Monday, 10 February 2020


On Friday the PUB sent its final Report on the Rate Mitigation Reference to the Ball Administration which it promptly released to the public. It would be nice to report that the PUB has contrived a magical solution to this enormous challenge, but there is no such good news. The Report, itself, is a bit of a disappointment though not because it contains no magic or that it offers limited solutions. It simply misses an opportunity to give certainty and clarity to the precise dimensions of the mitigation problem, fails to give Nalcor its proper berth, and fails to offer the Ball Government – and the public – advice on a realistic and permanent solution to the worst possible consequence of Danny Williams' legacy project. Obviously, I can be blamed for an excess of expectation.

Still, politicians sometimes need to be sent sobering messages. One might have been the impossibility that a domestic rate per KWh of 13.5 cents, proposed by the Ball Administration, had any rationale except a political one. There were others but, first, three observations are necessary:

1.       Despite having two worthy Consultants – Liberty and Synapse – available to conduct extensive analysis, the PUB accepted Nalcor’s figures as the sum necessary to meet Muskrat’s financing and operating costs. Nalcor’s revised 2019 figure of $725.9 million was put in circulation in advance of the last General Election but lacked any basis for why the figure should replace the $808 million figure used by Stan Marshall at a Memorial University Presentation in 2017. The PUB does not attempt to explain the discrepancy or give certainty to the lower figure. 
Worse, the PUB left Nalcor in control of the essential data on which its analysis is based. They ought to have removed them from any, except limited involvement. Having been abused by Nalcor during the DG-2 Reference and heard the Commission of Inquiry, where substantial testimony was heard – under Oath - dealing with Nalcor’s deceptive practices, what more convincing did it need?

2.      The PUB fails to confirm the accuracy of the Nalcor forecast rate of 22.89 cents per KWh which it describes as the domestic rate required to meet Muskrat Falls total cost obligations, which it bases on project costs of $12.7 billion. 22.89 cents is thought to be an “average cost” per KWh for the power produced - but it is not the real rate for island customers on the interconnected system, which is higher. The PUB is rightly concerned about the high power rates facing industrial customers but it fails to note that a subsidized industrial rate and a draconian Power Purchase Agreement (see item #3 below) fall on the domestic customer who must pick up the cost of the subsidy and any demand shortfall. Hence, the metric created by Nalcor and used by the PUB of 1 cent per KWh - representing $66 million of rate mitigation on domestic rates - is likely very misleading.

3.      The PUB understands that domestic demand has a direct correlation with the rate per KWh charged domestic consumers. Not only did they not explain the implications of the “take or pay” Power Purchase Agreement (PPA) which Nalcor imposed on NL Hydro, they also failed to deal with demand elasticity properly, allowing it to be reflected in its Low Demand scenario, which is quite unsatisfactory. Low income levels and an aging demographic likely imply above average sensitivity to cost; demand may be hit hard with planned cost increases. The PUB ought to have presented a series of Exhibits demonstrating the influence on demand at different rate levels. The public ought to be aware that this is a not one dimensional issue: declining demand due to both higher rates, technology, and demography are NOT divorced from the mitigation issue and never were. As noted, those risks were “baked” into the PPA at the start. Politicians and other policy makers needed to be reminded of the fact, if only because they should understand the origins of a situation possessed only of difficult choices. 
      It is also incomprehensible that the PUB does not explain any impacts on the domestic ratepayer beyond 2039. The Province’s return on equity was calculated over a 50-year time frame – to avoid “rate shock”. The dividends due the Treasury for its $4 billion equity are not substantially reflected in the current mitigation arithmetic; the Government’s cost of borrowing is over 4%. Therefore, mitigation is already costing us. As to the return of the capital to the Treasury, does the PUB view this issue a matter of intergenerational equity, as Nalcor does, too?

As it stands, the PUB sees opportunity for rate mitigation from “returns and dividends from Muskrat Falls, Churchill Falls and Hydro, Nalcor’s share of the export sales revenues, as well as water power rentals related to Muskrat Falls, Churchill Falls and Newfoundland Power” in an amount ranging “from $171 million in 2021 to $526 million in 2030.” But this is “much about muchness”[1]. The PUB is uncertain as to the amount of power available for export and notes: “Due to transmission constraints…the amount of capacity that can be exported is relatively modest.” It also acknowledges that “export market prices are currently low”; it might have added that they were low pre-Sanction but that mattered not a whit to Nalcor.

The essence of the PUB’s conclusions is found in the Exhibit (below) taken from page 75 of the Report. It depicts a problem that must be solved almost completely by “LCP Dividends & Water”, though water rental revenue is of such small consequence that it ought to have been just buried. And where do the dividends come from? Directly from the ratepayer, of course.

The rising amount of “dividends” shown in successive years (the large blue area) relates to both the presumption of higher demand and already prescribed higher domestic rates per KWh in those years. While actual (lower) demand may yet skewer this estimate, the forecast still comes with a caveat: The PUB notes that Hydro had committed to an equity target of 25% which the PUB proposes reducing to 20%. More equity means less money for mitigation.  However, the PUB cautions that any such decision impacting Hydro’s capital structure could “affect its self-sustaining status”. That means, in plain language, that Hydro may not have such flexibility and doing so may attract the notice of the Bond Rating Agencies who may add something to the “Net Debt” of the province.  

Otherwise, the PUB looked at “efficiency and productivity measures at Nalcor and Hydro, and Muskrat Falls Project operating and maintenance costs.” The Board found some potential savings -$22 million in 2021 to $48 million in 2030 – though considering Nalcor had already lowered the cost of operating the MFP, they cannot be seriously considered hard numbers. 

Electrification within the building and transportation sectors, after 2025, are estimated to be in the range of $40 million to $70 million….but the revenue potential and timing of these revenues continues to be refined…”, the PUB says.  The Board’s phrasing suggests that it is reluctant to support such a forecast and with good reason.  Readers are directed to a post by PlanetNL who dissected government’s electrification plans and concludes that they represent political sleight-of-hand rather than good business decisions.

Noted the PUB: “Other mitigation opportunities identified during the review include the provincial portion of the HST and the elimination of the rural subsidy…” the first of which, incidentally, PlanetNL has long advocated; possibly the PUB is reading his excellent work.  

The PUB, nevertheless, recognizing that there is uncertainty in their numbers, notes that “Even if all the recommended sources of mitigation are applied it is estimated that rates will still increase by just over 50% to approximately 20 cents/kWh”, and that the mitigation shortfall may be “just over $400 million in 2021.” It is an important statement. (It is also one of the reasons that this Blog has been telling Finance Minister, Tom Osborne, to get the deficit under control.) 

The PUB warns that this shortfall “would rise” if there are changes to the schedule and cost estimates of the Muskrat Falls Project, the timing of the transition of the Holyrood Plant and other cost increases…” which may make necessary “additional sources of mitigation.”

Considering the problems Nalcor is experiencing with delayed start-up of the generation plant, software problems on the LIL, operation of its synchronous condensers, and unfinished negotiations with over the Astaldi claim, we are learning that the price of incompetence is limitless. Then, the Holyrood Generating Station may never be shuttered in the interest of “security of supply”, in which case another $1 billion may be needed to secure its replacement.

How should the public react to this Report?

While it is wrong to “shoot the messenger”, I expected more from the PUB – not miracles – just more and better analysis as to the constraints of the mitigation options. Otherwise, it was asked to come up with the impossible.

As it stands, Government has received practically no benefit from the Study. While not surprised I am sure, they are grateful that the Reference allowed them to sidestep a tricky issue in a General Election. 

The PUB, on the other hand, possessing considerable utility expertise, ought to have known that using traditional metrics for this challenge was a hopeless exercise. They attacked the exercise as if it was a rate application from Newfoundland Power. The Reference needed imagination as well as some risk-taking which, admittedly, is not such a Board’s mind-set except that the cost would only have been advice, not money. The PUB, unaffected as it is by the exigencies of partisan politics, could have given a hapless Government the basis on which to have a conversation with prickly voters whose expectations the Premier has consistently – and imprudently - raised.

What might the PUB have proposed?

In place of fiddling over “efficiencies” from paring down Nalcor, worth just a few million dollars, they ought to have estimated the savings of a complete shutdown of Nalcor. In a small jurisdiction like ours, there is only room for ONE Hydro Corporation. The Feds must be aghast at such waste.

The PUB might have more bluntly reminded the Government, too, of the price per KWh paid by customers in the Maritimes.  While not a strictly comparable market environment, the Federal Government is sure to balk at subsidizing rates to a level lower than that of New Brunswick and Nova Scotia – notwithstanding the fact that the subsidy of Muskrat Falls is a direct subsidy to the cost of rates in the latter province.
In a similar vein, the PUB might have noted that voters bought into the Williams/Dunderdale/Martin Plan of electricity rates starting at 15.1 cents per KWh post-commissioning; it was an appropriate starting point for Premier Ball, and for all the right reasons. One way or another, the public is going to pay for their disengagement from reality during the Danny Williams era, even if they can rightly argue they were deceived.

In addition, had it been bolder, the PUB could have constructed a paragraph or two reminding the Feds of the tragedy in which NRCan was a culprit, having conducted a high school equivalent analysis of Nalcor’s business case for the Muskrat Falls Project. NRCan recommendation for the Federal Loan Guarantee was based on DG-2 estimates which the PUB called “desktop” or “concept study”, Nalcor having completed only 5-10% engineering design. The project estimates were bogus, as the Inquiry confirmed, and were rightly rejected by the PUB. The Federal Government’s acceptance of the DG-2 numbers was not only irresponsible, it constituted fuel for the train of deception that followed into DG-3 and afterwards. 

The Federal Government is not responsible for Nalcor’s deceit but, as citizens, we have a right to expect better from them. Had the PUB taken up this issue it might have been seen stepping into the political realm. But, bear in mind that the Government’s Reference was completely political anyway. The idea that either Nalcor or the Finance Ministry has half a billion dollars annually, not already put to use, is preposterous. The PUB had a right to answer the Reference in kind and should have. 

In failing to see the “big” picture aspects of the Muskrat nightmare, a Treasury “crusher” not a miscounting of the petty cash, the PUB needed to say to the Ball Administration: your request of $200 million from the Government of Canada is inadequate, that it needs to be higher. Why? Because based on reasonable certainties described in the Report, the PUB estimates a mitigation shortfall exceeding $400 million. They, and everyone else, know the “known unknowns”; we don’t have a handle on the cost of a) delayed start-up of the generation plant, b) software problems on the LIL, c) the repair/replacement of synchronous condensers, d) unfinished negotiations over the Astaldi claim, e) the cost of “security of supply” post-commissioning and f) how far demand will drop.

The one absolute certainty is that even a $200 million response from the Federal Government is too little. The idea that, after “tweaking” via electrification and bureaucratic efficiencies, the Newfoundland and Labrador Treasury still possesses fiscal room for rate mitigation is simply fanciful..

On this basis, I fear that the Ball Government is having the wrong conversation with the Federal Minister of Finance. This may be a point at which the Premier should be asking the Feds to place another energy asset – Muskrat Falls – inside the Federal Crown Corporation that owns the Trans Mountain Pipeline.

Finally, the PUB has returned the problem of rate mitigation to the place where it belongs. The politicial leadership has nowhere else to hide.  

Premier Ball will defer to the Liberal Government's man, Shamus O'Regan.

His offering, and its form, will be parsed for its generousity and its longevity.

Stand By!

[1] A Newfoundland euphemism rarely heard; similar to "much ado about nothing".