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Thursday 1 November 2018

BIG WINDFALLS TO COME FROM CHURCHILL FALLS?

Guest Post by PlanetNL

PlanetNL18: Big Windfalls to Come from Churchill Falls?
For decades, Newfoundland and Labrador (NL) Governments have recited the lost earnings potential of the Upper Churchill and bemoaned the billions earned by Hydro-Quebec (HQ).  They long for the day of August 31, 2041 when HQ’s locked-in low-price contract for 90% of CFLCo’s energy shall expire and most of the profit will flow into NL.

It’s the kind of linear-thinking politicians thrive on: if electricity prices remain constant, demand remains constant, and production costs remain constant, then the dream seems real.  A naïve Premier today may even be thinking of borrowing billions to mitigate Muskrat losses until 2041 because the mighty Upper Churchill will quickly pay it all back and more.
That would be a terrible gamble to take as already there are a number of economic threats to the viability of Churchill Falls power.
Nalcor Energy Marketing Not Earning Huge Profit Margins Today
NL Hydro has an exclusive block of 525MW capacity from Churchill Falls until 2041. It's purpose is to meet the Labrador Interconnected grid power requirements.  Surplus energy from that block has been historically sold through agreements with Hydro Quebec and for a few years by Emera Energy Marketing.

After Muskrat Falls sanction, Nalcor created a new division, Nalcor Energy Marketing (NEM), to manage the coming growth in energy sales opportunities.  It is responsible for sales of Muskrat surplus via the Maritime Link, the ongoing Churchill Falls surplus via HQ, and potentially yet to be developed sales opportunities such as Gull Island.  As well, there is the period beyond 2041 to consider when HQ’s contract for the bulk of Churchill Falls energy expires.  The formation of NEM makes sense within Nalcor’s strategy.

NEM annual reports allow analysis of its financial performance.  In 2016 and 2017, NEM recorded net profit of about 0.8 c/kWh on its Upper Churchill surplus energy sales.  Using this current figure as the baseline, this posting will present three primary issues that will push that profit margin down.

It is assumed that NEM sells mainly into US energy markets and its primary costs are energy and transmission.  NEM pays the same super-low 0.2 c/kWh energy rate as HQ.  Transmission is the main cost.  NEM has a transmission contract that approximates closely HQ’s current open-access transmission fee of 1.25 c/kWh.  NEM may also have to pay additional transmission fees in jurisdictions beyond Quebec depending upon the location of the sale.

Recent History: Export Prices Trending Down
The graphic below shows that the best days for US electricity export ended long before Muskrat was sanctioned.  2017 prices are over 60% lower than 2008, driven primarily by natural gas prices which have plummeted with the success of fracking technology for gas production in many eastern US states.

Source:  Hydro Quebec.com

Next, consider this re-framed snapshot of CFLCo total earnings potential.  If the 30,000 GWh taken annually by HQ from Churchill Falls were sold by NEM at their net profit margin of 0.8 c/kWh, the total earnings would be $240M.  Given NL’s 65.8% ownership of CFLCo, the return to NL would be $158M while HQ would earn the balance of $82M. 
Billion-dollar yields from Churchill Falls are strictly history.

The Future: Ongoing Downward Price Pressure
The US Energy Information Administration (EIA) makes publicly available some of the best statistics and forecasts needed for economic analysis.  The latest EIA long-term forecast is for US electricity rates is quite flat (negligible growth after inflation).  The corresponding EIA graphic below reveals a warning detail for energy generation businesses: their share of unit revenue within the forecast is expected to drop 10% by 2050.


To predict the impact on Churchill Falls profit margin, consider the roughly US 3 c/kWh energy price shown in the HQ chart above and then apply the EIA price drop of 8-10% post-2041.  It appears the profit margin will fall by 0.3 c/kWh.

Followers of energy technology may suggest the EIA’s pace of generation cost decline is too subtle.  Wind turbines and solar panels are winning record low energy supply contracts around the world and surely the trend is going to continue to be impressive over the coming decades.  More disruptive will be energy storage which is already taking off on a small scale and some research suggests it can be utility-scale in a couple of decades.  Ontario already has 20 energy storage facilities in the works.  Success of utility-scale energy storage would leverage the performance of intermittent renewables leading to the obsolescence of many existing power plants: this is a big threat to remote generation sites like Churchill Falls.

Rising Operating Costs
Churchill Falls operating and maintenance (O&M) costs have steadily risen and equate to 0.3 c/kWh at present.  As the facilities will approach 70 years old by 2041, there will be major sustaining capital investments driving O&M cost substantially higher.  

A modest program in the order of $500M could have the impact of adding another 0.3 c/kWh to O&M costs.  Such a budget could be exceeded on the CFLCo transmission assets alone should the replacement of conductors, structural upgrades to towers or other work be required.  If additional upgrades are required in the generating station or on dikes and remote sites, then costs rise more.

For this analysis, a $1B capital program resulting in 0.6 c/kWh cost increase by 2041 is predicted and this may be a very conservative estimate.

Rising HQ Transmission Fees
NEM will have to continually renew its transmission contracts with HQ, a cost that has a 100% certainty of increasing by 2041.  Like Churchill Falls, many key HQ transmission assets will be 50-70 years and HQ will be spending major capital on those assets both before and after 2041 and that will significantly impact their calculation of transmission fees.
For this analysis, a near 50% increase over 23 years on the current HQ transmission rate is estimated: a unit cost increase of 0.6 c/kWh.

Adding Up the Possible Changes
The three primary adjustments described above are summarized in the scorecard below starting with the existing NEM net profit and finally, predicting the profit/loss in 2041.

c/kWh
2017 NEM net profit
  0.8
2041 price decrease
- 0.3
2041 O&M increase
- 0.6
2041 HQT increase
- 0.6
2041 Total Changes
- 1.5
2041 Net Loss
- 0.7

Clearly the losses predicted in this very simple analysis are not what the people of this province have been conditioned to expect.  Whether Government and Nalcor have similar insights is unknown but based on their handling of Muskrat Falls it is very doubtful.  Yet the time to be accurately informed and prepared is now as market opportunities to keep Churchill Falls running beyond 2041 are going to be few and far between.  

Key Market Opportunity – Offsetting Ontario Nuclear
As prospects of exporting energy to the US after 2041 increasingly vanish, the best fit for Churchill Falls power likely exists in Ontario where a substantial part of their nuclear fleet is scheduled for a series of refurbishments over the next 15 years, as shown below.  Churchill Falls energy, in the long run, could offset several nuclear reactors.



There are many informed critics of the risks of Ontario’s nuclear refurbishment program who believe few if any of these refurbishments should be allowed to proceed and that lower risk alternatives exist for Ontario ratepayers.  Recognizing key risks, the project management process being used on these projects allows the option to terminate the project should delays and cost overruns become onerous. 

The new Quebec Premier has not been shy in campaigning on the potential for Hydro-Quebec to offer cheaper energy to Ontario than it would get from the Darlington project (Globe and Mail, Konrad Yakabuski, Oct.24, 2018).  The new Ontario Premier may be inclined to listen although the range of business interests in his province supporting the refurbishment projects are quite entrenched and powerful.

There is a new wrinkle though as Ontario faces potential energy shortages due to both the lost capacity during the nuclear refurbs and Premier Doug Ford’s recent cancellation of many renewable projects.  Ontario’s Independent Energy System Operation is now predicting a 1300MW capacity shortfall in 2023 and up to 3500 MW later in the decade as Bruce units are taken down (Globe and Mail, Shawn McCarthy, Oct.15, 2018).

This Province must ensure it is part of any conversations and negotiations and position itself as ready to commit post-2041 Churchill Falls energy to the solution.  This would allow customers to consider their long-term supply needs beyond the risks tied to the HQ contract expiry in 2041.

One thing is for sure, Hydro-Quebec will be at the center of any such supply arrangement and should be expected to put their own interests first, potentially building new hydro facilities in Quebec that will threaten to strand Churchill Falls energy post-2041.  Simply renewing a contract for Churchill Falls to maintain and serve Labrador power needs economically could be the sole post-2041 goal for NL.

If Ontario stays the course with its current nuclear refurbishment program, their next round of refurbishment would be due in the 2040s and 2050s.  New Brunswick’s recently refurbished Point LePreau nuclear plant would be due in the 2040s as well.  By that time, however, technology advances in renewables and energy storage will likely be proven better than either nuclear refurbishment or importing increasingly expensive long-distance hydro power. 

Should hydro power markets face serious long-term decline, Hydro-Quebec may choose to cut its losses starting with Churchill Falls, leaving Labrador an isolated non-exporting market.  Unless there is furious industrial growth within Labrador on an unimaginable scale, the cost of operations at Churchill Falls will not be sustainable.  Abandoning Churchill Falls and powering Labrador entirely from Muskrat Falls might seem a better fit but could Muskrat even operate if the Churchill Falls up-river infrastructure is not maintained and controlled beyond 2041? 

Not only are major windfalls from Churchill Falls unlikely post-2041 but perhaps in 23 years time, the most economic option could result in Hydro-Quebec supplying all Labrador interconnected power.