Guest Post by PlanetNL
PlanetNL37: Market Valuations for Gull Island and Churchill Falls
Plus The Atlantic Loop and A Curious Re-Analysis of Muskrat Falls
PlanetNL36 provided an analysis of the fair market value of Muskrat Falls based on prevailing wholesale electricity rates. The analysis concluded that the project would be completely incapable of generating any net earnings to put toward return on debt or equity. Worse again, like a true boondoggle it could continue losing money after it is put into operations. The Muskrat project should never have made it beyond round one of screening alternatives, let alone been sanctioned and built. That Nalcor and Government sanctioned a project that forced ratepayers to pay ten times greater than market price, and with cost overruns more than twenty times market price, is an obscenity.
The same methodology for economic worthiness is used to consider the market value of the potential Gull Island project and the Atlantic Loop. In addition, it will be used to put an estimate on the 2041 market value of Churchill Falls. Plus, one final look at Muskrat will consider whether the project in a lesser form might have been more viable.
To better understand the methodology, be sure to read PlanetNL36 first.
Gull Island – No Chance, Stan
Some guesswork is required and shall be based on the Muskrat Falls experience. We do know Nalcor and Government promote the potential Gull Island plant capacity as 2250 MW (2.7 times Muskrat) yielding 11.9 TWh of energy (2.4 times Muskrat).
The last detail allows computation of the gross annual revenue potential of near $480M using the current 4 c/KWh wholesale market energy price projection.
Operations and Maintenance costs might be the same as Muskrat at about $80M as the larger size of the plant is offset by a shorter and less complicated transmission system. Water power royalties to the Province should scale at 2.4 times that of Muskrat for $39M. Another expected allotment for First Nations settlements could easily exceed $10M per year. In total, $130M in operating costs leaves $350M remaining to go toward capital return. That is a lot better than Muskrat.
Using a 10% factor for overall rate of return with depreciation, which is not allowing much for risk given how poorly Muskrat has gone, the available $350M in annual return on capital indicates a sustainable maximum capital investment of $3.5B. That doesn’t look good.
Nalcor has not publicly uttered a cost estimate for Gull Island. Around 20 years ago it was thought to be about $4B but Muskrat was thought to be about $1.5B or so at the time. Those numbers are surely far too low. While Gull Island will not have nearly the same transmission line expenses, the generating facility will likely cost at least double that of Muskrat. A total project cost in the ballpark of $20B is a reasonable estimate.
Clearly the economics of Gull Island look like a dismal failure and the project should never be sanctioned. To achieve financial breakeven would require wholesale market energy prices to be at least 17 c/KWh. It would need to be even more than that as Hydro Quebec’s and other jurisdiction’s transmission fees must be costed into sales.
With wind and solar energy suppliers entering the North American market in abundance and pushing market prices ever lower, and more new technologies in development for both energy generation and storage, it appears that any notion of Gull Island ever being developed is the epitome of nonsense.
|Inside the Churchill Falls Generating Plant|
Gull Island Atlantic Loop – Really, Stan?
The proposition of the Atlantic Loop cannot go unassessed. The Gull Island scenario above allows only just enough new transmission line construction to get the power onto the Quebec grid. For the Atlantic Loop, a dedicated transmission line must extend all the way to New Brunswick, across it and into central Nova Scotia. A solid comparable is Manitoba’s Bipole III, which cost $5B. This raises the required wholesale cost of energy to 21 c/KWh. At that whacky price, the Atlantic Loop is Boondoggle II.
The Atlantic Loop concept is a mere political pipedream intended to distract the people of Newfoundland of their grief and fear associated with Muskrat Falls and for shameless vote pandering in the Maritimes.
New Brunswick and Nova Scotia have several better alternatives. Firstly, they have Hydro-Quebec next door who could supply energy if they accelerated some internal policies. Quebec would need to reduce in-province peak demand and they would need to reprioritize away from exporting energy to the US. Both things are slowly happening, the first by choice and the second a result of getting squeezed out of the market.
The cost of large-scale transmission line construction is a substantial handicap even to the Hydro-Quebec concept. New Brunswick and Nova Scotia are just as aware as anyone of trends in wind and solar generation and other developing technology opportunities. Dispersed pockets of renewable generation that avoid new transmission line construction, eventually supported by economic energy storage, is the economic roadmap toward full green energy at competitive market prices in all jurisdictions. Big hydro has had its day.
Stan Marshall said in an interview to CBC on June 10, “The problem we've had in Newfoundland, we've gotten terrible advice on our hydroelectric things.” Somebody needs to get Stan a mirror. And a calculator.
Churchill Falls – A Top Quality Asset
The scenario involving Churchill Fall is to assess its market value, not for construction, but as if it were to be acquired by a new owner. Post-2041 cash flows provide the answer.
Churchill Falls could not be more different than Muskrat Falls or Gull Island. Churchill Falls is a proven and reliable plant with exceptionally low operating costs. Its output is a staggering 5428 MW (10th largest hydro plant in the world) and it typically produces 35 TWh of energy annually.
Roughly 90% of the energy is taken under contract to Hydro Quebec until 2041 at the super-low price of 0.2 c/KWh. Supplemental revenue streams bringing total revenue, according to the recent 2020 Financial Statements, up to $146M while total expenses were $97M. On an energy basis, the revenue averaged 0.5 c/KWh while cost was 0.3 c/KWh.
Clearly the energy is being sold at way below market-price and will remain so until 2041. Doing an asset valuation on $49M profit will lead to a ridiculously low number, even less than the very low 2020 asset book value of $1.0B. We know the true market value is something far greater.
Beginning in 2041, all production should be expected to sell for the wholesale market price of energy. Hypothetically, if that contract ended today, the gross annual revenue would rise almost tenfold to $1.4B with expected gross profit of $1.3B.
The appropriate rate of return on a known low risk asset should also be adjusted lower than for Muskrat and Gull, by at least 2%. Dividing the gross profit by a rate of return and depreciation of 8%, indicates a fair market capital asset value of $16.25B.
There are several downside concerns and risks to consider though. Will Hydro-Quebec still want 90% of the energy or close to that? If not, transmission fees will apply to export sales sent through HQ at a cost of about 1 c/KWh. As well, will there even be a viable export market beyond Quebec post-2041. The plant by then is sure to require some major capital renewal in its next 50 years and some deduction should be reserved for that. Long-term trends in the price of electricity will also have a big effect – they could go up, but it seems more likely they could go down. These effects could easily half that the potential asset value.
Expressing the market value estimate to be in the range of $8-15B may be the best way to encapsulate the variances. As the Province owns 65.8% of Churchill Falls, their share of the asset value would be roughly $5-10B.
As shown in PlanetNL36, market energy prices were right about the same in the period of 2009-2013 prior to Muskrat sanction. The same valuation of Churchill Falls as presented here would have existed then. That Nalcor and Government spawned the far smaller and much more risky Muskrat Falls in this same cost range defies all sense.
Muskrat Without the LIL – Less Is More
OF the countless mistakes made in developing the Muskrat Falls project, one of the worst concerns the value of the Labrador Island Link (LIL) DC transmission line. It was very expensive and remains plagued with problems.
As this component is about 40% of budget, it is worthwhile to consider whether Muskrat might have fared better as a straightforward export only Government Business Enterprise, without the LIL. In this scenario, the Island could have remained isolated and continued to use Holyrood at a far lower cost than Muskrat in the short-term and eventually would have weaned itself off Holyrood through conservation measures and a small amount of renewable development added at market energy price.
This export-only Muskrat project would be assumed to cost $8.5B on the assumption that there is spare capacity on the Churchill Falls transmission lines to which it is connected or to the Gull Island lines if it were built. These are weak assumptions, but it reflects NL Hydro’s position from decades ago that Muskrat was never expected to be anything more than an add-on project with Gull Island.
From PlanetNL36, the total expected revenue on energy sales is $184M as Emera does not exist in this scenario to siphon off power without pay. O&M costs would be halved without the LIL but other operating costs the same, totalling $62M. With a gross margin of $122M, dividing by 10% yields a capital asset value of $1.2B. Adjusting rate of return 2% lower only increases the valuation to $1.5B.
The required revenue to cover $8.5B in capital is $912M demanding roughly the same 20c/KWh wholesale market price of energy as for Gull Island.
Even this lean and trim Muskrat is a big fat loser but at least it is only about half as bad as the 39 c/KWh price calculated in PlanetNL36 for the project with the LIL. The high O&M cost associated with the very complex LIL is half the answer while the commitment to give Emera 1.0 TWh of free energy is the other.
This somewhat curious finding should not be quickly forgotten.
If the LIL should prove unfit for purpose to reliably deliver winter power needs to the Island, or if it suffers major capital damage in a storm event, it may be time to cut losses and do something else. If the Churchill Falls transmission line has the available capacity, the Muskrat Generating Station could immediately generate greater returns for itself through energy export.
That scenario would need to take into consideration new actions the Island must take to make up for its energy shortfall. An urgent conservation program and a competition for a wind energy PPA could both likely be delivered at the market price of energy with little capital cost. Putting major capital into the LIL again to hope it works perfectly next time would likely be a distant second-best alternative.
It is a complex scenario to analyze but there is a clear possibility that Muskrat would operate more beneficially without the LIL and the Island electricity system would be made more reliable without it.
This eventuality should be ignored by no one involved in the negotiation of the resolution of the financial calamity of Muskrat Falls.