Guest Post by David Vardy
THE DECALOGUE: THE TEN COMMANDMENTS FOR
RATE MITIGATION
Introduction
The silence on rate mitigation is too deafening. The public needs to know what
is happening and what objectives are front and center in the negotiations, now
led by former Nalcor Chair Brendan Paddick. We need to adopt a set of
principles or criteria, which can both guide the negotiations and measure their
success. This post is an attempt to propose ten “commandments” for successful
rate mitigation. Because the “misguided” Muskrat Falls project and its impacts
on the province are of such “Biblical” proportions it is appropriate to invoke
the Mosaic law of the Decalogue, The Ten Commandments.
Premier Andrew Furey was first sworn in as Premier of Newfoundland and Labrador
on August 19, 2020. He appointed Brendan Paddick as chair of the Rate
Mitigation Team on September 25, 2020. This signalled that the rate mitigation
plan announced on April 15, 2019 by Premier Dwight Ball remained unfinished. It
also signalled that the progress reported by Premier Ball and regional Minister
Seamus O’Regan at a press conference on February 10, 2020 had not advanced as
planned and needed a “reset” and a new Team.
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| Brendan Paddick |
The Core Issue
At stake is the question of who bears the burden of the $74.6 billion in electricity costs over the next 50 years. The power purchase agreement between Muskrat Falls Corporation and NL Hydro, both Nalcor subsidiaries, calls for this amount to be recovered fully from Island ratepayers. GNL has the option in theory of shifting some of this amount to taxpayers; but in practical terms this is well beyond the capacity of a province already burdened with $47 billion in public debt.
The $74.6 billion, averaging $1.5 billion annually, is the total, in undiscounted dollars, of the accumulated revenue requirements of Muskrat Falls for the 50 year supply period, beginning after the start of full commercial operations. The estimate comes from evidence (IC-NLH-017, attachment 1, LUEC tab) presented to the PUB by NL Hydro during a 2018 hearing on cost of service.
This is the burden arising from the operating and capital costs of the project. Large hydro projects call for big capital investments. Most costs are costs of capital, including interest on debt, return on equity and repayment of borrowed and invested capital. The annual revenue requirements, including capital costs and operating expenditures, will exceed $1 billion during the first year of full operations. This is a similar order of magnitude as the GNL budgetary deficit.
This document sets out guiding principles which should guide the negotiating teams. These principles or rules also serve as criteria by which to measure the outcome of the negotiations.
1. Strengthening of the Public Utilities Board
First and foremost is the need for transparent, accountable oversight through a revitalized Public Utilities Board, whose jurisdiction should on no account be impaired or eroded.
The Muskrat Falls fiasco could have been avoided if the GNL had not undermined the authority of the PUB. The GOC bears some responsibility here. It was in order to ensure that the PUB would not interfere in any way with cost recovery and repayment of federally guaranteed loans that GNL excluded the project from the Board’s jurisdiction. The House of Assembly needs to overturn the amendments which eroded the powers of the PUB.
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| Premier Andrew Furey |
2. Termination of PPA
Second, the power purchase agreement, which loads 100% of the cost upon Island customers must be abandoned and replaced by agreements that provide energy access to customers in this province on an equal footing with customers outside the province. The monopoly powers of Nalcor must be terminated, allowing private capital the ability to put forward new renewable projects if they reduce power costs and improve reliability in the province.
The negotiations must begin by recognizing that the power purchase agreement and the back-end loaded cost recovery scheme must be abandoned. The notion that all costs can be recovered from present and future Island Interconnected customers must also be rejected. A new business framework is needed, one which will treat local consumers the same as consumers in Nova Scotia. New power purchase agreements must not discriminate against local consumers. We need to renegotiate most if not all of the agreements, starting with a tabula rasa, a clean sheet.
3. Protect Future Generations
Third, the financing of Muskrat Falls should not be achieved by shifting the burden to future generations. The rate structure for Muskrat Falls was back end loaded. Rates at the beginning were already going to be 20% lower than they would have been if traditional cost recovery was applied. Rate mitigation was already built into the project right from the beginning.
On top of that, how could we expect future generations to take on more debt additional to the $47 billion and rapidly rising public debt and other obligations, as measured by the Premier’s Economic Recovery Team? A restructuring which simply elongates repayment schedules would be such a poisoned chalice, one which the province should avoid.
4. No linkage with Churchill Falls
Fourth, a corollary of the second principle, is that the recovery of the Muskrat Falls should not be linked with Churchill Falls and its expected profit flow to GNL, after 2041. We should not place Churchill Falls as collateral for the restructuring of Muskrat Falls. Nor should we impair the rights of our children to unimpaired legacy assets.
The GOC team might propose that the project’s debt be rolled over for repayment after 2041, when we have access to 65.8% of the full profits from Churchill Falls. This would be another monumental assault on future generations, depriving them of the assets which are their legacy and bequeathing instead a mountain of debt from Muskrat Falls. We do not solve Muskrat Falls by trading off the much more valuable Churchill Falls asset.
Pressures to link Muskrat Falls with the end of the Churchill Falls power contract should be resisted. The solution is not a restructuring which defers capital costs for recovery after 2041. We need to deal with Muskrat Falls among the original parties, Emera Energy and the governments of Canada and Newfoundland and Labrador.
Preparation for 2041 is another project in its own right which will require a public dialogue and a new policy framework. It will call for formation of an expert team to advise GNL. It will also call for interventions with the GOC to deal with the issue of interprovincial wheeling of power.
5. GOC Holds Mortgage on Assets
Fifth, GNL has a major advantage in these negotiations. It is the GOC who will hold the assets in the event of default and it is they who would be left to operate the facilities or else decide to mothball them. The GOC would not want to be left holding the assets and forced to manage a public utility. This should be a powerful incentive for the GOC to play a constructive role and to avoid passing a poisoned chalice to the province. In light of this the option of default by the province is far from unthinkable. In fact it may be the best course of action.
6. All parties must share the burden
Sixth, all parties to the Muskrat Falls project must share the burden, including the Government of Canada (GOC), the Government of Newfoundland and Labrador (GNL) and Emera Energy. These parties, and not the ratepayers of NL, should bear the burden. Both the GNL and GOC ignored the warnings of the joint environmental panel who recommended that an independent economic and financial analysis was needed to confirm the business case for the project. Both governments also ignored the report of the Public Utilities Board which was denied access to the latest capital cost estimates and demand projections which they needed to render their advice.
Emera was equally complicit because they undoubtedly knew that the Muskrat Falls project was fatally flawed. All three parties must be prepared to restructure their financial demands so that any dividends or other returns are conditional upon future performance. The province will take the first hit because its investment is in the form of equity, not debt. Impairment of value will impact as well on the GOC and Emera, who must be prepared to make concessions.
7. Atlantic Loop is a Diversion
Seventh, there is little prospect that the Atlantic Loop will offer a solution to the recovery of Muskrat Falls costs. The Atlantic Loop is a diversion from the negotiations which must focus on the Muskrat Falls project and its three original partners without opening up multilateral negotiations on the ability of the Gull Island project to displace coal-fired thermal plants in Nova Scotia and New Brunswick.
It is unlikely that the Atlantic Loop will have much to offer GNL in its negotiations on Muskrat Falls. The focus has of late been on Gull Island or an expanded nuclear plant at Point LePreau, as options to shutter coal-fired plants. The costs will be high and few consumers are prepared to pay a premium to replace dirty power with green energy. Gull Island power will still require higher Atlantic rates and consumer resistance will be similar to the resistance by Island ratepayers to 23 cent/KWh Muskrat power.
8. Rates should reflect wholesale market prices
Eighth, the province is now interconnected and cannot operate in isolation from energy markets in the US and mainland Canada. Other jurisdictions are moving away from cost based, rate of return regulation and so must we. This does not mean deregulation. It means that other approaches such as performance based regulation must be introduced. It means more reliance on purchasing electric power in the wholesale market by companies like Newfoundland Power and NL Hydro.
If there is to be competition there must be open access and the barriers to access must be removed. These include barriers to inter-provincial wheeling of power.
The barriers also include tax policies which favour crown corporations shielded from federal corporate income taxation. This is a obstacle to the privatization of Crown-owned generation, transmission and distribution assets, which was recommended by the Premier’s Economic Recovery Team.
9. Public Engagement Imperative
Ninth, while the negotiations with GOC and Emera cannot be conducted in public, there is a need for more transparency than has been present to date. There is little evidence that the culture of GNL and its crown-owned energy corporations has changed since the Liberals took office in late 2015. The root cause of this is that Government has yet to act to modify legislation and provide clear direction on energy policy.. It behooves Premier Furey to now embrace transparency and accountability by sharing with the public his fundamental objectives and strategy for rate mitigation and for energy policy going forward. This cultural shift will take strong personal commitment by our new Premier.
10. GNL should mount a national campaign
Tenth, GNL must go beyond engaging its own citizens. GNL must also convince the Canadian public that the national government should do more to enable this province to recover from this “misguided” project. The GOC has to bear its share of the blame for the financial burden and so must Emera.
GNL cannot escape harmless as it faces the write-off of $5 billion or more in non-recoverable investment. The GOC will also have to make concessions and recognize a substantial portion of the project debt as non-recoverable. Emera will similarly have to recognize its loss on investment, which is disclosed in Nalcor’s financial statements as debt.
Conclusion
All three investment partners can be part of a new holding company for operating the project’s assets. Shareholding in the entity should be in proportion to the investment loss recorded by each partner. If the Government of Canada takes the largest write off, then it has control of how the assets are used and how surplus power is allocated after the commitments to Newfoundland and Nova Scotia are satisfied. If this leads to positive cash flows, dividends can be paid to all project partners.
A new joint power company should be created whose cost structure is realigned to allow it to produce and market energy on a sustainable basis. The capital structure has to be pared down to manageable scale, one which can be supported by power rates in line with the evolving market, recognizing that renewable energy costs are steadily declining.
If agreement cannot be reached on a plan which will create a viable entity to operate the facility then default by the province is a real option. If no agreement can be reached which meets the ten tests listed above then the province has to assess its financial exposure and the protection afforded by what former Premier Tom Marshall described as the “non-recourse” provisions of the agreements with the GOC.
These provisions were introduced through amendments to the Electrical Power Control Act and the Hydro Corporation Act (section 3.1 of each) intended to protect GNL from exposure to the liabilities of Nalcor and NL Hydro respectively. This assessment may confirm that our best solution is to default on the payments of $74.6 billion and let the GOC decide whether to operate or mothball the assets.
If the potential shortfall of $74.6 billion is accumulated for payment after 2041 the returns to our children and grandchildren will quickly be obliterated, denying our province any material benefit from Churchill Falls for perhaps another 65 years.
GNL has initiated considerable studies into electrical energy matters over the past two years, including the Muskrat Falls Inquiry and the Rate Mitigation hearings of the PUB. But do we have a policy framework and a cogent argument to garner public support nationally? Will strong political connections between provincial and national leaders suffice to achieve our goals when the stakes are so large? This seems highly unlikely. It is time for the Premier to speak to the nation on the case we are presenting and why it should be supported by all Canadians.
The Province should not agree to any compromise that does not treat present and future ratepayers fairly. If the Government of Canada and Emera Energy refuse to accept the project's financial reality and their role in creating it, then default is the preferred course of action.
David Vardy
