Thursday, 21 November 2019


Guest Post by David Vardy
Our credit rating, albeit already downgraded, hangs on a slender thread. It depends upon the false premise that Muskrat Falls is self-supporting and that Nalcor Energy is a “self-sustaining” Government Business Enterprise (GBE). Nothing could be further from the truth. This is the myth which supports our credit rating and which is our tenuous buttress against falling over a steep fiscal cliff.

Sturge: Project Rock Solid
On March 28, 2019, Nalcor’s then Vice President and Chief Financial Officer Finance Derek Sturge told the Muskrat Falls Inquiry that the financing of the project was “rock solid”  (page 26). This is the same CFO whose contract has just been terminated “without cause” and who was awarded a compensation package of $900,000, in keeping with Nalcor Energy’s entitlement culture. Legal counsel for the Muskrat Falls Concerned Citizens’ Coalition had asked him:

WILL HISCOCK: “So just to get this right, is it your view that any act, really, of a government authority can make an enterprise profitable? I mean, doesn’t that just defy the laws of economics? We can’t just write into the law that this is going to be a profitable project that returns 8.4 per cent return on equity, can we? We got no actual ability to have that materialize in the real world.”

Mr. Sturge responded as follows:

“MR. STURGE: No, I mean, there’s probably risks, but this contract, I think, is probably as rock solid as it gets in terms of saying that all of the costs incurred get recovered in rates.”

What confidence can we place in this evidence? Does the termination of Mr. Sturge’s contract with Nalcor relate in any way to his evidence that “costs incurred get recovered in rates”. Was this statement a myth or was it something more serious?

However he admitted that a rate “spiral” could occur:

“MR. HISCOCK: – the rates can go – the higher the rates go, the less power people use. MR. STURGE: Absolutely, and that’s why then – that’s why it is all – so you got to sort of separate. The contract itself works, but I agree with you that there’s a risk that you get into the cycle of rates increase, load decrease and you get into that spiral, absolutely.” (Ibid.) 
Derrick Sturge

“Understanding Muskrat” at 61 cents per KWh 
Marshall’s February 15, 2018 presentation at Memorial University, entitled “Understanding Muskrat,” identified an average unit cost of 22.89 cents/KWh, yet the projected load growth on page 25 contains a footnote saying the load is forecast on the assumption of a targeted rate of 18 cents/KWh? Did this reflect a recognition that not only was it unacceptable to charge rates of 22.89 cents/KWh but such a high rate would trigger a large drop in demand? Did it reflect an understanding that the costs of the project could never be recovered in rates because of consumer resistance? 

Nalcor assumed that price elasticity of demand would be very small, virtually zero. The reality is we have little experience of such large rate increases as we are about to experience. Dr. Jim Feehan’s research indicates that Nalcor may have underestimated the consumer resistance to high rates and also underestimated the long term price elasticity of demand 

Stan Marshall’s presentation informs us that the $808 million revenue requirement translates into a cost per kilowatt hour of 17.42 cents assuming that all 4641 GWh of power is paid for at that rate. With Island ratepayers bearing all the cost, and with only 1,324 GWh of Muskrat energy used on the Island, the inexorable arithmetic tells us that the cost per unit is much higher, at 61 cents or four times the cost of Holyrood power. In fact we must rely on hydro-electric power sources on the Island to cross subsidize the power to keep it down to the average unit blended cost of 22.89 cents per kilowatt hour, which includes low cost power from Bay d'Espoir. Does that sound like a self-supporting project?

Government’s Rate Mitigation Plan 
When the government of Newfoundland and Labrador (GNL) asked the PUB to find how to mitigate the cost of Muskrat Falls they acknowledged that revenue from rates would be insufficient. In fact GNL put the full revenue requirement to the PUB and tasked them to find $726 million in rate mitigation for 2021. The taxpayer was already bearing the cost of servicing the generation equity, estimated at over $3.1 billion and it has to be added to the $726 million. GNL has already borrowed that money and its servicing costs are included in the 13.4% of debt servicing costs reported in a recent presentation by the Economics Departmentat Memorial at page 24.

Potential for Impairment of value
The same presentation from the Economics Department informs us that “Prior to first energy being generated and sold, the asset value of Muskrat Fall will be based on historic costs and assuming that the price charged will generate sufficient revenue to cover  debt and equity costs” (Ibid., page 68). The key point is that the value of the financial assets used in calculating our net debt is based on “historic costs” which is what we paid rather than basing the valuation on market value or what the assets are really worth. The latest information is that $3.74 billion in equity has been invested by the province in transmission and generation assets.

If the $12.7 billion historic cost is revalued to $1.0 billion, to pick an arbitrary number, then a write down of $11.7 billion will more than extinguish our equity value and will bump our net debt up by $3.74 billion. If revenue does not cover cost there will be a write down:  “then either the asset value will fall or and net debt will rise or the tax payers will subsidize and that will increase the accrual based commitments and raise provincial net debt.” (Ibid.) This could drive net debt up from $15.4 billion to $19.1 billion. 

The Economics Department presentation identifies a number of key indicators, or vital signs, of our fiscal health. These include net debt, albeit an imperfect indicator, but one which discloses a disturbing trend. Our net debt per capita (page 19) is $29,264 compared with $17,867 for the rest of Canada. Another indicator is debt servicing costs of 13.4% compared with 6.8% for the rest of Canada (page 24). The cost of borrowing is a key issue and we now pay a premium of close to 120 basis points over Government of Canada long term bonds (57). All three of these indicators would be adversely affected by a write-down of the value of Muskrat Falls. We would be forced to pay higher interest on our borrowing, if indeed we could continue to borrow.
Stan Marshall
On October 8, 2019 Stan Marshall told the PUB that the province has to be concerned about the self-supporting status of Muskrat Falls? He said: “the province has to be concerned that the monies it has borrowed to finance the equity in Muskrat Falls could be self-supporting, and so it has to have revenues there to be able to do that and demonstrate that. Otherwise, the bond rating agencies would downgrade the province’s credit. It would cost more every dollar the province borrowed…. if there’s not enough earnings from the assets, it could be that those assets would be impaired and we’d have to write them down, and again they would show up on the books of the province.” (page 8)

Will the Muskrat Falls Inquiry deal with the Fiscal Impact?
The fiscal impact of Muskrat Falls received little attention during the course of the Muskrat Falls Inquiry? The Concerned Citizens Coalition wrote the Commissioner on February 22, 2019 and recommended he engage an independent financial expert: The Coalition believes fiscal impact is well within the Commission’s mandate. Yet it has been the silent elephant in the room!

“We ask that the Commission appoint an independent financial expert to quantify the “balance” described in section 5(e) of the Terms of Reference by measuring the allocation of costs and risks among the various parties to the Muskrat Falls project, namely the ratepayers of this province, its taxpayers, Emera Energy and the federal government, based on the agreements and arrangements at the time of project sanction and how the balance has now changed. This assessment should include the risks associated with the completion guarantee and with any indemnification or guarantees for which the province may be responsible as a result of the federal loan guarantee.”

“Both Nalcor and the government of Newfoundland and Labrador treated the project as self-supporting. The expert report should measure the likely revenues from rates and assess the prospect that the project will be self-supporting. Finally, we ask that this review provide an assessment as to how the project impacts on the overall financial position of the province and its credit ratings, particularly if the project is not self-supporting.” 

The Commission did not accept the advice of the Coalition. The Coalition posed questions on the  financing of Muskrat Falls and on the obligations falling on the province to  the Deputy Minister of Finance  when she was a witness at the Inquiry. She did not answer these questions nor were the probing questions ever answered during the course of the Muskrat Falls Inquiry? 

The government told the people of the province on December 18, 2012 that we were protected from any liability arising from the project. “The legislative amendments also provide for Nalcor and its subsidiaries to sign contracts for the project on their own behalf and not on behalf of the province. This protects the province from any liability for contractual obligations with respect to Muskrat Falls.” Was this a bold faced lie? 

Despite the federal loan guarantee it now appears that the province is potentially liable for payment of the full revenue requirements, amounting over the 50 year supply period to $74.6 billion (IC-NLH-017, attachment 1, LUEC Tab).

Unfortunately the Inquiry did not delve into these issues as deeply as the Coalition had requested. On the very last day of the hearings the Commissioner raised these same issues with NP counsel Liam O’Brien. 

O’Brien responded: “you heard some evidence that consumer consumption has been on a decline since 2015, and that’s without Muskrat Falls’ costs being built into rates. you’ve heard some evidence in terms of the dynamics of pricing and price elasticity and that it’s hard to predict, but I think it’s reasonable to assume that this decline would intensify in the face of doubling rates. A sharp decline could even have the effect of increasing rates further. And we heard some evidence concerning the utility death spiral, that sort of thing – whether or not that’s a – will occur, that – there’s some evidence on that.” (page 5)

We await the imminent report from the Commissioner. Will he opine that the project is financially “rock solid” as former Finance VP Derek Sturge stated or will he confirm that, with contrived load projections and deliberate understatement of cost, the notion that Muskrat Falls is self-sustaining is nothing but a myth and that the flawed business plan for the project will trigger a utility death spiral? 

This is a time of great peril for our province and time for us all to face the truth. We must demand that truth be told and demand consequences when truth is not spoken. Without truth there can be no trust. The institutions on which we have traditionally relied to provide insights are no longer functioning. Sad to say we cannot rely on government alone to show leadership to navigate the perilous waters that lie ahead. Blind faith in our leaders has failed us miserably. 

My fear is that neither the Inquiry nor the PUB will disclose the truth about the fiscal impact of Muskrat Falls. Many do not want to hear the truth. Many do not want to tell the truth. If we the people are prepared to settle for comfortable myths in order to carry on without dealing with harsh reality then we must accept the consequences. But we must also ask: is it fair to our children and grandchildren whose legacy will be a mountain of debt?

David Vardy