PlanetNL19:
Muskrat Dividends Will be Negative
While megaprojects have huge costs, their promoters love to
talk about the benefits. At the Decision
Gate 3 (DG3) final sanction stage in 2012, Nalcor developed cost and benefit
models that predicted not only that Muskrat was going to be billions cheaper
for ratepayers than the Isolated alternative but that the Province would reap many
billions in dividends. Key Muskrat promoters
heard from at the Inquiry so far still seem to cling to expectations of positive
dividends from the project.
This post lays out how Nalcor and Government failed to assess
rate affordability and revenue risk before sanction. As a result of one of the key risks becoming
realized, Government’s anticipated dividends will be greatly exceeded by
subsidies and mounting debt servicing costs.
These two-way cash flows must only be considered together in finding the
true dividend or net loss on the project.
Government and taxpayers will struggle to subsidize high Muskrat costs
in every year of the 50-year project payback term leading to massive new debt
growth far larger than the original capital cost of the project.
Computing
Dividends in 2012
Dividends are simply the return on equity from an asset. At DG3 of the Muskrat project, Government expected
to contribute equity of $1.6-1.8B.
Applying an 8.4% return, a fairly typical rate for Canadian and US
utilities over the 50-year financing term, Nalcor indicated Government would
get a $22.2B return on their equity. These
figures are nominal dollars, undiscounted for inflation or financial risk – it’s
these big unadjusted numbers that the promoters have frequently relied on when
talking about the return on Muskrat.
In estimating the “Isolated” scenario over the same term,
Nalcor calculated net Dividend gains of $4.5B.
The Muskrat “Interconnected” option (Muskrat Falls) was, by comparison,
$17.7B or 4 times better. The term
“better” should be qualified however: all this extra cash was to come from
ratepayers so it isn’t as though such extraction of capital should be
considered a simple given and without risk.
There is little evidence that Nalcor and Government considered actual affordability
to end-users in their pre-sanction studies – it’s almost as if ratepayers were
viewed as ATMs always ready to churn out more money on request. Assessment of this vital risk to project
payback was neglected.
Dividends
Increase With Muskrat Cost Increase
When known project capital costs had escalated to $12.7B in
2017, Nalcor recalculated Government’s equity investment at $4.0B. Not surprisingly, when Nalcor revised Power
Purchase Agreement cash flows in 2017, return on equity to Government was
scaled up accordingly. After all, the
contracts were written to guarantee 8.4% return on equity: in effect, Government
would simply be investing more money to make more money without any concession
or consideration for the impact on ratepayers.
The issue of a utility (or their shareholder) being rewarded in
this fashion for management incompetence is not unique. There are critics throughout the industry who
have eloquently expressed that wherever regulatory authorities tend to pass
costs onto ratepayers, public utility companies tend to be eager to build
expensive projects of questionable need.
On top of that, they are not afraid to incur cost overruns if they are confident
their regulator will pass on the costs.
A utility pushing major capital expansion would ideally
consider two key revenue risks. One is
that the regulator could deem some of the costs were not prudently incurred and
therefore the ratepayers would not be responsible to pay back those amounts. In the case of Muskrat, Government chose to usurp
the local regulator, the PUB, with legislation holding the ratepayer responsible
regardless of cost: Nalcor and their shareholder aggressively mitigated this
aspect of their risk.
The second risk is the destruction of the market resulting
from post-project shock pricing. The shock may cause a dramatic elasticity
impact as consumers use less electricity or the most cash poor among ratepayers
simply can’t afford to pay their bills. This
latter category of risk presently poses great threat to Nalcor’s revenue
projections. They planned inadequately
to anticipate it and they have no viable plan to counter it -except to hand off
the looming losses to their shareholder, the Government.
Subsidizing
the Market
Over a year ago, Premier Dwight Ball realistically spoke of Government recognizing that most ratepayers can’t afford a doubling of rates. Ball indicated a rate ceiling of
about 17-18 c/kWh that would require rate mitigation of around $400M annually. On the Uncle Gnarley blog, we think the
number will run higher, possibly in the $500-600M range but we’ll use the Premier’s
number for the moment. 
In 2021, the first full year of project payback, Nalcor’s 2017
revision of the PPA numbers shows Government receiving $151M as its return on
equity. However, if Government is
simultaneously doling out rate mitigation measures of about $400M, it is
obvious that Government will incur a net $250M loss. This is money it must raise from taxpayers or
it must borrow. Based on the Premier’s
heady and incomprehensible claim during the fall byelection that neither
ratepayers nor taxpayers will pay for Muskrat, it seems 100% certain that the net
cost of mitigation will be new debt.
Keep in mind also that the PPA costs are heavily backloaded
and steadily increasing: rates need to rise significantly to keep pace. Just this October, Nalcor released new unmitigated cost projections starting at 24.2 c/kWh (HST incl.) in 2021, rising
to 33.3 c/kWh in 2038. The 9.1 c/kWh
increase represents at least $600M of additional revenue requirements.
The answer does not lie in Government amending their rate of
return to below 8.4%. This would do absolutely
nothing.
Let’s imagine that the scheduled $151M return on equity in
2021 is reduced by $100M which looks initially like a pretty dramatic
concession. The problem is that any
adjustment is applied to both revenue and cost simultaneously – they offset and
eliminate each other. Government has
$100M less income and they have $100M less subsidy to pay: the end result is
the $250M subsidy is unchanged.
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Related to this Post:
Will Muskrat Pay Dividends? by David Vardy
The Wonky Economics of Muskrat Unveiled by David Vardy
_____________________________________________
Government
Debt Spiral
The bottom line here is that Muskrat is poised to bleed the public
dry. There will be a net public subsidy
lasting the entire 50-year term of Muskrat project payback. Return on equity is gone – it will always be
a negative, a subsidy. Government will
have to contend with the high costs of subsidizing the market every year to
ensure everyone can receive electricity.
These perpetual losses will hammer Government through the accumulation
of many billions in new debt.
Firstly, the $4.0B equity investment in the project must be
considered an unrepayable dead loss. This
money was borrowed by Government with a series of bonds requiring annual
interest payments that won’t be serviced by the Muskrat return on equity that
was supposed to pay them. Each year,
Government will borrow more money to pay the interest, creating new debt that
will demand more interest the next year. It is a scenario that will repeat and compound
every year.
Next, the annual net subsidy poses an even larger debt
threat. Annual losses in the hundreds of
millions are bad enough but the new debt will also grow interest servicing
costs that will compound and grow exponentially.
To get a full technical workup on the threatening Government
debt spiral, review PlanetNL3 posted over a year ago. The bottom line worked out at that time was
that Muskrat could accumulate net losses exceeding $100B over 50 years. Even if half that or quarter that amount,
it’s still shocking to think that Muskrat is going to continue to waste huge
amounts of public money for decades to come.
Missing from the earlier analysis is another little known but very
troublesome problem. Very little of the
project’s $7.9B debt financing is extended to the full 50-year term. Substantial parts of the first $5.0B are due
on significantly shorter terms and much of the $2.9B second round of debt comes
due in the 2020s and 2030s. The notable
problem here is that Nalcor or Government won’t have the cash to pay off the
maturing bond issues. New bonds will be
taken out on terms that are surely not going to be nearly as favourable as the
bond markets quickly wise up and seriously degrade the Province’s bond ratings. The result will be significantly higher
interest costs than are forecast in the PPA.
Besides that, the same effect will hit all of Government’s bond
replacement activity, not just those related to Muskrat. This trickle on effect attributable to
Muskrat will impact the Province by many billions more.
Will the
Promoters Still Promote
Several of the biggest promotors at Nalcor and Government are
still to be heard from in the coming weeks at the Commission of Inquiry. Could they possibly still tout the originally
expected $22B in benefits that was supposed to flow into Government coffers as
though it were still going to happen? Could
they even talk of greater benefits such as the post-overrun $40B, meanwhile
ignoring the larger ongoing costs Government will incur? Will they refuse to acknowledge there was any
revenue risk in their plan at all? Will they recognize the absurd level of
increased debt that threatens to destroy the solvency of the Province?
If they couldn’t think of these issues prior to sanction, how
could they possibly rationalize the issues now.