The method that Nalcor is using to price the electricity
from Muskrat Falls should be a major concern to the residents of the province. The
cost to the ratepayer, in the first instance, will be kept artificially low to
obscure the true cost of the project. Here are the reasons why you need to be
concerned:
to Newfoundland and Labrador Hydro (a regulated subsidiary of Nalcor) under
what is known as a Power Purchase Agreement (PPA). Under this agreement, electricity
will be priced in constant dollars and will escalate annually by a figure adjusted
for the rate of inflation. This is also known as “escalating supply pricing”. The
project, then, would be paid for over a period of 57 years. In other words, the
returns on the project are back-end loaded,
the depreciation in particular, is calculated by using what is referred to
as a sinking fund – the depreciation is written off much later, a procedure that
is used by only a few provincially owned utilities in Canada. The
simple fact is that the provincial government, through Nalcor, is ‘kicking the
can down the road’ and making it a problem for the next generation. Only
government would engage in this practise. Private enterprise, especially those
with public shareholders, like Fortis, would not.
In the early years the Muskrat Falls project will lose money
under conventional pricing. Normally the cost of service (COS) pricing
methodology is used. The COS method would see the project paid for over a much
shorter period, depreciation would be calculated using a different method and future
generations would not be compromised.
“this (PPA) approach avoids intergenerational inequity…” In other words Nalcor
is suggesting that your children and grandchildren will be paying essentially
the same price for power as you would today on an inflation adjusted basis. In
fact, the opposite is true. Planning to pay for a project over 57 years in constant
dollars means that there is no flexibility to adjust for technology changes
over this period (witness the extent to which the emergence of natural gas is
changing the pricing of electricity in the Northeast United States).
(MHI), the PUB’s chief consultant, also admitted, in its submission to the PUB,
that “… uncertainties in power systems have been
augmented by various factors such as advancements in technology, the increased
complexity of system design and operation, the deregulation of the utility
business, the increased utilization of intermittent energy sources and the
imposition of more mandatory regulatory requirements.” 57 years is a long forecasting
period to assume no technology change and, in any case, forecasts over this
extended period mean very little, no matter how solid the assumptions.
Moreover, significant capital may have to be expended over the next 30 or so
years to repair or replace parts of the infrastructure.
term financing for projects such as Muskrat Falls is obtained by floating long
term bonds. The maximum length of a bond is 30 years. We do not know if
the escalating supply price method takes into account the level of interest
rates beyond the initial bond term when this project will have to be refinanced,
nor the cost of refinancing. One very knowledgeable person observed: “Who is
going to lend money for a fixed rate of interest for 57 years?” I would be very
surprised if the Federal Government loan guarantee extended beyond the initial
period.
note that the transmission line from Muskrat Falls will be financed by a new
corporate entity; Emera of Nova Scotia will be part owner. The conventional
method or the cost of service (COS) approach is being applied for its pricing
strategy. The reason: a PPA agreement wouldn’t pass muster under the Nova
Scotia PUB Board. Emera shareholders wouldn’t go for it either!
submission to the PUB stated that “…the PPA approach…recovers all
investment and operating costs and provides the shareholder (Nalcor) with
positive cash flow every year. There is no subsidy in the early years, there is
no foregone income…”. This is nonsense, especially when only 40% of the power
will be sold. The PUB in its Report to Government on March 30, 2012 stated:
“Nalcor explained that it does not intend to sell Muskrat Falls power for
$214/MWh and instead will sell it to (Newfoundland) Hydro at $76/MWh.” With a recently announced 25% increase in the
capital cost of this project Muskrat Falls power will rise to approximately
$267/MWh and $95/MHh respectively. Under this approach to pricing there will be
a significant shortfall of cash in the early years and up to the point of
break-even which some have suggested will be around the year 2028. Either the
ratepayer pays or the taxpayer pays in the form of a subsidy directly to
Nalcor. Alternatively, Nalcor will be paying a lot fewer dividends to the
government – a subsidy by any other name.
all it is an agreement between two government- owned entities. The Minister
needs to tell us why the PPA will not be subject to the Public Utilities Act. He
needs to inform us why Nalcor will not be subject to the regulations of the PUB.
He needs to tell us why he is engaging in voodoo economics to justify the
Muskrat Falls project.
Written by Brendan Sullivan
(Brendan Sullivan is an economist and businessman in St.
John’s).
At $95/MWH price to NFLD HYDRO then With a distribution cost by Nfld Power– they say 30 percent price increase before the recent capital cost increase. 15 or 16 cent/kwh power is to be expected. As for technology , present 11.2 cents comes down to about 6 cents equivalent with efficient heating and add 2 to 3 cents for equipment cost.Who will not switch to efficient heating- and there goes the demand on the grid. The technology is here now. Maybe if enough electric cars were used in the future it may help the demand issue– but thats a gamble.
Not only the price. The PPA should have very clear terms on 1) When the power will be delivered (in daytime periods during the winter, or regular montly intervals) 2) The penalties if Nalcor can not deliver the power to NLH as required 3)The capacity which will be made available.
I would also like to know if the CPW includes the interest payments the government will have to pay for the money borrowed to provide the equity contribution. I would expect the inclusion of the equity debt payments would show the isolated option to be the cheaper option.
It must be remembered that a 2 billion equity contribution, if put on our debt, would result in a 100 million less debt servicing charge.
This was not included in the CPW analysis between the options.
This is the true voodoo economics.
I share your fears over Muskrat Falls expressed on this fine blog.
There is only one possible saving grace for Muskrat economics that I can think of and it relates to financing rates. Our best hope is that the federal loan guarantee allows us to borrow at close to current federal govt bond yields. I am quoted a yield today of only 2.24% on a GOVT OF CDA 3.50% 01DEC45 bond. Note there is no maximum duration on bonds. There is in fact significant demand for long term debt from many institutional investors trying to match long term liabilities to long term assets (think life insurers).
I recall seeing a Nalcor document that assumed 7.4% as the debt cost so there are significant potential savings on financing costs that could be realized. Why haven't I heard more discussion of this issue in the media or from our politicians? For example, will these interest savings compared to Nalcor's assumptions be passed onto consumers or retained by Nalcor? Maybe the PPA would address that. Also, what is the financing strategy? Will we try to borrow in advance of capex needs to lock in low rates now? What will be the maturity structure for the borrowing? The longer the better in my opinion given today's low rates. And, of course, it would also help to know the terms of the loan guarantee.