Guest Post by David Vardy
many people in this province believe we are heading for a fiscal cliff? How
many are aware of how precarious our position has become as a result of our
high public spending, combined with the tragic decision to build Muskrat Falls?
What are the options available to us? This post will review some of the
options, including early negotiations on a possible power contract with Quebec
after 2041 and the prospects of enhanced federal support. My intention is to
bring some of these options to light for respectful, informed dialogue. With
final reports due soon from both the Muskrat Falls Inquiry and the Public
Utilities Board there is a plethora of evidence and ideas. Sadly the greatest
dearth of research relates to the fiscal impact of Muskrat Falls, which is the
real elephant in the room.
Liberal government raised taxes and fees when they first came into government
but they have done little on the expenditure side. Public discussion of late
has focused on the equalization program which is intended to equalize the
fiscal capacity of the provinces. Yet we currently receive no equalization.
When oil revenues fell the province maintained its high expenditures and
ratcheted up its overall (current and capital account) deficit. We borrowed to
replace the reduced offshore royalty revenues and have failed to bring
expenditures under control.
Leader of the Opposition has proposed a referendum on equalization in order to
improve the province’s bargaining position with the federal government. However
the equalization program is locked in for five years, capped at $20 billion
with Quebec receiving two thirds of the total equalization pie. It is hard to
take the referendum proposal seriously. It is tantamount to voting for a pay
increase which somebody else will pay, namely taxpayers across Canada.
are the options available to deal with our fiscal situation? Should we sell off
Muskrat Falls? Should we build a case for more federal help? Should we attempt
to generate cash today by renegotiating the Churchill Falls contract so that
power sales after 2041 can produce cash in provincial hands today? Or must we
simply tighten our belts and allow rates to double?
Frontier Centre for Public Policy (FCPP) has released an evaluation of Nalcor’s
hydroelectric assets in a paper by Ian Madsen entitled “As Falls Muskrat Falls,So Falls Nalcor: A Valuation & Strategic Appraisal Of Newfoundland &Labrador’s Electric Utility”.
This FCPP paper examines privatization and divestiture of Nalcor as an option
to deal with the province’s fiscal crisis. It concludes that a large write down
of asset value would be required in order to privatize Nalcor. This means that
the province would have to absorb most of the existing debt, including the debt
of Muskrat Falls, in order to make divestiture feasible.
FCPP favours privatization of crown corporations as a matter of policy but they
are not optimistic that it will be any kind of panacea for the province’s
fiscal dilemma. However they speak positively of the value of the province’s
investment in Churchill Falls: “the present value of its share of Churchill
Falls’ future impressive repriced power sales is substantial, and can be used
to refinance the company to make such a divestiture a success. It can be
collateral that could be offered to Ottawa, or an acquirer.”
a restructuring of Nalcor is necessary “it is unreasonable to expect
provincial, let alone Canadian taxpayers to fund such a restructuring if the
provincial government does not contribute to the restructuring itself.” Clearly
the FCPP does not support federal subsidies as a means of solving our fiscal
crisis. However they do see Churchill Falls as an important asset and a
potential source of fiscal relief not only after 2041 but even today.
Federal Options: Dignity vs Nuclear
all think tanks think alike. The Schroeder Institute has a different view from
that of the Frontier Centre about the role of the government of Canada and the
role they can play in coming to our rescue. This view builds upon the
well-known concept that the Confederation contract creates an obligation for
the federal government to come to the aid of a financially distressed province.
This unwritten obligation is supported by actions taken in 1993 to provide
succour to the Romanow government in the province of Saskatchewan.
number of proposals have been advanced which hinge upon the 65 year power
contract between CFLCo and Hydro Quebec. Writing on the CBC website, Bob Hallett of the Shroeder Policy Institute has proposed what he calls the
“Dignity Option”, which he contrasts with the “Nuclear Option”. This is based
on the loss which Newfoundland and Labrador has sustained in economic rent
since Churchill Falls over the 42 years the contract has been in effect. Canada
would pay the province $900 million a year because it failed to ensure that
CCFCo (Brinco) would have access to Quebec’s high voltage transmission lines in
order to sell its power to markets outside Quebec. In the Schroeder Institute
proposal Canada would also absorb $500 million in interest on federally guaranteed
debt and assume interim responsibility for principal repayment. After 2041, GNL
would repay the $8 billion principal on the federally guaranteed debt. Without
such federal intervention the province would not be able to pay either the
interest on debt or to meet principal repayment obligations. It would be forced
“Nuclear Option” is the more dramatic option. The province would default on its
obligations to pay interest on any of its debt or to make principal repayment.
It would lose its credit rating along with access to financial markets. It
would be forced to curtail services in order to eliminate its $1 billion
operating deficit and its $1 billion capital deficit. The federal government
might be forced to take action to avert bankruptcy by a Canadian province and
to prevent the ripple effect on other provinces and on the Government of
Canada. Hallett cites the Saskatchewan experience of 1993 where the province
faced severe pressure but avoided the “Nuclear Option” by working with the Government
of Canada to design a plan for fiscal recovery through provincial cutbacks and
increased federal payments.
the Schroeder Institute believes that GNL cannot handle the current fiscal
situation without increased federal support. The evidence presented to the PUB
during their rate mitigation hearing confirms that more federal support is
needed. The largest single rate mitigation measure proposed to date is one
whereby the province foregoes its dividends, thereby shifting costs from the
ratepayer to the taxpayer.
is not a solution; not even a placebo. The additional $1 billion annually in
the cost of providing electricity, known as revenue requirements, is too much
for a small province to bear, with its shrinking population and its high dependence
on volatile oil and gas revenues. Yet there can be no free lunch. The province
cannot expect to fund programs more generously than other provinces and yet
expect the national government to bail us out.
a 59 page submission to the PUB entitled “Management of Muskrat Falls’ Excess Costs Using Future Electricity Sales from Churchill Falls after 2041”, by “RBB” (anonymous) has proposed a number of
mechanisms whereby the province can turn its ownership of two thirds of the
shares in Churchill Falls into cash long before 2041.
“By September 01, 2041 the Newfoundland share of
the 34 TWh yearly electricity production will revert to Newfoundland &
Labrador. The Newfoundland ownership of the CF(L)Co is 65.8% and approximately
21 TWh of supplementary energy will be available to Newfoundland. This
electrical energy represents more than 4 times the annual production of Muskrat
Falls. At a present value of between $0.03 per kWh and $0.06 per kWh in 2041,
this production is worth between $630 millions and $1.2 billions per year and
perhaps more. Churchill Falls has been rightly called the golden goose of
Newfoundland and Labrador. This will be similar to inheriting more than four
projects like Muskrat Falls in one shot, all paid for, all reliably operating.”
(pages 18-19) RBB estimates GNL’s 65.8% share of Churchill Falls to be worth
more than $15 billion today.
proposes a negotiating strategy for GNL to adopt with the province of Quebec
whereby GNL receives cash today in order to relieve its present financial
plight. The first component involves taking Churchill Falls power purchased
from Quebec and using it to level out the flow of power from Muskrat Falls as
well as to export the power through the Labrador Island Link and the Maritime
Link. Power could be accessed on an exchange basis with no immediate cost as
future power returned to Hydro Quebec is traded for delivery of Churchill Falls
second component is to sell power to Quebec in 2041 and beyond for cash today.
He estimates that a ten year extension of the contract would generate $200-$300
million annually in additional revenues. This annual payment could be increased
by extending the length of the new contract.
third component advanced by RBB is the sale of part of the province’s shares in
Churchill Falls, to take effect on September 1, 2041, which is the date on
which the 65 year power contract expires. RBB acknowledges that the sale of
equity may be contentious. It is the second component, the present sale of
future power for cash today, upon which RBB principally relies.
order to determine how power tomorrow translates into cash today both parties
need to anticipate demand for and supply of power 22 years into the future,
along with future power rates, projected by RBB at $60-$90/MWh. “In practice the price will probably evolve
from the current ~$0.03 per kWh and increase slowly towards the above high end
values of the order of $0.09 per kWh reached in 2006-2008 era.” (Pages 37-38)
They also need to agree on the appropriate discount rate. This creates a high
level of risk and uncertainty. Are there measures which can be taken to
mitigate or hedge the risk? Can a level playing field be created, one in which
GNL is not on its knees and desperate to reach an agreement in order to avoid
closing hospitals and schools and to avoid the doubling of power rates?
secret negotiations already happening?
his testimony before the PUB Nalcor CEO Stan Marshall confirmed that
negotiations were taking place with Quebec. He also said that Quebec would want
to reduce the uncertainty surrounding the future long before 2041. He did not
disclose the nature of these negotiations but he did say that the recent
decision of the Quebec Superior Court relating to the Renewal Contract for the
last 25 years of the Churchill Falls power contract left a number of matters,
including water management on the Churchill River, to be negotiated between the
parties. He said that there were discussions “involving a minimum of four
provinces” and the federal government relating to power development. He also
mentioned Gull Island. We can reasonably assume that the negotiations now
taking place involve a number of players and will likely take considerable
time. Yet they place a lot of risk on the province.
stakes in all of these discussions are high. The matters under negotiation are
complex. It is important that we do not make major concessions on our legacy
assets (including Churchill Falls and our offshore resources) in order to avoid
taking responsible fiscal decisions. We need to separate our immediate fiscal
pressures from long term decisions that impact future generations. Sensitive
negotiations cannot be conducted in public. Yet some parameters must be
established and our citizens need to know what they are.
the great uncertainty surrounding the completion of the Muskrat Falls project
we must beware of a fire sale. We also need to gain a better understanding of
the value of Churchill Falls in 2041, bearing in mind the rapidly reducing cost of renewable energy other than large hydro projects.
Hydro Quebec will be well prepared to renegotiate the Churchill Falls power
contract as must we. We need to stabilize the project and place our fiscal
house in order rather than to negotiate from a position of desperation. We
should not be hoping that some kind of miraculous Gull Island deal will save
our bacon. Indeed it is questionable how much more the GNL should be investing
in this project having spent over $140 million up to the end of 2018. Remember the Muskrat
Falls project was sanctioned only after the province spent five years trying
unsuccessfully to develop Gull Island.
his testimony to the Muskrat Falls Inquiry energy economist A J Goulding
commented upon our province’s export prospects for hydroelectric power:
“Because of the distance resources from NL must travel to supply into larger
export markets, NL resources must be significantly cheaper than local or more
adjacent resources to cover the cost of transmission. Furthermore, resources
with similar or better cost structures exist closer to the target markets.
Finally, procurement initiatives in the Northeast US are often designed to
favor (to the extent possible under US Federal law) in–state or in-market
resources. Taken together, these factors suggest that new NL renewable
resources are unlikely to be competitive in export markets” (source: CIMFP Exhibit P-o4457 at page 60).
we make a case that Canada has an obligation to NL for having failed to support
wheeling of Churchill power through Quebec? Beaudoin argues that there are a
number of technical reasons why Quebec could not have provided a power corridor
with Quebec, including the following: “The power corridor idea would have
required avoiding the non-synchronized Alternating Current (AC) grid in Québec
to enable electrical synchronization with the New England and Ontario grids.
That configuration would have removed Hydro-Québec as a partner in this
project.” (source: RBB Submission to PUB at pages 19-20).
intransigence of Quebec was used to justify the building of Muskrat Falls. Are
we now going to use it as a bargaining tool with Ottawa?
can be certain that the federal government will not entertain a “bailout”
without sacrifice by the province. To do so would be to reward profligacy.
Instead we can expect that Canada will demand responsible financial measures be
taken before agreeing to absorb interest payments on federally guaranteed debt.
Falls may be our “golden goose” but we cannot negotiate with Quebec on our
knees. With uncertainty as to when Muskrat Falls will be ready for operation it
is far too early to talk about divestiture. We have first to take measures to
deal with our overall deficit. We must prepare ourselves with a clear set of
objectives for any negotiations with Quebec and/or Ottawa and there must be
public dialogue to establish the parameters for those negotiations.