrity of our public institutions and upon the governance of the province.

Here are some of the other conclusions of GT which also influenced the overstatement of the CPW for Muskrat Falls:

- an "...overstatement of the load forecast used in the sanctioning decision".

- omission of price elasticity for NP General Service customers and NLH industrial customers as well as the effect of Conservation and Demand Management (CDM).

- Nalcor over-stated "numerous macro-economic variables” such as GDP, personal disposal income, population and average housing starts - relative to projections prepared by independent agencies including Statistics Canada and the Conference Board of Canada (CBOC).

- "there was no formal review and acceptance of the load forecast" and there was a "lack of quality control review surrounding the...process, too". 

- "Nalcor also used higher customer rate projections for the Isolated Island option” than for the Muskrat Falls option which would impact the CPW due to price elasticity.

- Nalcor employed an unrealistically low - P50 - Risk rating to the assessment of Tactical Risk contingency. (GT defines "Tactical" Risk as those associated with "the base capital cost estimate as a result of uncertainty with..." project definition and scope admission, construction methodology and schedule, performance factors and price (excluding escalation). Rather than P50, GT states that an independent assessment shows that P-factors ranging from P70 to P90 are more reasonable. (P-Factors indicate the probability that costs will exceed or fall below the estimate. A P50 means there is a 50% chance of the project costing more than the estimate while a P90 would have reduced the probability to 10%). This decision alone - based upon a P90 risk rating - would have increased capital cost by $767 million and a higher CPW for “Inter-Connected” Option. 

- In addition to the inappropriately selected "Tactical" Risk contingency, Nalcor also excluded approximately $500 million of "Strategic" risk exposure from the capital cost estimate and "incorporated (it) into a "management reserve". (GT defines "strategic" risk as to those risks linked to labour availability, productivity and schedule risk exposure.)  GT reports that that strategic risk exposure "did not form part of the capital cost nor was it included in the CPW calculation".

- The contingency for only for Tactical and Strategic Risk omitted from the Inter-Connected Option amounts to $1.267 billion. GT chronicles myriad other omissions.

- Nalcor's failure to account for the contingencies recommended for high risk projects like Muskrat Falls, means that the DG3 estimate should have been $7.5 billion rather than $6.2 billion (without financing costs). GT quotes a former member of the LCP Project Team stating that “if the P75 recommendation from the 2012 Quantitative Risk Assessment (“QRA”) had been selected as the sanction cost basis, the sanction basis would have been $7.5B”.

In addition:

- GT stated that the original “July 15, 2017 schedule was a P1 (which) meant that there was a 99% probability that the schedule for first power would not be met". In other words, Nalcor sought project sanction knowing that there was a 99% probability that the Schedule could not be met. 

The PMT (Project Management Team) recommended to the Nalcor Executive that a provisional schedule reserve allowance should be made to account for the difference between the target date and the probable date. The Report makes this observation: “GT notes that Nalcor Executive wanted to maintain the Target Milestone Schedule, and thus no schedule reserve allowance was made to accommodate the residual risk exposure identified in the QRA.”

- GT noted that only $34 million operating costs for Muskrat were included in the CPW calculation at Sanction. The new forecast (announced by Nalcor CEO Stan Marshall) is $109 million.

- Nalcor included $418 million in the CPW calculation for refurbishments to the Holyrood Generating Station when in 2012 AMEC had completed a study indicating a total cost of $353 million for the refurbishments – an 18% difference which Nalcor described as a contingency. The misreporting cited by GT had a material impact giving the Interconnected (Muskrat Falls) Option an unwarranted advantage.

This is a partial list of Nalcor’s omissions from the CPW calculation; others were noted by GT which helped favour the MFP.

Here are some other issues given prominence in the GT Report:

- The conclusion made by Nalcor around availability of power from the Upper Churchill “was inconsistent with the findings of the Nova Scotia Utility and Rates Board (NSUARB)”. 

Nalcor had vigorously asserted that there were risks that power from the Upper Churchill might not be available to the Province upon expiry of the Upper Churchill Contract.

Bewilderingly, Nalcor was telling Emera a completely different story than it was telling either the PUB or the public of this Province.

- GT confirms that Nalcor "did not have formal discussions with Hydro Quebec" regarding the import of power from/via that source.

- GT delivers this disturbing conclusion:

“Although strategic risks were not included in the capital cost estimate at DG3, they were included in the project estimate at DG2. It was noted that this change was made during the negotiations with Emera Inc. Nalcor stated “that it was required to respond to Emera’s concern regarding its ability to sell the strategic risk concept to the Nova Scotia regulator, the Nova Scotia Utility and Review Board”.

This statement is highly significant. It IS the boldest confirmation yet of outright misrepresentation to a public destined to shoulder the burden of this unnecessary and falsely “sold” project.

Without the Nova Scotia UARB having signed on to the project, the Federal Loan Guarantee would not have been approved. The Forensic Auditor has confirmed that Nalcor was prepared even to misrepresent the actual costs of the project in a bid to make sure that the FLG was approved and that the Muskrat Falls project would proceed at all costs.

Given this evidence, it is clear that the Commission of Inquiry needs to investigate why Nalcor withheld important information to make sure that the Muskrat Falls project proceeded.

Finally, it is noteworthy that the GT Report was based upon a limited Audit.

GT does not quantify the full effect of the poor data, low-balling of Risk and costs on the CPW analysis. It does not examine the risks surrounding the Strait of Belle Isle crossing, potential food contamination, the North Spur or Water Management issues.

There are other shortcomings, too, which the Inquiry needs to address in the coming days. Not least of them is consideration of the "origins" of the SNC-Lavalin Risk Register of April 2013 - ostensibly given to Nalcor not long after project sanction - which identifies 40 risks having a potential cost to the project of $2.4 billion. Former Nalcor CEO Ed Martin has stated publicly that he did not receive the document. 

We need to ask GT to identify whether the $1.3 billion shortfall in strategic and tactical contingency reserves which Nalcor withheld are included in the $2.4 billion SNC Lavalin Risk Register. Has GT reviewed Nalcor’s Risk Registry to assess whether the 40 individual components and their collective risks are fully encompassed by GT’s risk distribution database and how this database compares with that of another of the Commission’s expert witnesses, namely Dr. Bent Flyvbjerg?

Now that the analysis and conclusions of the Forensic Auditor have been released, the public has confirmation that there was a deliberate plan to advance sanction of the project, regardless of the consequences. This plan fell short of the mark in many ways but most particularly by failing to apply due process to the need for the project and to robust and transparent consideration of all the alternatives.

The Report's frightening conclusions constitute a condemnation of Nalcor's leadership at the time of Sanction and of the Government of the day, which also failed in its duty to protect the financial interests of the province.

The GT Report confirms that the 2012 Sanction of the Muskrat Falls project constituted a serious breakdown in our governance processes.
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Editor's Note:
Readers who want more information on the contents of the Grant Thornton Forensic Audit written in a comprehensible manner should read GT's PowerPoint Presentation to the Inquiry. The PPP is found here.