Guest Post by PlanetNL
PlanetNL39: Dr. Furey’s False Diagnosis
Premier’s Rate Mitigation Plan is a Bust
In his old profession, Dr. Furey could never get away with giving a terminally ill patient a pain killer and proclaiming to them that they are cured. In politics though, he is shamelessly practicing that game to the fullest. If you believed his July 28 grandstand with his pal the Prime Minister was indeed a good and permanent rate mitigation solution for Muskrat Falls, then you have taken his bait, hook, line, and sinker.
There is very little in the announced Agreement in Principle that permanently decreases the cost of Muskrat to be borne by ratepayers. This post will explain the problems and risks of five of the six measures that were announced as the rate mitigation solution. It will also identify additional risks to demonstrate how impossible the task it is to have ratepayers pay for Muskrat. But that won’t stop the politicians from trying to do it anyway.
The July 28 Documents
The key document released on July 28, the only one that carries real weight, is the Agreement in Principle (AIP) on how the Government of Canada (GoC) and the Government of Newfoundland and Labrador (GNL) have restructured the Muskrat Falls project’s debt and equity. This agreement has signatures for both parties and appears as though it will be fully adopted through Amendments to existing project agreements.
The take-or-pay nature of the agreements is not changed by the AIP and there remains tremendous burden for ratepayers to pay for the project. The changes are largely in timing and provides little remedy to the long term-problems. Notably absent is any mention of Emera whose contractual rights to investment return are presumably left entirely intact as per the original agreements.
There were also two letters exchanged between GNL and GoC acknowledging that the Hibernia Net Profit Interest earnings owned by GoC have been notionally offered to GNL. These letters do not have contractual language and merely signal an intent to begin an intergovernmental process to develop agreements requiring subsequent approval. Considerable time, effort, and luck will be required to make this a reality.
The other document released on July 28 was a GNL Technical Briefing slide deck provided to media explaining a few details of the AIP and the rate mitigation measures including the Hibernia NPI benefits. Vital details on required revenue, the actual expected dollar value of the measures, and energy sales forecasts, were entirely missing and presumably won’t be released until NL Hydro is compelled to do so for the Public Utilities Board. Likewise, nothing is discussed regarding risks. The Technical Briefing is a carefully manufactured viewpoint that GNL wants repeated by the media.
Debunking the 6 Rate Mitigation Measures
GNL’s strategy in promoting rate mitigation in the last few years involved repetitive efforts to pump up fear of a major rate increase as soon as the entire Muskrat project is fully commissioned, as is now expected in late 2021. In the Technical Briefing the do-nothing unmitigated cost is shown as 23.1 c/KWh. Compared to the 12.5 c/KWh cost of energy since the latest rate increase on July 1 of this year and especially to those who know that for much of the last decade rates have hovered around 10-11 c/KWh, it’s a very scary threat of a rate increase.
With fearmongering well executed, GNL - or more precisely, the Liberal Party and Premier Furey – has positioned itself as the fixer who will mitigate rates. Their Technical Briefing outlined 6 GoC/GNL policy changes that they say will reduce the unmitigated rate by 8.4 c/KWh to 14.7 c/KWh. As 14.7 is much closer to 12.5, Furey was basking in self-congratulatory excess, claiming he has saved ratepayers from the evil Muskrat.
It isn’t so. He has just stalled the inevitable and made it worse by accepting more debt and interest costs. What’s amazing is how soon his plan is likely to entirely fall apart. He has only laid out the case for mitigating the rate in 2022 (see exhibit below).
While he promises rates will only rise by 2.25% annually afterwards, the temporary nature of nearly all the rate mitigation measures shows that NL Hydro will be devastatingly in arrears as it fails to collect enough money to pay its bills in the years following. It won’t be long before NL Hydro will be going to the PUB demanding unplanned rate increases to try and stay afloat.
#1 GoC Investing $1.0B in the LIL
First and foremost, this is a loan with some language around it, trying to help it masquerade as something else. This new loan is solely to be used for the purpose of paying the interest due on other loans. Some readers may know this concept – it’s called being in the poorhouse.
Premier Furey approves of this concept. Somehow, taking a project that can’t afford the debt it already has and giving it more debt, is the prescription to make things feel better. Sound more like a prescription to keep coming back to an inept doctor.
The fine print says GoC will allow NL Hydro to borrow $150M per year until the full $1.0B is exhausted in 7 years time. The Technical Briefing indicates that the $150M will translate into 2.3 c/KWh of rate reduction. That’s true only for the first 6 years and will provide barely half that benefit in year 7. After 2028, the 2.3 c/KWh of rate relief disappears and is compounded by interest costs adding another 0.5 c/KWh in burden.
The $1B bond is due in 2042. This timing is surely selected to coincide with the expiry of Hydro-Quebec’s low-price contract on Churchill Falls power. GNL and GoC must be assuming that the new Churchill sales contract will either pay off the bond or at least give NL Hydro the creditworthiness to take out a new bond to replace it.
#2 GoC Waives FLG2 Bond Guarantee Fee
When the $2.9B second round of debt was taken on, GoC imposed a 0.5% annual surcharge for providing the loan guarantee. This rate mitigation measure appears that it will abolish the resulting $14.5M expense. This is the only permanent cost reduction presented in the entire AIP. The Technical Briefing pegged it as a 0.2 c/KWh reduction to rates.
#3 GoC Providing $1.0B FLG3 to Reprofile Debt Payments to 2029
This is not extra money although it has been disingenuously presented as such in many quarters including by GNL and GoC. What it does is allow bond maturities that are scheduled to occur between now and 2029 to be refinanced. Instead of the original $7.9B in FLG/FLG2 debt diminishing to $6.9B by 2029, it will remain at $7.9B.
What that means is that NL Hydro won’t have to collect extra money in sinking funds to pay off those maturing bonds. The Technical Briefing indicates 0.7 c/KWh rate mitigation from this tactic. The flipside of the relief period is that there is now more bond money owing and fewer years left to pay it off: a sharper rate increase of about 4 c/KWh should be expected in 2029 to recommence the sinking funds. In addition, the extra $1B in debt by 2029 incurs new interest costs growing to 0.5 c/KWh in new rate impact.
#4 GNL Restructuring $2.0B in MFLTA Equity to Preferred Shares
This one requires Dr. Furey, the math and accounting expert, to explain how it is a benefit because real math says it looks like a new cost. The Technical Briefing indicates a 1.5 c/KWh rate reduction suggesting required revenues relative to the original agreements would decrease by about $100M due to this measure. The problem is two-fold.
First, the original agreements fully backloaded MFLTA equity return so there was nothing due on it in the opening years of the 50-year payback period. What Nalcor and GNL were doing was accruing the earnings on the books to be paid out later while compounding full interest charges of about 8.5% on the amount owed. So how does Furey’s math reduce something by $100M when it was already at zero?
Second, the new preferred shares demand interest payments of 3%. Starting in 2022, ratepayers must pay an unexpected new expense of $60M to GNL. GNL also did not indicate that utility dividends shall stay within the utility for rate mitigation: it appears then that GNL is intent on extracting as much cash as possible starting in 2022.
Put these two together and instead of a cost reduction of $100M in 2022, it sure looks like there is a cost increase of $60M. Rather than mitigating 1.5 c/KWh, GNL is going to drive an immediate and permanent 0.9 c/KWh rate increase. This looks like a 2.4 c/KWh error in the rate calculation.
Either GNL has made a horrible math blunder or they have some hidden cost adjustment plan that they have not yet revealed. Perhaps like all good loansharks, they intend to take the deficit amount of $160M and throw it in their deferred ROE accrual account where it can earn 8.5% return to supposedly make more money off ratepayers. The illusions of voodoo economics have yet loosened their grip and appear to have made a new friend in Furey.
#5 One-Time Refund of Financial Reserves
With this one, it appears there is money already set aside that is no longer required to meet the existing agreement conditions. The key word is “one-time”: the refund will go straight to ratepayers for 2022 only. The stated rate relief of 0.8 c/KWh won’t be available in 2023 and onward.
#6 Hibernia NPI Provided By Province
The Technical Briefing claims 2.9 c/KWh rate mitigation benefit which indicates an expected cash flow of about $190M from this source. There are serious risks associated with this assumption.
Firstly, the mention of any Hibernia NPI benefits is completely absent from the formal AIP. What we have here looks awfully like an election promise by PM Trudeau that could be at serious risk if this province does not return a high number of Liberal MPs and if Trudeau cannot form a majority government. Ratepayers should be very wary this promise may not be fulfilled.
Secondly, the alleged sum of $3.2B in transfers extends to Hibernia’s expected decommissioning date in 2047. Between now and then a lot could change that can jeopardize returns. Will Hibernia continue to operate all that time and do so efficiently? And what of the price of oil and potential profitability from which NPI is calculated? That profitability has never been better than now but that may be a short-term condition.
Between bald-faced electioneering and the economic risk of oil prices sagging or of increasingly environmentally focused regulatory schemes reducing profit, the eventual benefit to ratepayers may be severely overestimated. In the not impossible worst case, this rate relief item could disappear entirely.
The Unstated Hidden Cost of Steadily Rising Utility Costs and Falling Electricity Usage
What Furey has done is put all the benefits in play for 2022 and conveniently ignored that most of them will fall away over time and some may not be realized at all. He carefully chose not to provide any future looking information other than to claim 2.25% rate increases will cover all required revenues.
A key problem going forward though is that steadily rising utility costs are likely to continue at an annual rate of 1-2% and that electricity usage, apart from a post-pandemic rebound into next year, is likely to show declines of at least 1% annually. Falling sales and rising utility costs will fully absorb those 2.25% rate increases.
Theses factors mean there won’t be anything available from the rate increases to meet the foreseeable rising costs of Muskrat payback. 5 of the above mitigation items are temporary or at risk of not being realized. NL Hydro will be going to the PUB for large rate adjustments on a frequent basis.
The possible unreliability of Muskrat operations is another major cost risk borne by ratepayers in Furey’s scheme. NL Hydro must act to recover all unanticipated repair expenses and excess fuel costs from ratepayers.
A Weak Plan Only Leads to More Debt and Economic Demise
Premier Furey announced his unprepared and ineffective plan likely because his pal the Prime Minister had told him he was out of time and options. With a federal election imminent he trotted out his inadequate plan and tried to spin it as best he could, designing it mainly to extract maximum rate reduction in 2022 at the expense of everything else in the future.
If the downsides and risks play out as identified in this assessment, while rates are held to only the 2.25% escalation plan, NL Hydro could be in the hole by over $100M in just a year or two. That would need only either item #5 or #6 to fail as noted.
If the plan is as hapless as it looks, NL Hydro’s cumulative unforeseen debt could be approaching $1B in as little as 4 years when NL Hydro’s breakeven rates may need to be in excess of 20 c/KWh but Furey’s rate promise would have it at barely 16 c/KWh. By 2029, the required rate differential may exceed 10 c/KWh.
Within another two or three years, Furey or his successor will be electioneering on the next phase of fixing Muskrat. Perhaps they will convert the last of the equity to preferred shares and do more borrowing against long-awaited post-2041 Churchill Falls income.
For politicians, Muskrat is the gift that won’t stop giving them more opportunities to grandstand. For ratepayers, it is the nightmare that will never end.
When it comes to Premier Furey’s new rate mitigation plan as the remedy for what ails ratepayers, don’t be surprised when feverish rate increases soon cause your condition to dramatically worsen. Best you find a new doctor.