Still Time to Play the Muskrat ‘Hedge’

We all like to avoid risk.  Whether purchasing insurance, making an investment or constructing an RRSP, we employ strategies
to reduce risk.  What we have engaged in,
is called a ‘hedge’.

The word hedge is from Old English, hecg,
originally any fence, living or artificial. The use of the word in the sense of
“dodge, evade” is first recorded in the 1590s;[1] so, the idea is not new.

Like insurance against fire, a hedge
can be a simple concept; your portfolio manager may employ more complicated
schemes from using derivatives, swaps, options or futures.  Depending on the level of protection sought,
a multitude of hedge strategies are available to help everyone sleep at

Can a hedge strategy be employed to protect
us from the risks of the Muskrat Falls Project?

Indirectly, yes, by engaging one that offers protection from the threat of high oil prices. 

Forecasted increases in the price of oil constitute
the chief justification for building MF.
Offshore oil provides a direct link between world oil prices and NL’s royality structure.  Hence, NL
enjoys the benefit of an excellent natural hedge, one which a decision to sanction MF will
immediately ruin .

Oil is used to generate electricity at the
Holyrood Generating Station.  Critics of
MF have suggested refurbishing Holyrood is a cheaper, less risky option.  Conservation programs, additional wind and some small hydro projects (if the
demand is proven) could be added, when necessary. This is inherently a conservative strategy because it is
‘demand’ based, whereas MF is a purely speculative play.

Nalcor will acknowledge that the capital cost
of renovating Holyrood is relatively inexpensive.  The largest expense is fuel; on this basis, it speculates that MF is the lowest cost option by
$2.2 billion.

That said, our hedge will offer protection only
if oil prices go up; if they go down, for a lengthy period, then Nalcor’s
assumptions about Muskrat are wrong anyway.

How will our hedge strategy work?

To state the obvious,
higher fuel costs at Holyrood also equates with more royalties
for the NL Treasury via offshore production.

For the ‘hedge’ to work, the Government simply has to commit to the fiscal discipline necessary to ensure that the
hedge is covered (paid ). And, it must decide the price, per
barrel of oil, at which Holyrood generation is too expensive for the rate payer.  It would make this decision using the same price per barrel that might, otherwise, trigger MF sanction.  That price becomes
the ‘benchmark’ and you will be shielded from the effects of any price that goes higher than that benchmark.

A little more information is necessary. 
The Province receives about $25 million
revenue, annually, for each dollar the price of oil goes up (or loses when oil prices drop).  Based upon 2010 generation numbers, Holyrood
costs $1.4 million, annually, every time oil increases by one dollar. Even when
we start supplying Vale’s 80 megawatt requirement at Long Harbour, together with some domestic demand, Holyrood
generation will no more than double. So, let’s say 3 million barrels is the maximum quantity
Holyrood will require. 
The figure allows us to conclude that Holyrood, at worse, will cost $3
million annually for each dollar the price of oil increases.

This is important to know; we need to be sure
that a precipitous decline in offshore production will not imperil our
strategy. That is not likely. In fact, total oil for Holyrood, to 2041, would
represent less than 2% of our offshore oil resource, as Cabot Martin advised
the PUB last November. 

What happens next? Royalties
received by Gov’t, in excess of the benchmark price will be dedicated
to what we might call “the Muskrat Hedge”.
These funds will no longer be used for
general government revenues, as they are now; instead, they will be segregated and used to
subsidize your electrical bills.
You are participating in a hedge fund!  Consider it one of your smarter investments.

It’s not complicated, either.  Government need only have the discipline not to use the money for another hockey rink.  If its motivation for MF is truly your financial protection, it will send you a cheque monthly from the “Muskrat Hedge” Fund, when oil prices warrant.  MF won’t proceed.
What if the
Government fails to offer the opportunity of a hedge program and proceeds with MF anyway? 
This is a matter of grave concern. Why? Because, if MF proceeds and the
price of oil falls, ratepayers will be stuck; firstly, with billions of dollars of additional debt.  Secondly, a decline in the cost of electricity,
in more open markets, will make our economy less
competitive. And, thirdly, falling oil prices will
mean a poorer treasury; that won’t be good for you, either!
I like OUR ‘hedge’
strategy better.  A
nd we won’t have an $8-10 billion boondoggle, at Muskrat Falls,
keeping us awake nights.

Source: Wikipedia [1]                      
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.


Bill left public life shortly after the signing of the Atlantic Accord and became a member of the Court of Appeal until his retirement in 2003. During his time on the court he was involved in a number of successful appeals which overturned wrongful convictions, for which he was recognized by Innocence Canada. Bill had a special place in his heart for the underdog.

Churchill Falls Explainer (Coles Notes version)

If CFLCo is required to maximize its profit, then CFLCo should sell its electricity to the highest bidder(s) on the most advantageous terms available.


This is the most important set of negotiations we have engaged in since the Atlantic Accord and Hibernia. Despite being a small jurisdiction we proved to be smart and nimble enough to negotiate good deals on both. They have stood the test of time and have resulted in billions of dollars in royalties and created an industry which represents over a quarter of our economy. Will we prove to be smart and nimble enough to do the same with the Upper Churchill?


  1. There's another factor that weakens the Muskrat Falls case that has not been discussed by Nalcor or highlighted in media, and that's interest rates. Unless Nalcor is signing a 55 year term on its multi-billion dollar loan, won't it come up for renewal at some point… presumably at current, and quite possibly higher, interest rates?

  2. Geoff: The question you raise is important for several reasons. The Feds, in the Federal Loan Guarantee (FLG), communicated the same concern by fundamentally re-structuring the financing of the MF Project. I refer you to item #'s 3.2 and 3.3 of the FLG which states that the Guaranteed Debt shall be repaid on the basis of a "simple mortgage-style amortization". The MF asset will have a max. term of 35 years after Financial Close and the Labrador Island Link (LIL) will have a max. Term of 55 years after Financial Close. (Financial Close follows the date on which all financial documents have been executed.) This amortization style (which requires payments of principle and interest, as on a home mortgage) is at a variance with the Plan originally conceived by Nalcor and submitted to the PUB. Nalcor's plan allowed the financing costs of the Project to be subsidized on the front end, evidently to avoid rate shock. It provided for no capital repayment in the early years of the payment schedule. As a result of the "simple mortgage-style" amortization the Feds have imposed, Nalcor now needs to revamp its numbers and inform ratepayers of the revised rates it will have to charge in order to generate sufficient revenue to cover financing.

    There is much in the FLG "Term Sheet" that the Government has avoided discussing with the public. This Blog will attempt to disclose some of them.

    In the meantime, let it be said that if the Provincial Government proceeds with sanction, prior to meeting all the conditions set out in the FLG, it will have allowed itself, using public money, to be be at complete mercy of Emera and the "Independent Engineer", who according to the terms of the FLG, is representing both the Feds and the banks.

  3. You say MF is purely a speculative play and that the alternative, the isolated option is conserveative, a 'demand play'. I would argue that they are both speculative plays. The demand is forecast to increase about 1 percent per year. This is based on the assumption MISTAKE that efficiency as it applies to housing and commercial is approaching SATURATION. Their forecast allows virtually no savings from efficiency. Heating and hot water is 80 percent of our domestic consumption. And this usage, rather than being at a saturation level, is in fact subject to declines of 65 percent from present cost effective technology.And recent building code adoptions will also bring efficiencies. One can ignore this at one's peril. So the demand forecast is very very speculative also. Your hedging idea as to the oil price seems a good one. Now efficiency and wind and island small hydro can rapidly offset oil use at Holyrood. Our generation from Holyrood as a percentage of the total was about 18.5 percent over the period 2003-2007, and has dropped to 13 percent average over the last 5 years. Oil use went down from 2 million to 1.5 million barrels per year. The correct island strategies can push Holyrood oil use to zero. So can oil consumption be hedged as well as oil price?
    And you still seems to confuse conservation with efficiency. Efficiency is the the wise use of electricity, and does lead to conservation. But efficienvy avoids demand controls, which our Premier refers to as rationing. So technically, to avoid rationing and demand control, one should think in terms of efficiency. Winston Adams

  4. Winston, these are all good comments. Just remember the hedge is intended to protect consumers from 'high' oil prices; this is the reason the Province cited for proceeding with the MF Project. In addition to the element of price, oil consumption can and, probably should be benchmarked, as part of such a strategy, for various reasons. A hedge strategy can be complex or as simple as an insurance policy on your house. The fact is, there are many ways to avoid exposing the small population of this Province to the enormous financial risk of Muskrat Falls. You have pointed out others using conservation and efficiency strategies. The Hedge Strategy is just one more in a larger arsenal of tools the Government can use to protect the consumer, assuming that is the goal of the Province. Clearly, I have some doubts about that thesis.

  5. I fully support the idea of developing programs that strongly encourage people install more efficient electrical units for both heat and hot water, as per Winston's proposal. If there are concerns as to the efficacy of such systems, NALCOR should have done research to rule it out as a viable option. That they did nothing, except selectively choose to go ahead with Muskrat Falls is, in my opinion, tantamount to negligence.

    The government is even more negligent in that they excluded all possible options from consideration by handicapping the PUB. Their flimsy rationale that all other forms of energy will increase in lock-step with the increasing costs of Muskrat Falls is disingenuous at best. They have no basis for such assertions and are playing fast and loose with the truth.

    We are being dragged along on this Muskrat path, whether we want it or not, and this government is willing to sacrifice our future on the basis of shoddy research and analysis by their pet, NALCOR. When it was $6.2 billion, the Isolated Island Option was supposedly just over $8 billion. Now that MF is rapidly approaching that number and climbing, everything else is going up as well. How do they know that, especially since the actual price of oil has trended well below their projections for the past year? Further sustained oil increases are unlikely for years and yet, we are led to believe this is what will make other options more expensive.

    This government employs nineteenth century logic and can't get beyond old technology while the rest of the world is adapting and changing rapidly. With education and technology we were supposed to become more educated but the backward thinking of these "leaders" will cause us to be a laughing stock for the rest of the world.

    • I am advised that the power companies are 'considering a concept' to implement a 'pilot project' for the efficient heaters i propose. I am 3 years ahead of them in my research. They are very cost effective, without doubt, at reducing huge amounts in energy and demand on our system. Nalcor don't respond when I offer them the results of my research. Hundreds have been installed by customers who just have heard from others and then see the excellent results. My research showed that for heat for a 1000 sq ft cottage for a full year at min 21C indoors was 243.00 tax not inc. It is obvious what this does to demand forecasts, when implemented on scale. Winston