Guest Post by PlanetNL
PlanetNL34: Labrador Industrial Rate Policy Overdue for Revision
(With Update - June 8, 2021)
The price paid for electricity by the Iron Ore Company of Canada (IOC) in Labrador City and Tacora Resources, the new operator of the Scully Mine in Wabush, is very low. It is shockingly low.
According to a footnote found in the 2017 General
Rate Application submitted to the Public Utilities Board (PUB) by NL Hydro, the
blended cost for the Labrador Industrial Rate that is specific to only the
Labrador West iron ore mines was a miniscule 0.315 c/KWh.
The mining companies are getting record high iron ore
prices these days and sending their profits not just out of province but out of
country. Providing them electricity at giveaway
pricing is a practice that needs to end right away. They can easily pay a fair price for
electricity and would still make enormous profit.
The Provincial Government, despite their talk of desperate need for rate mitigation, is apparently happy to let the giveaways continue. This post shows the opportunity cost of Government’s blatant negligence.
Background On Why Rates Are Low
The mines in Labrador West built their own 225 MW
generating station at Twin Falls and transmission lines in the early 1960s. In 1974, they agreed to close their
generating station and relinquish water rights to the new Churchill Falls
project (CFLco) which would produce much greater power from the same flow at
their plant. CFLco agreed to supply the 225
MW for 40 years at no charge. It was a
win-win for both parties.
Beginning in 2015, after the supply agreement fully
lapsed, the 225 MW block of power reverted fully to NL Hydro from whom the mining
companies now purchase energy as part of the Labrador Interconnected System
(LIS). By luck and good fortune, much of
it their own making, the mining companies are getting an extraordinary deal on
their electricity costs.
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| Photo Credit: IOC |
The LIS regulated cost-of-service methodology only attempts to collect the minimum costs of serving customers. As the LIS is getting energy from CFLco at 0.2 c/KWh until 2041, that cost component is incredibly low. As much of the transmission system was built by the mining companies and handed over to NL Hydro, the book value of transmission assets is very low and the resulting charges are a tiny fraction of what they would otherwise be. Those are the two major elements that make up an industrial cost of service rate.
The mining companies are not in the least to blame
for their low rate and they deserve a lot of credit. Their investments decades ago have led in
large part to the low rates they enjoy today.
The commercial and residential customers benefit
from the infrastructure the mining sector created as well. Neighbouring Hydro-Quebec has among the
lowest rates in North America but the LIS rates are about 60% less again.
Government Understands the Opportunity Cost But Still Not Doing What They Said
Back in 2012, Government presented clear plans for a new Labrador Industrial Rate Policy that would bring rates in close alignment to the market price for energy commencing in 2015. They revised the quantity of power for existing Industrial customers to 239 MW and indicated that the price would gradually escalate to wholesale market price by 2020, a figure that is about 4 c/KWh today.
Government also advised that commercial and
residential rates would not be affected with the change to Labrador Industrial
Rates. What this shows is that
Government wanted to target this one specific sector to have the Utility capitalize
on a reasonable profit opportunity. That
profit would be returned to the Shareholder, the Government of Newfoundland and
Labrador.
This is one of the rare smart utility decisions
Government made during this period. The
problem is they never followed through on their intentions.
Not only has the rate increase not happened, but there is also no evidence it ever will. Submissions by NL Hydro to the Public Utilities Board Rate Mitigation Hearing in 2019 included rate projection forecasts for the period to 2039. These forecasts have revenues collected from the Labrador West mines barely creeping above current levels.
Somehow, Government managed to have some minor elements
of their plan implemented but not the most substantive part to charge a fair
price for electricity. There is no known
legal constraint preventing it other than for Government to make a minor
amendment to Utility legislation.
During the intervening period, Wabush Mines did
close in 2014 but resumed production in 2019 under a new owner, Tacora
Resources. IOC also made noises during
this period when iron ore prices went through a cyclical dip, claiming that its
future was uncertain.
The politicians may have delayed action due to concerns about a soft market, but that condition did not really last that long until sizable profitability was restored. It remains a mystery as to why no action has been taken to increase the rates as was planned.
Iron Ore Markets are Booming
As a result of Government’s procrastination, it is
allowing the mining companies to enjoy record profit taking. They could easily afford to be paying market
prices for their electricity.
Two pieces of publicly available data on IOC are a
good measure of the situation.
First is the price of iron ore which has quadrupled
since the low year of 2015 as seen in the chart below. Iron one is a global commodity that experience
boom and bust cycles. In this chart we
see a low period where spot prices are US$50-60/ton. 2019 and 2020 were a good bit better and 2021
so far is almost off the charts.
[Source: https://www.mining.com]
The second source of data examined are Annual
Reports for Rio Tinto, the 58.7% controlling owner of IOC, and one of the
world’s largest mining conglomerates.
Those reports contain a clear summary of IOC’s financial performance. Data for the 2010-2020 period was collected to
match the years shown in the commodity price chart above. Examining both charts provides a clear
understanding of IOC profitability vs commodity price.
The correlation between commodity price and
profitability is clear. During the worst
of the down cycle, IOC was roughly a break-even operation. In the worst year, 2015, net income was a
loss of US$12M (too small to be visible in the chart) when iron ore prices
averaged US$50/ton. As market price
recovered, IOC returned to solid profitability.
To be clear, IOC is not in the poorhouse. They may have been worried back in 2015 but
that troubling period was very short. In
the 11 years shown, they have returned an average profit of US$350M. The most
recent two years are well above that mark and based on 2021 spot prices to
date, IOC might be on track to remit a whopping US$1B this year to very happy Rio
Tinto executives in Australia.
Can IOC afford to pay market price for their electricity? Most definitely, 100%!
As a privately held US-based company, Tacora
Resources financial data is not publicly accessible. It may be safe to assume that if they were
confident in their business plan when they purchased the mine in 2017, they should
be ecstatic with the implied increased in returns since then.
Energy Usage and Actual Energy Sales
In the 2017 GRA, Tacora Resources energy
requirements were unknown and not forecasted and exact reports of usage cannot
be located. Their maximum load was
estimated to be 50 MW and usage of 0.4 TWh energy is assumed.
IOC’s usage was estimated to be 1.73 TWh in the
2017 GRA, this was 71% of the total LIS energy requirement all by itself. In the 2018 Industrial Customer Rates Hearing,
the PUB made no adjustment to the Labrador Industrial Rate, resulting in IOC’s estimated
annual billing of $4.7M. It is likely
that IOC production has increased since then and electricity consumption would
be up from earlier estimates. Given
where ore prices are, the company should be trying to run all equipment at 100%
and using key production staff on plenty of overtime to increase profits.
The combined revenue of the Labrador Industrial Rate group is likely around $6M. Combined energy demand from the two companies is estimated to be at least 2.2 TWh. It is quite possible that the blended cost of generation and transmission is now below 0.3 c/KWh.
A Large Opportunity Cost
Government’s intent in 2012 to charge market pricing
energy to the mining firms should have proceeded as planned. Had they done so, based on a wholesale market
energy rate of 4 c/KWh, NL Hydro would be collecting $84M additional revenue.
The companies can afford to pay more for their
power. Just a short drive across the
Labrador-Quebec border is another comparably large iron ore mine that is paying
market price for their electricity from Hydro-Quebec. The continuation of 1960’s electricity rates
for the mining companies on the Labrador Industrial Rate must come to an end.
There is another dimension to the opportunity cost
as well. Tacora’s 50MW load has directly
come at the expense of surplus energy exports.
With 0.4 TWh less energy to export, Nalcor Energy Marketing, which could
have sold that energy for 4 c/KWh, will have incurred a reduction in profit of $15M. Increased usage by IOC would contribute to
millions in additional losses on export sales.
In effect, Government is not just sustaining the excessive profitability of the mining industry by sustaining unreasonably low rates, they are providing an indirect subsidy by giving away potential earnings on surplus sales.
Will Government Do the Right Thing To Correct
This?
Government should act promptly to update
legislation to ensure that NL Hydro can raise Labrador Industrial Rates at the
soonest opportunity. NL Hydro and the
PUB require the amendments to redesign rates and remove the opportunity cost of
$84M.
Within the amendments, Government must direct the
PUB to not allow multi-year phasing in of the increase either. The delays have already cost the Province hundreds
of millions in lost revenue that could have helped reduce deficits and long-term
debt. IOC and Tacora would otherwise use
the excuse of “rate shock” and the PUB may have to grant a slow phase-in. This increase should happen in one shot.
Cutting into the huge profits being sent to
Australia and the US is nothing for our Government to feel the least bit
worried about.
Delaying this action any longer though, should make
the public very concerned about what the hell Government is thinking in failing
to raise the Labrador Industrial Rates.
Be prepared to be disappointed though.
While the iron ore market dip in 2015 might have
caused Government to hesitate in raising the rates, surely the evidence was
there by 2017 that IOC, reporting US$377M in after-tax profit could fully bear the
rate increase. Why was this not planned
into the 2017 GRA for rate increases at that time?
When the Liberals under Premier Ball launched
their rate mitigation strategy two years ago, IOC profits were topping US$500-600M. Action to raise Labrador Industrial Rates to
market price energy should have been viewed as high priority low-hanging
fruit. Why was it not in there?
At no time to date from any political party has there
been any mention of this obvious and deserving rate correction. We do hear many politicians talking about high
corporate profits and low corporate taxes – does this not fit into a similar
line of thinking? How can they not know
about this?
Many House of Assembly members and bureaucrats
(especially those in Finance and Natural Resources) would be familiar with the
2012 plans for the Labrador Industrial Rate and with all that has happened
since involving Muskrat Falls, rate mitigation and the deficit, it is simply
too convenient to think that everyone forgot about this.
Correcting this large oversight would bring the
same benefit to Government as increasing the HST by 1%, a tactic suggested in
the Greene Report (this report also missed out on identifying the opportunity,
but it seemed to just ignore Utility business in general as being something off
limits). Wouldn’t the public prefer that
fair energy rates be charged to highly profitable mining companies before
raising the HST on ourselves?
Despite the Utility’s and the Government’s obvious
need for improved revenue, they just are not going after this easy and justifiable
revenue opportunity. Instead, they are
content to have earnings on surplus energy sales diminish.
This one is beyond absurd. The giveaway to foreign corporations is
indefensible.
Something is very rotten in the state of
Newfoundland and Labrador politics.
If there are any honest and competent politicians in this province today, will you please take up the cause to fix this injustice. You have received the facts – now act on them!
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* Update to this Post found at Government Accountable for $1B+ Giveaway to the Iron Ore Mining Sector (Update)