DAVID VARDY’S TEN COMMANDMENTS FOR RATE MITIGATION

Guest Post by David Vardy

THE DECALOGUE: THE TEN COMMANDMENTS FOR
RATE MITIGATION

Introduction

The silence on rate mitigation is too deafening. The public needs to know what
is happening and what objectives are front and center in the negotiations, now
led by former Nalcor Chair Brendan Paddick. We need to adopt a set of
principles or criteria, which can both guide the negotiations and measure their
success. This post is an attempt to propose ten “commandments” for successful
rate mitigation. Because the “misguided” Muskrat Falls project and its impacts
on the province are of such “Biblical” proportions it is appropriate to invoke
the Mosaic law of the Decalogue, The Ten Commandments.

Premier Andrew Furey was first sworn in as Premier of Newfoundland and Labrador
on August 19, 2020. He appointed Brendan Paddick as chair of the Rate
Mitigation Team on September 25, 2020. This signalled that the rate mitigation
plan announced on April 15, 2019 by Premier Dwight Ball remained unfinished. It
also signalled that the progress reported by Premier Ball and regional Minister
Seamus O’Regan at a press conference on February 10, 2020 had not advanced as
planned and needed a “reset” and a new Team.

Brendan Paddick

The GNL has adopted the goal of maintaining Island Interconnected rates at just
above their present level. They set a rate of 13.5 cents per KWh as their goal.
What should we, the public, be seeking from the rate mitigation negotiations
being led by Brendan Paddick? Paddick has stepped down temporarily as Chair of
the Nalcor Board to work with the federal designate, Serge Dupont. Dupont is a
former Deputy Minister of Natural Resources Canada and a seasoned advisor on
finance and energy matters.


The Core Issue


At stake is the question of who bears the burden of the
 $74.6 billion in electricity costs over the next 50 years. The power purchase agreement between Muskrat Falls
Corporation and NL Hydro, both Nalcor subsidiaries, calls for this amount
to be recovered fully from Island ratepayers. GNL has the option in theory of
shifting some of this amount to taxpayers; but in practical terms this is well
beyond the capacity of a province already burdened with $47 billion in public
debt.

The $74.6 billion, averaging $1.5 billion annually, is the total, in
undiscounted dollars, of the accumulated revenue requirements of Muskrat Falls
for the 50 year supply period, beginning after the start of full commercial
operations. The estimate comes from evidence (IC-NLH-017, attachment 1, LUEC
tab) presented to the PUB by NL Hydro during a 2018 hearing on cost of service.

This is the burden arising from the operating and capital costs of the project.
Large hydro projects call for big capital investments. Most costs are costs of
capital, including interest on debt, return on equity and repayment of borrowed
and invested capital. The annual revenue requirements, including capital costs
and operating expenditures, will exceed $1 billion during the first year of
full operations. This is a similar order of magnitude as the GNL budgetary
deficit.

This document sets out guiding principles which should guide the negotiating
teams. These principles or rules also serve as criteria by which to measure the
outcome of the negotiations.

1. Strengthening of the Public Utilities Board

First and foremost is the need for transparent, accountable oversight through a
revitalized Public Utilities Board, whose jurisdiction should on no account be
impaired or eroded.

The Muskrat Falls fiasco could have been avoided if the GNL had not undermined
the authority of the PUB. The GOC bears some responsibility here. It was in
order to ensure that the PUB would not interfere in any way with cost recovery
and repayment of federally guaranteed loans that GNL excluded the project from
the Board’s jurisdiction. The House of Assembly needs to overturn the
amendments which eroded the powers of the PUB.

Premier Andrew Furey


2. Termination of PPA

Second, the power purchase agreement, which loads 100% of the cost upon Island
customers must be abandoned and replaced by agreements that provide energy
access to customers in this province on an equal footing with customers outside
the province. The monopoly powers of Nalcor must be terminated, allowing
private capital the ability to put forward new renewable projects if they
reduce power costs and improve reliability in the province.

The negotiations must begin by recognizing that the power purchase agreement
and the back-end loaded cost recovery scheme must be abandoned. The notion that
all costs can be recovered from present and future Island Interconnected
customers must also be rejected. A new business framework is needed, one which
will treat local consumers the same as consumers in Nova Scotia. New power
purchase agreements must not discriminate against local consumers. We need to
renegotiate most if not all of the agreements, starting with a tabula rasa, a
clean sheet.

3. Protect Future Generations

Third, the financing of Muskrat Falls should not be achieved by shifting the
burden to future generations. The rate structure for Muskrat Falls was back end
loaded. Rates at the beginning were already going to be 20% lower than they
would have been if traditional cost recovery was applied. Rate mitigation was
already built into the project right from the beginning.

On top of that, how could we expect future generations to take on more debt
additional to the $47 billion and rapidly rising public debt and other
obligations, as measured by the Premier’s Economic Recovery Team? A
restructuring which simply elongates repayment schedules would be such a
poisoned chalice, one which the province should avoid.

4. No linkage with Churchill Falls

Fourth, a corollary of the second principle, is that the recovery of the
Muskrat Falls should not be linked with Churchill Falls and its expected profit
flow to GNL, after 2041. We should not place Churchill Falls as collateral for
the restructuring of Muskrat Falls. Nor should we impair the rights of our
children to unimpaired legacy assets.

The GOC team might propose that the project’s debt be rolled over for repayment
after 2041, when we have access to 65.8% of the full profits from Churchill
Falls. This would be another monumental assault on future generations,
depriving them of the assets which are their legacy and bequeathing instead a
mountain of debt from Muskrat Falls. We do not solve Muskrat Falls by trading
off the much more valuable Churchill Falls asset.

Pressures to link Muskrat Falls with the end of the Churchill Falls power
contract should be resisted. The solution is not a restructuring which defers
capital costs for recovery after 2041. We need to deal with Muskrat Falls among
the original parties, Emera Energy and the governments of Canada and
Newfoundland and Labrador.

Preparation for 2041 is another project in its own right which will require a
public dialogue and a new policy framework. It will call for formation of an
expert team to advise GNL. It will also call for interventions with the GOC to
deal with the issue of interprovincial wheeling of power.

5. GOC Holds Mortgage on Assets

Fifth, GNL has a major advantage in these negotiations. It is the GOC who will
hold the assets in the event of default and it is they who would be left to
operate the facilities or else decide to mothball them. The GOC would not want
to be left holding the assets and forced to manage a public utility. This
should be a powerful incentive for the GOC to play a constructive role and to
avoid passing a poisoned chalice to the province. In light of this the option
of default by the province is far from unthinkable. In fact it may be the best
course of action.

6. All parties must share the burden

Sixth, all parties to the Muskrat Falls project must share the burden,
including the Government of Canada (GOC), the Government of Newfoundland and
Labrador (GNL) and Emera Energy. These parties, and not the ratepayers of NL,
should bear the burden. Both the GNL and GOC ignored the warnings of the joint
environmental panel who recommended that an independent economic and financial analysis
was needed to confirm the business case for the project. Both governments also
ignored the report of the Public Utilities Board which was denied access to the
latest capital cost estimates and demand projections which they needed to
render their advice.

Emera was equally complicit because they undoubtedly knew that the Muskrat
Falls project was fatally flawed. All three parties must be prepared to
restructure their financial demands so that any dividends or other returns are
conditional upon future performance. The province will take the first hit
because its investment is in the form of equity, not debt. Impairment of value
will impact as well on the GOC and Emera, who must be prepared to make
concessions.

7. Atlantic Loop is a Diversion

Seventh, there is little prospect that the Atlantic Loop will offer a solution
to the recovery of Muskrat Falls costs. The Atlantic Loop is a diversion from
the negotiations which must focus on the Muskrat Falls project and its three
original partners without opening up multilateral negotiations on the ability
of the Gull Island project to displace coal-fired thermal plants in Nova Scotia
and New Brunswick.

It is unlikely that the Atlantic Loop will have much to offer GNL in its
negotiations on Muskrat Falls. The focus has of late been on Gull Island or an
expanded nuclear plant at Point LePreau, as options to shutter coal-fired
plants. The costs will be high and few consumers are prepared to pay a premium
to replace dirty power with green energy. Gull Island power will still require
higher Atlantic rates and consumer resistance will be similar to the resistance
by Island ratepayers to 23 cent/KWh Muskrat power.

8. Rates should reflect wholesale market prices

Eighth, the province is now interconnected and cannot operate in isolation from
energy markets in the US and mainland Canada. Other jurisdictions are moving
away from cost based, rate of return regulation and so must we. This does not
mean deregulation. It means that other approaches such as performance based
regulation must be introduced. It means more reliance on purchasing electric
power in the wholesale market by companies like Newfoundland Power and NL
Hydro.

If there is to be competition there must be open access and the barriers to
access must be removed. These include barriers to inter-provincial wheeling of
power.

The barriers also include tax policies which favour crown corporations shielded
from federal corporate income taxation. This is a obstacle to the privatization
of Crown-owned generation, transmission and distribution assets, which was
recommended by the Premier’s Economic Recovery Team.

9. Public Engagement Imperative

Ninth, while the negotiations with GOC and Emera cannot be conducted in public,
there is a need for more transparency than has been present to date. There is
little evidence that the culture of GNL and its crown-owned energy corporations
has changed since the Liberals took office in late 2015. The root cause of this
is that Government has yet to act to modify legislation and provide clear
direction on energy policy.. It behooves Premier Furey to now embrace
transparency and accountability by sharing with the public his fundamental
objectives and strategy for rate mitigation and for energy policy going
forward. This cultural shift will take strong personal commitment by our new
Premier.

10. GNL should mount a national campaign

Tenth, GNL must go beyond engaging its own citizens. GNL must also convince the
Canadian public that the national government should do more to enable this
province to recover from this “misguided” project. The GOC has to bear its
share of the blame for the financial burden and so must Emera.

GNL cannot escape harmless as it faces the write-off of $5 billion or more in
non-recoverable investment. The GOC will also have to make concessions and
recognize a substantial portion of the project debt as non-recoverable. Emera
will similarly have to recognize its loss on investment, which is disclosed in
Nalcor’s financial statements as debt.

Conclusion

All three investment partners can be part of a new holding company for
operating the project’s assets. Shareholding in the entity should be in
proportion to the investment loss recorded by each partner. If the Government
of Canada takes the largest write off, then it has control of how the assets
are used and how surplus power is allocated after the commitments to
Newfoundland and Nova Scotia are satisfied. If this leads to positive cash
flows, dividends can be paid to all project partners.

A new joint power company should be created whose cost structure is realigned
to allow it to produce and market energy on a sustainable basis. The capital
structure has to be pared down to manageable scale, one which can be supported
by power rates in line with the evolving market, recognizing that renewable
energy costs are steadily declining.

If agreement cannot be reached on a plan which will create a viable entity to
operate the facility then default by the province is a real option. If no
agreement can be reached which meets the ten tests listed above then the
province has to assess its financial exposure and the protection afforded by
what former Premier Tom Marshall described as the “non-recourse provisions of the agreements with the GOC.

These provisions were introduced through amendments to the Electrical Power
Control Act and the Hydro Corporation Act (section 3.1 of each) intended to
protect GNL from exposure to the liabilities of Nalcor and NL Hydro
respectively. This assessment may confirm that our best solution is to default
on the payments of $74.6 billion and let the GOC decide whether to operate or
mothball the assets.

If the potential shortfall of $74.6 billion is accumulated for payment after
2041 the returns to our children and grandchildren will quickly be obliterated,
denying our province any material benefit from Churchill Falls for perhaps
another 65 years.

GNL has initiated considerable studies into electrical energy matters over the
past two years, including the Muskrat Falls Inquiry and the Rate Mitigation
hearings of the PUB. But do we have a policy framework and a cogent argument to
garner public support nationally? Will strong political connections between
provincial and national leaders suffice to achieve our goals when the stakes
are so large? This seems highly unlikely. It is time for the Premier to speak
to the nation on the case we are presenting and why it should be supported by
all Canadians.

The Province should not agree to any compromise that does not treat present and
future ratepayers fairly. If the Government of Canada and Emera Energy refuse
to accept the project’s financial reality and their role in creating it, then
default is the preferred course of action.

David Vardy

OPINION POLL OVER-RATES INEFFECTIVE TORY OPPOSITION

Having survived in spite of themselves, in Opposition the Tories have been lazy and uninspiring.  The fact that it is summer, and the House of Assembly is closed, admittedly makes their job tougher, except that the Party’s manifest weakness is not a seasonal problem.

REMEMBERING CABOT MARTIN (1944-2022)

He was an exceptional person. A gifted intellect for sure; irascible and argumentative, too. What endeared him to many was not just that he was analytical and insightful, but that he was honest and forthright. He was a public policy wonk; resource policy interested him most. He loved to travel and read; people, with something to say, were always important.

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I must say that after the Muskrat Falls fiasco, I thought our government had finally learnt its lesson and would not to rush into another such scheme where calling it “green” was enough to suspend all critical analysis.