Guest Post by David Vardy
province’s deteriorating fiscal position has been linked with Muskrat Falls but
yet it has received scant attention. Virtually absent from the Muskrat Falls
Inquiry (MFI), and from the PUB reference Inquiry into Rate Mitigation options,
is the fiscal impact of the project. It remains the elephant in the room, in
plain view but virtually ignored by both inquiries. Yet it is the major public policy issue
facing the province.
PUB reference Inquiry is focused on the means whereby revenues can be generated
to pay the increased revenue requirements to operate our electrical power
system, rather than on the fiscal impact. In its work the PUB has been directed
to examine measures to reduce the cost of providing electrical power as well as
to identify new sources of revenues. The
fiscal impact of the project remains outside of the scope of the PUB. All of
this suggests we must look to the MFI for an assessment of fiscal impact.
the terms of reference for the MFI include the fiscal impact? Section 5 (e) of
the terms of reference includes the following language, which I take as an
The commission of inquiry, in carrying out the terms of reference referred to
in section 4 shall consider: e) The need to balance the interests of ratepayers
and the interests of taxpayers in carrying out a large-scale publicly funded
underlining I have supplied below, in combination with section 5(e), suggests
that the Commissioner intended to include fiscal impact as well as the
“business case” for the project when he wrote his interpretation of the terms
Generally speaking, it is clear to me that the Order in Council, and
specifically section 4, is geared to focus the Commission’s work and mandate,
primarily at the least, on the business case put forward by Nalcor leading to
the official sanction of the Muskrat Falls Project by Government in December
2012 as well as the reasons why the costs of construction of the Project have
escalated from the initial estimates made. By business case, I mean
specifically the case advanced by Nalcor, and accepted by the Government, for
the need, financial viability, costs and benefits of the Muskrat Falls Project.
Really what is primarily being asked of the Commission is to explain what was
done by Nalcor and the Government of Newfoundland and Labrador to cause the
Muskrat Falls Project to be sanctioned, whether the analysis done by Nalcor and
the Government was reasonable considering best industry practice and why the
Project cost has escalated so significantly.
All of what I have stated above leads me to conclude that the Government’s
focus in drafting and approving the Terms of Reference found in the Order in
Council is very much based upon the Project’s viability, risks, costs and
benefits and the consideration of these by Nalcor and the Government at the
time of sanction and thereafter.
terms of the federal loan guarantee provide an understanding of the obligations
accepted by the Government of Canada and identify the commitments imposed on
the province. Much was made of the benefits of the loan guarantee, which
reduces our borrowing costs and improves the business case for the project. The
loan guarantee was intended to provide access to borrowed funds at the lowest
possible cost. The federal government guarantee de-risked the investment from
the lender’s standpoint, making it possible to raise $5 billion in debt at a
lower interest rate than would be available to the province or to Nalcor Energy
on its own. This was subsequently raised to $7.9 billion in March of 2017.
return, the province gave undertakings to the federal government, in the loan
guarantee agreements and in the power purchase agreement between NL Hydro and
the Muskrat Falls Corporation (MFC). The undertakings made by GNL can be
grouped into two categories. The first category includes those measures that
apply during the construction of the project, a period spanning the eight years
from sanction on December 17, 2012 to late 2020 when the project is scheduled
for completion. The second category deals with undertakings after the project
is completed and extending over the 50 year period from 2020 to 2070.
attention has been focused upon the 50 year operational undertakings. Most of
the discussion has centered instead on the eight year construction phase. The
obligations imposed upon the province during the operational phase are very
demanding, no less demanding than those during the construction phase.
the construction phase the project injected economic stimulus, albeit at a very
high cost for each short term job it created. After construction is finished
the project will attempt to recover these construction costs along with the
cost of operation and maintenance as well as extraordinary and emergency
repairs. The largest costs relate to interest on debt, repayment of principal,
dividends and repayment of equity investment, and depreciation. The total
revenue requirements in 2021 amount to $725.9 million, rising to $2.5 billion
province was required to provide a “completion guarantee”, which meant that
regardless of how high the costs went the province would provide equity financing
and guarantee that the project will be finished. The project cost at sanction
(December 17, 2012) was estimated at $7.4 billion, including $1.2 billion in
invested $500 million in the Labrador Island Link (LIL) and the federal government
guaranteed $5 billion, leaving $1.9 billion to be invested by the province. The
$1.9 billion from the province was to be the “base equity”. The latest
estimates from Nalcor Energy show that the province’s equity is now $3,739
million, almost double the $1.9 billion estimated in 2012, while Emera’s equity
is $865 million, up from $500 million in 2012 (see Table below, from Nalcor’s
response to my ATIPPA request). Federally guaranteed debt has increased from $5
billion to $7.9 billion. (Note that savings in financial costs appear from the
table below to have contributed to a
reduction in Nalcor’s estimated cost, reducing it below the official $12.7
billion estimate which has remained unchanged since 2017).
province’s undertaking is to keep its equity investment in place until earnings
allow equity to be returned to the shareholder. Essentially this means that the
“construction undertaking” remains in place for 58 years and not just for the
eight year construction period.
operational undertakings call for the province to ensure that NL Hydro receives
sufficient revenues to meet all of its obligations to MFC. This is all set out
in the loan guarantee agreement and in the power purchase agreement. Schedule A
of the loan guarantee agreement calls for GNL to
that, upon MF achieving in-service, the regulated rates for Newfoundland and
Labrador Hydro (”NLH”) will allow it to collect sufficient revenue in each
year to enable NLH to recover those amounts incurred for the purchase and
delivery of energy from MF, including those costs incurred by NLH pursuant to
any applicable power purchase agreement (“PPA”) between NLH and the
relevant Nalcor subsidiary or entity controlled by Nalcor that will provide for
a recovery of costs over the term of the PPA and relate to:
initial and sustaining capital costs and related financing costs (on both debt
and equity), including all debt service costs and a defined internal rate of
return on equity over the term of the PPA;
operating and maintenance costs, including those costs associated with
transmission service for delivery of MF power over the LTA.
language is found in the power purchase agreement, confirming that NL Hydro
must recover all costs, including those relating to debt and equity. This means
that the province is guaranteeing that the federal government will not be
required to meet its guarantee unless NL Hydro defaults. In practical terms the
default of NL Hydro would be tantamount to default by GNL. It also means that
the province is guaranteeing that Emera will receive its full 8.5% return on
latest Nalcor estimate of the 2021 revenue requirement for Muskrat Falls is
$725.9 million, as disclosed in Table 1 of the response to my ATIPPA request.
This includes $70 million as return on Emera’s equity in the LIL as disclosed
in Nalcor’s response to my ATIPPA request.
Muskrat Falls Concerned Citizens’ Coalition (MFCCC) has raised questions with
various witnesses at the Muskrat Falls Inquiry to get a better understanding of
the province’s financial exposure. In particular, questions were put to former
and present officials of the Department of Finance. We expected that government
officials would offer a clear analysis of the numerous legal agreements
underlying Muskrat Falls and the financial obligations to which the province is
exposed. The answers were not particularly edifying but they did suggest that
government’s understanding of its obligations is revealed in its rate
April 25, 2019, GNL issued a press release on rate mitigation,
which contains the following statement:
the Honourable Dwight Ball, Premier of Newfoundland and Labrador, was joined by
the Honourable Siobhan Coady, Minister of Natural Resources, to release
“Protecting You from the Cost Impacts of Muskrat Falls.” It is designed to
protect residents from increases to electricity rates and taxes resulting from
the Muskrat Falls project that would affect the cost of living…
manage electricity rates, approximately $725.9 million is expected to be
Muskrat Falls costs in the first full year of electricity generation.
$725.9 million is Nalcor’s estimate of the revenue requirements for Muskrat
Falls in 2021. It is the very same number provided to me by Nalcor in response
to my ATIPPA request of July 3, 2019.
includes $70 million in dividends for Emera. This informs us that GNL believes
it has an obligation to ensure that Emera receives its assigned rate of return
linked with that allowed by the PUB to Newfoundland Power (NP). NP is not
“guaranteed” a rate of return. They are allowed to earn this ROE but it is not
guaranteed. However Emera appears to be “guaranteed” a rate of return. How else
can this be interpreted?
included in the 2021 revenue requirements of $725.9 million is a return on the
province’s equity investment in the LIL of $645 million, which amounts to $55
million. Not included in the 2021 revenue requirements is any allowance for the
$3.1 billion invested as equity by the province in generation assets and in the
transmission line between Muskrat Falls and Churchill Falls. Based on the 8.4%
“assigned IRR” in the power purchase agreement the dividends would be $260
million. If instead we use the province’s weighted cost of debt, estimated at
4.6%, the cost of borrowing this $3.1 billion would be $143 million.
reason no cost of capital is ascribed to the borrowed $3.1 billion is because
the province expects to receive future dividends and future return of equity
capital in the future. This deferral of dividends reflects the hybrid of “cost
of service” and “escalating supply prices” used in recovering costs through
does the province record these future dividends? Are they considered financial
assets in the accounts of the province? To answer this question we need an
assessment of the fiscal impact of Muskrat Falls over the full 58 year period.
be quite candid I have always viewed these “dividends” as highly speculative.
The escalation of project costs from $6.2 billion at Decision Gate 2 to $12.7
billion today renders the prospect of GNL receiving these dividends in the
future to be unlikely.
fiscal obligations of the province during the “operational” 50 year phase of
Muskrat Falls are staggering and remain to be assessed. Some of the obligations will be offset by
fuel savings and by export sales. Some will be offset through increased
electrification of the economy, such as the conversion from fossil fuels to electric
power use in transportation. Very little if any revenue will come from higher
rates simply because of demand elasticity and ratepayer resistance to higher
worst case scenario can be inferred from a report prepared for the PUB during its
inquiry into “cost of service” issues and released in response to a request for
information from Industrial Customers. It can be found in attachment 1 toIC-NLH-17 on the PUB webpage. It tells us that revenue requirements for which NL Hydro is
responsible under the power purchase agreement is $74.6 billion in nominal
Muskrat Falls Corporation (MFC) bills NL Hydro for revenue requirements which
exceed its ability to pay then does that place Hydro in a default situation?
Does this lead to the seizure of Hydro’s assets as was suggested during his
summation by Coalition Counsel Geoff Budden?
LeBlanc, in the following exchange with NP counsel Liam O’Brian on August 15,
2019, the final day for summations from the parties to the Inquiry, asked this
COMMISSIONER: – the Concerned Citizens Coalition raised an issue earlier this
week with regard to a situation that would arise if, for instance, Newfoundland
Hydro was, as a result of customers not taking the power, not – and reducing
their demand, a situation would arise where Newfoundland Power could not
actually obtain the funds necessary from the ratepayers to actually meet the
financial commitments under the financing
the question that was posed and with no answer – no certain answer – but one
that I think we talked about at the time – I talked about with Mr. Budden is
what then happens? Who has recourse against whom? Are, for instance,
Newfoundland Hydro’s assets in jeopardy? Is the government, ultimately, the
party who has to pay? Do you have any thoughts, or does Newfoundland Power have
any thoughts, on what would happen in that situation?
L. O’BRIEN: In the event, I guess, if the question is in the event that
Newfoundland and Labrador Hydro is not able to provide sufficient power to
Newfoundland – or sorry – Newfoundland Power is unable to collect sufficient
funds to pay for those – pay for that pay – I would assume – or pay for the
power – I would assume it’s the Power Agreements that would kick in and that
Hydro would be the one that’s – and taxpayers would be the ones that would be
holding the burden.
refers to a “death spiral”:
you’ve heard that consumer – you heard some evidence that consumer consumption
has been on a decline since 2015, and that’s without Muskrat Falls’ costs being
built into rates. And you’ve heard some evidence in terms of the dynamics of
pricing and price elasticity and that it’s hard to predict, but I think it’s
reasonable to assume that this decline would intensify in the face of doubling
rates. A sharp decline could even have the effect of increasing rates further.
And we heard some evidence concerning the utility death spiral, that sort of
thing – whether or not that’s a – will occur, that – there’s some evidence on
that. But the
THE COMMISSIONER: So, again, it’s sort of like a bit of a predicament.
L. O’BRIEN: It is sort of a predicament. When rates rise, consumption drops. As
consumption drops, in order to cover the cost of providing electricity, rates
has to – rates have to further rise. So it’s kind of a cyclical conundrum
Premier Tom Marshall told us that there was to be no recourse to the province
or to assets not pledged as security to the federal government. What happens if Hydro cannot meet its payment
obligations? Will Hydro’s assets be taken, despite the fact that they have not
been pledged as security to the federal government under the loan
guarantee? Or will the province step in
and meet the payment obligations, thereby inserting the taxpayer to assume the
obligations that had been imposed on the ratepayer?
Coalition did not get a clear answer to these questions from the Finance
officials who testified at the Inquiry. We are left to infer the answer from
government’s rate mitigation plan. The answer is that government believes it
must meet the financial obligations over 50 years, beginning with $725.9
million in 2021, and increasing to $2.5 billion in 1970, including dividends to
Emera. The worst case scenario is $74.6 billion in provincial exposure, from
2021 to 2070.
are left to ponder whether the federal government guaranteed Muskrat Falls or
did the province provide the ultimate guarantee? During the construction phase
the province was called upon for its completion guarantee, which raised our
equity exposure from the initial $1.9 billion to $3.8 billion. If the federal
government had baulked on the second loan guarantee the province’s exposure
would have been $2.9 billion higher, or $6.7 billion, more than the DG2 cost
estimate for a project the PUB could not endorse.
the 50 year operational phase the province will be in an impossible position.
The burden of rate mitigation will continue for 50 years and it will increase.
mitigation is an admission that the investment in the project will not be
cost-compensatory or self-supporting. At some point the province’s equity will
have to be written down and this will commensurately increase our net debt. At
this point our equity investment in generation and transmission assets is
estimated at $3,739 million. This investment is at extreme risk!
Emera’s dividends are indeed guaranteed by the province we have to question why
they were allowed such a high rate of return, given that they were de-risked by
suffered such egregious exposure during the construction phase what can we
expect during the 50 year operational phase? Will we be exposed to the worst
case scenario of $74.6 billion? Will the settlement of claims with Astaldi and
other contractors increase our exposure?
the federal government recognize that the conditions set forth in the loan
guarantee cannot be met without placing the province into bankruptcy?
are we being so generous to Emera? Why are we guaranteeing a return far in
excess of returns earned by other low risk investments such as Government of
the Muskrat Falls Inquiry report on the fiscal impact of Muskrat Falls? Why was
the fiscal impact on the province not more explicit in the terms of reference
of the Muskrat Falls Inquiry? Was the ambivalence deliberate? Ought the fiscal
impact to have been central and not peripheral?
How did a federal guarantee of bond interest and principal
repayment become a provincial government guarantee of all costs
over a 50 year period, including payment of Emera’s tax-free dividends?
are we ignoring the elephant in the room, in plain sight?