Guest Post by PlanetNL
PlanetNL41: The Millstone Reaches A
PPA Payments Commenced; Capital Cost
Understated; 2022 May Get Rough
A letter sent to the Public Utilities Board from NL Hydro on
November 25, 2021 contains sobering news about an important milestone.
It reported that all four turbines at
the Muskrat Falls (MF) hydro generation have passed their initial run-in tests
resulting in the plant being considered fully commissioned and
in-service. Ditto for the Labrador Transmission Asset (LTA), the new
HVAC line that connects Muskrat to Churchill Falls. With completion of the
construction phase for these two major assets, payment is now due for their
Is this happy news or grim
news? If you’re a ratepayer expected to pay off this unneeded
megaproject, likely forced to spend way more on your electricity costs, maybe
mad as hell is a more apt feeling.
MF and LTA Will More than Double
According to the terms of the Muskrat
Falls Power Purchase Agreement (PPA) signed off at sanction, the MF and LTA
assets are now payable by NL Hydro with cost recovery due solely from Island
ratepayers. On behalf of those ratepayers, Hydro made immediate and
unspecified payments on November 25 to initiate the PPA’s 50-year repayment
Based on Hydro’s mid-2020 update of cashflow
estimates for MF and LTA payments, the amounts due begin at almost $35M per
month. That figure escalates by more than 500% over 50 years mainly
because Government’s return on equity (ROE) is to be very slowly phased in
during the payback period.
Why do the MF and LTA costs increase so
much, you may ask? Deferred ROE is added to the original equity
contributions and the sum is compounded at a rate of 8.4% annually as per the
PPA. The phase-in of ROE payout is so slow that for about 30 years,
there will be more interest accrued in the account than is paid
out. Based on current estimates, Government’s equity account likely
swells by an extra $10B (at about year 30) before payouts rise enough to exceed
the interest cost. According to the PPA, Hydro must pay the works
and Hydro’s main revenue source is the ratepayers. The average
monthly amount due over the 50-year PPA is in the vicinity of $90M.
The yet to be approved rate mitigation
measures will decrease this somewhat but the final figures are not terribly
clear. The creation of $2.0B in Government preferred shares yielding
3% interest payments increases cost by $5M per month immediately but it
mitigates a large part of the long term PPA escalation. Furthermore,
with return on equity during construction reset to zero (more on that later in
this post), another major source of cost escalation is averted. The
average payment due is likely to be over $60M per month but Hydro is yet to
verify with their own updated projections.
For reference, ratepayers currently pay
about $60M per month to fully sustain both Hydro and Newfoundland
Power. This figure appears set to double in order to pay for MF and
LTA, even with the significant rate mitigation concessions on equity return.
|WHO IS SMILING NOW?|
LIL Cost Impact Yet to Arrive
The Labrador Island Link HVDC
transmission will add another large dollop of costs. Until very
recently, Hydro had expected full commissioning and completion of the LIL at
much the same time as MF and LTA. Several years ago, Hydro even
thought the LIL may be completed a couple of years ahead of the generation side
of the project but the last few percent of effort to achieve completion have
remained elusive and riddled with problems. Hydro is now saying
March 31, 2022 is their probable completion date but the track record on LIL
suggests much more time will be needed.
The LIL Payments were previously
forecast at almost $35M per month but with some additional delay charges, it
will surely exceed that level. Of the proposed rate mitigation
measures, none are direct concessions to the way LIL is costed unlike the
reductions to ROE proposed for MF and LTA. Hydro, and hence the
ratepayers, are responsible for the full ticket on the LIL.
Rate Mitigation Proposal Still Doesn’t
The only other meaningful rate
mitigation measures are those of indirect subsidy and
desperation. The transfer of Hibernia revenues, forecasted to be an
average of $10M per month over 26 years (not 50) is merely a
subsidy. It may be 50% higher in the first few years but will tail
off as time goes on and Hibernia production levels decrease. The
creation of a new $1B loan to help make the minimum payments is like giving a
drunk some money to buy more booze just to keep them quiet – you can guess what
happens when that is gone. At an average of $10M per month, this
loan will be exhausted in about 8 years.
Fuel savings at Holyrood and new energy
exports will probably affect the required revenues by about $10M per
month. Government and Hydro are probably estimating more for that
but they are only fooling themselves. The proposed rate increase of
1.1 c/KWh will generate about $5M per month.
The last act of desperation, in
defiance of accounting standards, is to remove depreciation as a normal cost of
business. Depreciation normally aligns with the paying off of
financed assets, however, as the rate mitigation proposal includes deferral of
bond repayments and sinking funds to June 2029, and as ROE payments on MF and
LTA will be little to nothing during that same period, Government appears to be
asking Hydro to bend conventional accounting standards to ignore depreciation
costs for a few years. If so, the interim benefit to reducing
required revenue will be about $20M per month.
To recap, there appears to be about
$40M per month in MF and LTA costs already due inclusive of direct mitigation
measures and sooner or later another $35M due for the LIL. Indirect
subsidies and questionable accounting treatment, mostly of a temporary nature,
may offset $60M of those costs for a few years. There appears to be
a minimum $15M per month revenue deficit and the amount is only likely to grow.
This can mean only one
thing. Get ready for Rate Mitigation Plan 2nd Edition
in another year or two, leading up to the next election. It will
have to deal with the growing deficit in required revenues, and the diminishing
usefulness of several of the short-term original rate mitigation
measures. Another significant rate increase appears inevitable.
Understated Final Project Capital Cost
For the past year or so, Hydro has said
that the project will come in at $13.1B. The breakdown of that is
$6.7B for the Muskrat Falls generation site, $1.1B for the LTA, and $5.3B for
With ongoing delays, the LIL cost is
sure to go beyond the $5.3B figure that was a Fall 2021 completion
target. Additional capital is being spent every month if only on
sustaining general operations and maintenance but the problems surely imply
spending beyond just that. In addition, the equity interests of
Emera and the Province are accruing 8.5% annual interest in lieu of delayed
payouts. That equity now totals about $1.9B as of last month so the
ongoing accruals alone will add over $13M per month.
Ballparking $0.1B in extra capital cost
per quarter seems a reasonable estimate for the ongoing delay. Given
the very slow progress apparent in reports from Hydro and Liberty Consultants,
the latter monitoring it for the PUB, a full year of delay is not
improbable. That would increase official capital cost by
The word “official” in the last
sentence is quite deliberate because Hydro and Government have said there is no
equivalent equity capital appreciation in the MF and LTA side of the
project. This has always been a strange approach that has undervalued
the capital cost of the project. It is dubious and creative accounting – one
more instance of voodoo economics!
The capitalization of return on equity
during construction until payouts commence is standard practice in virtually
all project financial structures. Without properly assessing and
including it, target return levels cannot be achieved.
Hydro and Government have been engaged
in a charade flaunting conventional standards for financial
structure. It’s known that the full return on equity during construction
has been included in the original PPA payment schedule design. Yet
they would not include it as an obvious capital cost. Hydro and
Government wanted to eat their cake and keep it for later too. The
benefit of doing so is that it allowed them to make the capital cost of the
project “officially” smaller than it truly should be.
Now that the project has reached the
end of construction, it is possible to estimate the extent of the missing
interest charges. A couple of methods were used that arrived
at essentially the same number: roughly $1.5B is missing from the capital cost.
By normal project finance standards,
the properly stated capital cost of the project is considerably higher than
current Hydro official figure of $13.1B. With another year of
ongoing LIL overruns and conventional financial treatment of accrued equity
during construction for MF and LTA, the expected proper figure for total
project capital cost ought to be $15B. Should the Astaldi contract
dispute end with a substantial payout to the Italian firm, tack that on too.
Bond Ratings in 2022 Could Go South
It’s important to acknowledge that the
rate mitigation plan to reset return on equity during construction to zero will
make this hidden $1.5B capital cost go away which is good for
ratepayers. So why bring it up now?
One reason is that the true capital
cost when applying regular project economics and not voodoo economics, and
before any mitigation measures are applied, is $15B or more. That is
what the history books should say. The current method of valuing the
project was and remains disingenuous.
Another key reason is
that the proposed reset action on the timing of return on equity from sanction
in December 2012 to completion in November 2021 needs to be recognized for what
it is: a $1.5B equity write-off. Government intends to fully forego
payback and future returns on the 9 years of return on equity accrued during
construction to which it was entitled in the PPA.
Furthermore, by converting $2B of the
equity to preferred shares with a 3% yield, Government has committed to take a
much lesser return on investment. Putting the two measures together
is the same as saying that as of November 25, 2021, Government has reduced it’s
required ROE from 8.4% to 3.6%.
The revised ROE of 3.6% would barely
cover the bond interest cost on Government’s $3.4B in direct equity
contributions for MF and LTA. However, a large part of that revised
ROE income is deferred many years into the future and should be considered at
very high risk of never being received at all. Only $60M, from the
$2B in equity converted to preferred shares, can be counted upon to be
received. $60M on $3.4B results in an effective ROE rate of just
1.8%. The other 1.8% is pinned on hope and a prayer.
The effective write-off and drastic
reduction in ROE is sure to be seriously evaluated by the bond rating agencies
next year. Up to now the bond raters have been speculative and
largely given the benefit of the doubt that Government’s bonds will have
reliable cash flows coming to them. That soft view was easy when
project completion always seemed at least a year away. They can’t do
Now that the payment phase on MF and
LTA has begun and ROE is being officially slashed, the agencies will have to
get serious in examining the situation for what it is. With so much
left to be proven regarding the viability of the project and whether all of the
financial obligations can be met, they could very well react negatively and
lower the Province’s credit rating.
Should that occur, the pressure on
Government to raise electricity rates to eliminate any deficit in Hydro
revenues and to prop up cash flows to Government will be
immense. Failure to do so would almost certainly lead to further
credit rating reductions.
There is undoubtedly potential for
plenty more grim news for both ratepayers and taxpayers in 2022 as the true
burden of Muskrat costs are revealed and Government walks a dangerous highwire
of difficult to support debt with no safety net other than ratepayers’ and taxpayers’