DOING THE MATH ON A MINING SUBSIDY

An article in the Kamloops Daily News, written by Columnist, Jim
Wentworth, in June 2012, notes that an electrical subsidy to a proposed mine
called Ajax, would alone cost B.C. taxpayers
$16.5 million
.

The Kamloops article
suggests British Columbians already believe that they pay too much for
electrical power. Wentworth adds that, “the negative revenue impact of these
various resource projects may increase (B.C.’s power costs) even further. So
the impact on residential ratepayers will be very substantial if the current
rate structure for mining projects, such as Ajax, is not amended”.

The issue is important to NL not just because our power rates are
going up substantially too, but because of the parallels with the B. C. issue for
power subsidies to Alderon and to other 
mines in Labrador. 

I thought it time to put some numbers to the issue of electrical subsidy;
we should decide if the cost should concern us in NL as it concerns some
residents of B.C. 

Alderon is the most advanced of the mine proposals; it can help us
define some of the parameters for our calculation.


What rates should we compare?

Our object is to calculate the subsidy that island ratepayers will
incur relative to the price a mine might pay (similar to Alderon’s Kami Mine)
for Muskrat Falls power, not at Soldier’s Pond but prior to transmission.  All the information required, is currently in
the public domain.

The arithmetic is actually fairly simple.  I am using Nalcor’s estimated cost of MF power,
based upon the “Power Purchase Agreement” (PPA) rather than the higher “Cost of
Service” (COS) rate. You should know something about those two schemes.

Essentially the difference is that the PPA involves a 50 year
payback period in which the depreciation is written off much later than under
the COS approach and according to David Vardy and Ron Penney involves a cash
shortfall which will have to be made up by Nalcor or the Government,
constituting, in essence, a subsidy.

Under the PPA, Nalcor opts for a scheme “…which brings lower rates,
in the early years, which are intended to be offset in later years” (Vardy/Penney, page 60, PUB Review). Hence,
in the early years, the users of the electricity essentially get the power rate
“subsidized”.  That’s the PPA. And that ‘subsidized rate’ is estimated to be 8.7 cents
per KWh in 2017 (ref. page 59, PUB Review). It is that lower PPA rate that I am
using to calculate the mining subsidy.

That
said, a strong case can be made for using the higher Cost of Service (COS) rate.
The COS
approach
follows standard business terms, for writing off depreciation and
capturing a rate of return.  It
is
the scheme that Emera negotiated for its participation in the financing of the Labrador
Island Link (LIL).
Unlike Nalcor, it is forced to operate on the business
principles that both its lenders and investors demand.  The
cost to you of MF power, if the COS method of financing were employed, is 21.4
cents per KWh (this figure, again, does not include transmission costs to the
island).

Before I do the math, let’s bring Alderon Iron Ore into the
picture.


Alderon
Iron Ore
, on its web site, informs us of “Good access to low cost (~4
cents
per
KWh) electricity produced at Churchill Falls”.  Given that the Province has used Alderon and
other potential mines in Labrador to justify building Muskrat Falls, we are
left to assume that it is prepared to compete with that price and offer it as
an “industrial rate”.

Hence, we will use 4 cents per KWh in our calculation.  In order to suggest a range of subsidy,  we will also do the arithmetic using an
“industrial rate” of 6 cents per KWh; though it is not a likely scenario given
utterances from the Government.

How much power does a mine need?

Power requirements will depend upon the size of the mine and
whether it is a simple extraction process or whether, in the case of an iron
ore mine, it also ‘pelletizes’ or turns into ‘concentrate’ the mined ore.  On page 12 of the document recently released
by the Province, entitled “Labrador mining and power: how much and from where?”
Alderon’s Kami Mine is said to have a preliminary requirement of 58.3 MW and an
additional 80 MW, if pelletizing takes place.  These numbers give us basis on which to
calculate how much power a mine, of the Alderon type, will use. 


Let’s assume that our mine and pellet plant will have an
electricity requirement of, say 138 MW.

Megawatt (MW) is a Unit of power that defines the ‘capacity’ of a
system and tells us how much power a system can carry at peak demand.  A megawatt hour (MWh), on the other hand, is
a unit of one million watts of power applied over a period of one hour.

Mines, after start up, use power at a fairly constant rate; we
shall use 80% of capacity as a reasonable estimate.   Next, we must convert Megawatt hours (MWH)
to Kilowatt hours (KWh), which is the Unit (1000 watts per kilowatt) used to
calculate your own power bills.

Hence, 80% of 138 MWs times
8,760 (number of hours in a year), converts to 967,104 megawatt hours.
Converted to kilowatt hours (KWh); that’s 967,104,000 KWh.

Finally, using the
benchmark industrial rate of 4 cents per KWh against the PPA rate of 8.7 cents
per KWh, let’s do the math:

 ___________________________________________________________________________

PPA Rate  (KWh)                             8.7 cents
Less: “Industrial
rate”                    4.0 cents
 
                  =                                         4.7
cents (per KWh, subsidy)
 
                 X                                         967,104,000
KWh
                                                          
(estimated annual power
                                                          
used)
 
                 =                                        $45,453,888 (based on DG-                                                                                       2 estimate)
ADD: 24% for DG-3 Project
           Cost Increase                       

Total Subsidy based on PPA
Electrical Rate                                $56,362,821 (based on DG-3
                                                                                        estimate)


In summary, using “industrial rate” of 4 cents per KWh and the rate customers on the island will pay for Muskrat Falls generation only, the subsidy to our mine is $56.36 million.

(If the Province were to set an unlikely rate of 6.0 cents per KWh, as the “industrial rate”, the subsidy (based on DG-3) would still be $32,378,641 annually).

And, the subsidy  does not reflect the liklihood of cost overruns. 
 

I suggest you also need to calculate
the subsidy based upon the more conventional COS calculation at 21.4 cents per
KWh (plus 24% for DG-3). If you try this at home, please use your calculator sitting down!

Russell Wangersky of The Telegram
wrote an excellent Editorial on November 3, 2012 entitled “Let’s call this
what it really is – a tax”

. Wangersky’s views are summed up in the Editorial’s headline and in many ways they
mirror the views of Jim Wentworth at the Kamloops Daily News.  

(Note: Wangersky is using 7.6
cents per KWh which is the 2010 PPA cost of MF power, I am using Nalcor’s 2017
numbers (reflecting an annual increase for inflation of 2%), when MF comes on
stream; no mine is expected to need the power before then).

I wonder if Mr. Wangersky read
the investor information on Alderon’s  Web
Site.  He might have noted, as did I, that
Alderon’s forecast Internal Rate of Return (IRR) is estimated at 40.2%. The
payback period for its Kami Mine is 2.5-2.8 years.

If our theoretical mine has any
similarity with Alderon’s Kami Mine, we ought to ask this question among others: this the
picture of a mining company in need of a subsidy?


We know what Premier Dunderdale would say.  Please tell me what you think.  See the “Comments” section below. And, while you are doing that, you may wish to leave your answer, having calculated the subsidy based upon the Cost of Service (COS) power rate and an “industrial rate of 4 cents per KWH.

Des Sullivan
Des Sullivan
St. John's, Newfoundland and Labrador, Canada Uncle Gnarley is hosted by Des Sullivan, of St. John's. He is a businessman engaged over three decades in real estate management and development companies and in retail. He is currently a Director of Dorset Investments Limited and Donovan Holdings Limited. During his early career he served as Executive Assistant to Premier's Frank D. Moores (1975-1979) and Brian Peckford (1979-1985). He also served as a Part-Time Board Member on the Canada-Newfoundland Labrador Offshore Petroleum Board (C-NLOPB). Uncle Gnarley appears on the masthead representing serious and unambiguous positions on NL politics and public policy. Uncle Gnarley is a fiscal conservative possessing distinctly liberal values and a non-partisan persusasion. Those values and opinions underlie this writer's views on NL's politics, economy and society. Uncle Gnarley publishes Monday mornings and more often when events warrant.

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4 COMMENTS

  1. There is a grave danger in building infrastructure for mining projects, that may or may not happen.

    We have to distinquish between projects that are funded, like IOCs expansion project, and those which are new builds, depending on market financing. The price for Iron Ore is not anywhere near where it was three years ago, and several of these "projects" look to be at best highly doubtful. The story in the Weekend edition of the Telegram explained some of the market impacts, but if anyone needs a primer on current international iron markets, look at the Morgan Stanley analysis.

    http://www.businessinsider.com/morgan-stanley-explains-the-iron-ore-price-crash-that-nobody-can-stop-talking-about-2012-9

    We are ahead of demand here. seriously so.

  2. You show a subsidy of 56 million for one mine operation.I have calculated that a customer rebate plan that would cut demand on the island by 40 MW per year ( and allow zero use of Holdrood after a decade) would cost 52 million per year and would allow 13,000 conversion to efficient heat per year. This can be financed with a 8 percent add to the current electriciy rate but providing a 30 percent reduction in residential monthly bills. This is an investment of about 100.00 per person, and is completely self fiancing from energy savings. Many USA jurisdictions are investing in energy efficiency appproaching this 100.00 per person level. Recall the word Gravy by Ed Martin, and ask where the gravy is going; to residents to to mining companies? Residents will pay over 30 percent more by 2018. But the gravy is flowing freely to mining companies. Perhaps it's protected under the Charter? The gravy train for mining companies- what section is that? Under the disability section, dealing with morals and ethics – corporate disability, that's it. Winston Adams

  3. Mr. Sullivan, I wonder how many of the 66% of people polled, and said to be in support of Muskrat Falls, would respond if they read your article. If these poll numbers are correct, and I have serious reservations, then too many people have their heads AND torso buried in the sand.

    This myopia, and lack of comprehension of the dangers facing us should this project proceed,is all the more reason for a referendum on Muskrat Falls. It would allow the critics and the facts to be given equal time and an opportunity to counter the government's propaganda. In that event, if people still don't want to be educated, then the province will truly get what it deserves.

    It is terribly frustrating and difficult to try to get the facts out, in the face of relentless propaganda and nationalist zeal. Unfortunately, these tactics will not pay the bills when the true costs of Muskrat Falls are known…but by then it will be too late.