Don’t Give Away the Upper Churchill Again

Updated Discussion Note on Selected Historic Events and Issues of the Upper Churchill and CFLCo January 2024-Roland Martin (1)

Preface-January 2025

This Discussion Note, “Don’t Give Away the Upper Churchill Again” was written in January 2024 and delivered to the Premier of Newfoundland and Labrador, Andrew Furey, via his Chief of Staff; to the Chair, Acting Chair and CEO of NL Hydro; and to the Minister of Industry, Energy, and Technology, Andrew Parsons, via his Deputy Minister. There was no follow-up, request for discussion, or attempt to understand the author’s experiences and “lessons learned” from his decades of involvement in the original 1974 purchase of NL’s controlling shareholding in Churchill Falls Labrador Corporation (“CFLCo”), or as a long-time director of NL Hydro and its Upper Churchill Falls operations and relationship with Quebec Hydro. That document suggests NL focus on developing the 1600MW of additional capacity of CFLCo as identified by both Quebec Hydro and NL Hydro, and that negotiating an early termination of the 2041 Power Contract would not be the best strategic decision at this time. The Discussion Note also reviews the history of attempts and failures to develop the 2250 MW Gull Island site since 1974.

The announcement on December 12, 2024, that NL Hydro and Quebec Hydro has entered into a complex 51+-year Memorandum of Understanding (“MOU”) that essentially gives control of most of Labrador’s future hydropower natural resources to Quebec is the event that sparked the author to update his January 2024 Discussion Note with some observations and questions on this profoundly important MOU.

The non-binding MOU bundles four separate hydro projects into one group of negotiated results, all done in secret without a Terms of Reference that the  NL public could determine if our negotiators achieved their objectives: 1.) terminates the current CFLCo Power Contract that is set to mature in 2041 and substitutes a new one to mature in 2075; 2.) outlines plans for a 550MW expansion of CFLCo’s turbine capacity; 3.) outlines plans for a second powerhouse adjacent to CFLCo’s plant with 1100MW of capacity; and 4.) outlines plans for developing the 2250MW Gull Island site.  

Some observations:

1. From the information provided it is difficult, if not impossible, to assess the specific financial projected results of each of the four hydro projects, and to evaluate whether NL will get fair value market prices for its hydropower resources going forward through the five decades of the MOU.
2. Why are the projected increased financial benefits for NL Hydro presented as if they are confident results when none of the proposed additional hydro projects have detailed designs or engineering plans? The only firm financial result appears to be the renegotiated 50-year term for the CFLCo Power Contract, extending its approximately 5400MW contract termination by 34 years, at new prices that are very hard to calculate and to determine if they are fair value.
3. Why does Hydro Quebec, who will be in charge of the design and construction of the 550MW and 1100MW expansions and the 2250MW Gull Island project, get a “15-year exclusivity right on all future plans and development options for these three NL hydropower natural resources projects” even if the delays or failures of those projects to proceed might be caused by Hydro Quebec?
4. If the 550MW and 1100MW CFLCo expansion projects are in such demand as sources of new capacity and the forecast economics are so attractive that both can be financed by the strong balance sheet of CFLCo whose two shareholders are NL Hydro and Quebec Hydro, then why haven’t these projects been pursued before as the top priority?
5. The two CFLCo expansions and Gull Island are projected to add approximately 3,900 MW of hydropower capacity, of which Hydro Quebec will get 90.8%, but no additional energy is generated because there apparently are no new water sources. Why were NL’s abundant wind power natural resources in the Labrador areas accessible to CFLCo’s facilities and infrastructure not included in the negotiations? These renewable wind energy resources are very valuable and could maximize the value of the Upper Churchill River’s reservoirs and increase the “economic rents” to NL as the owners of these natural resources.
6. Why are all these four projects being bundled into one complex and extremely long-term contract package?
7. Has any independent national or international utility consulting company reviewed this non-binding MOU, and if so, what were their conclusions; and if not, why has there not been an independent review done?

Introduction-January 2024

“We must never give away the Upper Churchill again” should be the guiding principle for any discussions and plans for the future of these immensely valuable hydro resources. The resources of the Churchill River have the potential to be the most valuable on the planet in the next two decades, a value that should be maximized for their owners, the people of Newfoundland and Labrador (“NL”).

Here are a few key facts to set the stage for this Discussion Note:

1. Churchill Falls Labrador Corporation’s (“CFLCo”) owns one of the World’s largest hydropower projects of 11 generating units with total rated capacity of 5428 MW that cost over $900 million to develop from the late 1960s to 1974. To put this in context, the NL interconnected electrical system is approximately 2000 MW, and the 824 MW Muskrat Falls hydro project has cost approximately $14.0 billion to develop.
2. CFLCo is debt free, has over $1 billion of shareholders equity, and in 2022 had revenues of $185.6 million and a Net Profit of $81.2 million.

3. During the period 2018-2022 the average sales of energy to Hydro Quebec were approximately $63 million annually, which at the purchase price in the Power Contract of 0.2 cents per kilowatt hour (“kwhr”) equates to approximately 32 billion kilowatt hours of electricity annually.

4. If Hydro Quebec were to pay just one cent per kilowatt hour “(kwhr”), CFLCo’s annual revenues would increase 500%, or approximately $260 million per year; at 3 cents/kwhr $950 million per year; and at 6 cents/kwhr revenues increase approximately $1.86 billion or 2950%! As a reference point, the current retail price of electricity for consumers in NL using 1000kwhr monthly is approximately 13.25 cents per kilowatt hour, or 65 times what Hydro Quebec is paying, not including the transmission costs to Quebec. By contrast, in 2022 Hydro Quebec’s residential customers for monthly electricity usage of 1000 kwhr paid approximately 7.75 cents per kilowatt hour.

5. The enterprise valuation of CFLCo, were it to receive a fair price for its clean hydroelectricity in 2041, would be many tens of billions of dollars, an enormous increase in valuation for both CFLCo’s shareholders, Quebec, and NL.

Purpose of the Discussion Note

To understand the present situation with respect to the massive hydro power resources of Labrador and their increasing economic value in a world transitioning to low emission clean energy to combat the risks of climate change, one needs to review and learn from the past 50 plus years during which NL received, and continues to receive, a very small percentage of the benefits from its hydro natural resources. It has been estimated that to date NL has received approximately $2 billion while Quebec has received approximately $25 billion of the economic value from the 65-year 1969 Power Contract for the Upper Churchill River, a contract that can only be described as ‘unconscionable’ considering its vast one-sidedness and Quebec’s continued refusal to adjust its unfairness.

In a 1981 speech and in his book “Where I Stand”, former Prime Minister Brian Mulroney stated that the Power Contract, “does not reflect in any way the new economic and energy realities that have developed since the OPEC crisis. The inequality and absence of fair play in the contract in question is obvious. Simple decency and the most elementary spirit of justice demand its immediate renegotiation.” Over 42 years later that unconscionable situation still exists.

This Discussion Note covers some of the key issues related to Newfoundland and Labrador’s ownership of the vast natural water resources of the Upper Churchill River and its original development by Brinco, which in 1969 entered two Power Contracts with Hydro Quebec totaling 65-years, terminating in 2041. It also outlines some of the events subsequent to the purchase of control of CFLCo by NL in 1974. It is not an exhaustive history or analysis of these topics but relies on the experiences and memory of the author. Its intention is to highlight possible areas for renewed public policy focus by the NL Government, and to provide some historical context and information to assist with the research and development of a long-term strategy for these enormous hydro power resources.

Background

In June 1974 the Newfoundland Government of Premier Frank Moores completed the involuntary sale by Brinco of its controlling ownership in CFLCo at a purchase price of approximately $160 million, of which $30 million was later allocated to the value of the other water rights on the Churchill River previously owned by Brinco.

It was soon apparent that in an era of high inflation and high interest rates, and a 40-year power contract, renewable for an additional 25-years at even lower fixed prices with no escalation clause (0.25 cents/kwhr decreased to 0.20 cents/kwhr in 2016), that CFLCo’s operating cash flows would become a serious challenge to keeping the huge hydro power company solvent. That forecast financial situation would also mean no payments to the new shareholder to retire the acquisition debt!

One of the first things the new owners did was to repatriate CFLCo to St. John’s from its headquarters in Montreal, and to integrate, where possible, the administration of the company with its new parent company, Newfoundland Hydro. In addition, and quite important, the tax position of CFLCo was changed to one of a “tax-free crown owned corporation” and special preferred dividends payable to Newfoundland Hydro were created. These actions deferred the looming cash flow challenges, aided by the impact of subsequent reductions in inflation and interest rates.

CFLCo became a subsidiary of Newfoundland Hydro, and its separate Board of Directors, while cognizant of the company’s covenants and governance responsibilities, was a smaller Board and generally recognized as being junior to the main Hydro Board. One historical action of relevance is the fact that Hydro Quebec had traditionally had two directors on the CFLCo Board, but around 1980 the Newfoundland Government instructed that no Hydro Quebec representative was to be elected a director at the next Annual Meeting, an action that deeply upset Hydro Quebec and the Quebec Government.

This Note lists a number of “key historical events and dates” and will draw attention to the 1999 Shareholders Agreement between Newfoundland Hydro and Quebec Hydro, the first time a Shareholders Agreement had been developed for CFLCo. This Note also discusses the expiry of the initial Power Contract on August 31, 2016, and the beginning of a new 25-year Power Contract, and the fact that certain NL tax exemptions awarded to CFLCo to assist with the project’s initial financing ceased as of that new contract date.

Important Churchill River and CFLCO Events Subsequent to the 1974 Acquisition of Control

• After acquiring control of CFLCo in June 1974, and the water rights to the Lower Churchill River and related waters, NL began the development of the approximately 2200MW Lower Churchill hydro project at Gull Island in 1975, which was the second phase of developing the Churchill River that Brinco had originally proposed but was rejected by the NL Government. By the time the early engineering and construction work on the Gull Island project and underwater tunnel across the Strait of Belle Isle were suspended between $150-200 million had been spent, some of which was provided by the Federal Government who had become indirectly involved though the jointly owned Lower Churchill Development Corporation (51% NL-49% Canada), which subsequently became dormant.

• In June 1976 Newfoundland attempted to gain access to approximately 800 MW of Upper Churchill Falls power from CFLCo, as an alternative to developing Gull Island. The NL House of Assembly passed a Resolution requesting such Recall power and subsequently passed the Water Rights Reversion Act, but after several years of lower court challenges by Quebec, this Recall power action was rejected at the Supreme Court of Canada level.

• The legal defeat of the 1976 Recall power request for 800 MW set in motion a 40-year series of legal battles and stop-start Lower Churchill River project developments, some together with Hydro Quebec and others alone, none of which came to a successful conclusion. However, in 2023 NL Hydro finally commissioned power from the 824 MW Muskrat Falls project, which includes transmission systems under the Strait of Bell Isle, across the Island of Newfoundland, and back to the Upper Churchill Falls plant of CFLCo; as well as 500MW of underwater cable across the Cabot Strait to Nova Scotia that was developed on time and on budget by Emera Inc.

                        Some Key CFLCo and Upper Churchill Falls Dates and Events:

• On May 16, 1961, the Water Lease on Upper Churchill River was authorized by the “Churchill Falls Power Corporation Limited (Lease) Act, 1961”, (originally named Hamilton Falls Power Corporation). This is a 99-year lease, renewable for an additional 99 years.

• The 1969 Power Contract between CFLCo and Hydro Quebec was for an initial period of 40-years to August 31, 2016, at 0.25cents/kwhr, and a similar Power Contract already embedded in the initial Contract took effect September 1, 2016, for 25-years to 2041, but at a sales price of 0.2cents/kwhr, approximately 20% lower than the initial 40 years!

• In June 1974 the NL Government purchased Brinco’s controlling interest in CFLCo, and all its other water rights in Labrador.

• During the NL Government of Brian Peckford there was a “national campaign” to communicate the unfairness of the CFLCo Power Contract to the Canadian public, and to explain the fact that NL was hostage to Quebec for any future Churchill River developments. In 1984 there was almost a “deal” on improving the financial terms of the existing Power Contract and working together with Hydro Quebec to explore expanding CFLCo’s capacity in the Upper Churchill River watershed, and to develop other Labrador and Quebec River sites including Gull Island.  On February 1, 1984 a “Letter of Intent” outlining key elements of the proposed negotiations was signed by NL Hydro and Hydro Quebec in which Quebec recognized the necessity of a “fair and equitable return to Newfoundland as the owner of the Churchill Falls resource”, and agreed to devise a formula whereby Newfoundland would receive such a fair and equitable return; the Letter went on to outline the main principles for negotiations that were targeted to achieve a settlement prior to March 30, 1984.  However, after over 70 meetings, the Quebec Government unexpectedly demanded significant strategic changes in direction that brought the negotiations to a halt and the signed Letter of Intent did not end up resulting in an improved Power Contract settlement or any new hydro development. (It is significant to note that during the current discussions between NL and Quebec they are estimating there is an additional 1600 MW of power capacity available for development in the CFLCo main generating assets and watershed.)

• During the 1989-1996 period of the Clyde Wells Government there were intense negotiations on developing Gull Island and improving the Power Contract terms, but they also failed. Again, these negotiations took place over a period exceeding one year and involved significant work by financial and technical committees from NL Hydro and Hydro Quebec. During this period the water and power natural resources of Newfoundland and Labrador were placed under new public policy governance through the comprehensive NL Electrical Power Control Act 1994 enacted by the NL House of Assembly.

• The government of Brian Tobin restarted negotiations with Quebec in the 1996-2000 period, and Gull Island development was again the prime focus! One important component of those negotiations was the demand by Quebec that there be a formal CFLCo Shareholders Agreement, and such an Agreement was entered in June 1999. However, while both partners succeeded in improving the revenues of CFLCO with a Guaranteed Winter Availability Contract (“GWAC”) whereby additional firm capacity was made available to Hydro Quebec, the development of Gull Island and other joint activities with Quebec failed to reach a successful conclusion.

• The NL Government of Roger Grimes restarted negotiations with Quebec during 2001-2003 and reached a “Framework Agreement for the Development of Gull Island” that would have provided some of the power for NL, but most going to Quebec; and with Quebec being extensively involved in the financing and having certain default rights. This Lower Churchill negotiation became a major political issue that resulted in the Chair of NL Hydro and another director resigning. Discussions eventually terminated after the 2003 election of the government of Danny Williams.

• In 2010 the Muskrat Falls hydro power project was announced by Premier Williams, and under his successor it was sanctioned for development in 2012 with an estimated cost of approximately $7.4 billion. Muskrat at 824 MW is a much smaller project than the approximately 2200 MW Gull Island site. After much delay, huge cost increases, major political and public debates including the NL Government established Public Inquiry, and the still unfinalized proposed July 2021 “$5.2 billion Rate Mitigation Plan” funded by loans and other support from the Federal Government, the Muskrat Project is now estimated to have project costs more than $13.5 billion. It is finally delivering power to Nova Scotia and the Island of Newfoundland.

Highlights of the 1999 CFLCo Shareholders Agreement and New Winter Availability Contract

As mentioned earlier, previously there was no CFLCo Shareholders Agreement prior to the negotiations with Quebec in the 1999-2000 period, something that caused Quebec great frustration because they are a significant minority shareholder with 34.2%.

The results of the NL Government negotiations with Quebec on Gull Island and other potential Labrador and Quebec waters failed, however, the establishment of a Shareholders Agreement was finalized in June 1999 which gave Hydro Quebec significant rights and participation in the operations of CFLCo, plus the GWAC between CFLCo and Hydro Quebec was agreed to. (See Appendix I for Highlights of the Shareholders Agreement.)

Implications and Opportunities of CFLCo’s Tax Exemptions Expiring in August 2016?

In the Upper Churchill Water Lease of May 1961 CFLCo was granted an exemption from a number of Provincial taxes, including an exemption from any new taxes imposed after 1966 and an exemption from increases in any existing taxes. These tax exemptions were part of the negotiated funding and mortgage terms to finance the CFLCo hydro assets related to the Upper Churchill Falls and were valid only during the initial term of the 1969 Power Contract, which expired on August 31, 2016, by which time all of CFLCo’s debt and mortgage obligations had been repaid. (See Appendix II for the main elements of CFLCo’s tax exemptions.)

Concluding Comments

This Discussion Note has highlighted some the historical events and major issues that have confronted the Province of Newfoundland and Labrador since the Government of Joseph Smallwood provided a 99-year renewable Water Lease on the Upper Churchill River, and subsequently approved Brinco to enter a 65-year Power Contract between its subsidiary CFLCo and Hydro Quebec. A lot has happened since these agreements of the late 1960s, most of which have not been to the financial advantage of, or fairness, for the owner of those renewable natural water resources, the people of Newfoundland and Labrador.

This Note is intended to provide some background to this long period of unsatisfactory results for NL from the development of the enormous hydro resources of the Upper Churchill Falls, and hopefully to contribute to NL not repeating the mistakes and profound “give away” to date of the massive hydro power resources of the Churchill River.

The Power Contract will expire on August 31, 2041, and with it will end billions of unreasonable economic gains to Quebec. The sale of any future Upper Churchill Falls power will be open for negotiation at market prices. Hydro Quebec will likely still be a minority shareholder (34.2%) and obviously a major potential customer for some of the 5428 MW of renewable hydro power. In addition, the 1999 Shareholders Agreement will have expired.

The Churchill River hydro resources will become significantly more valuable during the period of just over 17-years leading to the termination of the current Power Contract in 2041. Its value can be increased further by developing and coordinating power production of some of the abundant wind power energy resources in the immediate Upper Churchill area. Therefore, any reasonable increase in the price of CFLCo power to Hydro Quebec, or any other purchaser, would result in many hundreds of millions of new revenues annually for the Province of Newfoundland and Labrador.

In the meantime, the NL Government must not negotiate away the “family crown jewels for a few trinkets” when they are worth tens of billions of dollars and are some of the most valuable clean energy natural resources on the planet.

If Quebec is sincere in wanting to develop a new and positive relationship with NL with respect to its Churchill River hydro resources and ensure any future negotiations are fair to NL, then one suggestion that could prove Quebec’s goodwill would be to establish an early strategy to develop the currently estimated 1600 MW of additional power capacity of CFLCo such that it maximizes value for NL, while at the same time being reasonable for Quebec. Any other discussions of future Labrador hydro resources, or the premature negotiation of the current Power Contract prior to its expiration in 2041, should be set aside, at least until a fair agreement on the 1600 MW is finalized.

“We must never give away the Upper Churchill again”.

(1)-Roland Martin is a former Deputy Minister and Comptroller for Newfoundland and Labrador and is the longest serving Director of the Churchill Falls Labrador Corporation and NL Hydro Corporation group of companies serving from 1974 to 1997. During the past two decades he has been a strategic energy advisor to the Governments of Nova Scotia, Newfoundland and Labrador, New Brunswick, British Columbia, and the Government of Canada, as well as for utility and energy companies.

Appendix I

                                    Highlights of the 1999 CFLCo Shareholders Agreement

A major outcome of the 1998-1999 negotiations between NL and Quebec was the inaugural establishment of a Shareholders Agreement for CFLCo committing the two shareholders, NL Hydro and Hydro Quebec to significant legal and operational terms and management decision making processes, in fact in many cases the creation of a “veto” power for Hydro Quebec.

In addition, the GWAC contracts CFLCo to guarantee Hydro Quebec additional capacity of 682 MW during the winter periods November-March, from November 1, 1998, to August 31, 2041. That expiry date coincides with the expiration of the second Power Contract that succeeded the original Power Contract on August 31, 2016. The total estimated revenue to CFLCo from the GWAC is estimated to be $1.5 billion over its term of 43-years, starting at $3.4 million in 1998-99 increasing to $34.3 million in 2022 and escalating at 1% per year until expiry in 2041.

The negotiating of the GWAC by the two shareholders of CFLCo was a prudent fiduciary responsibility decision that was in the interest of the two CFLCo shareholders that solved the potential cash flow problems of the Company because the existing two Power Contracts have “no escalation clause for revenues”, and an impending 21% decrease in the power rate to one shareholder, Hydro Quebec, in August 2016 could have triggered a serious financial crisis, if not before then.

One very significant thing that has occurred since the negotiations of the 1999 GWAC and Shareholders Agreement is the fact that all the bond and mortgage financing for the original approximately $900 million construction of the CFLCo generation plant, reservoirs, transmission systems, and other facilities have been completely repaid and currently the Company is debt-free with approximately $122 million in the bank, a profit of $81.2 million in 2022, and total shareholders’ equity of approximately $1.0 billion as of December 31, 2022.

Hydro Quebec did increase the revenues it would pay in the future for CFLCo power but there was no change in the terms of the original Power Contract, and partly in return Hydro Quebec got the Shareholders Agreement it had desired for some time. It is debatable whether the NL Government, as ultimate controlling shareholder, gave up a lot to get the GWAC.

Some of the elements of that Shareholders Agreement are:

1. Changes in Corporate Governance at the Board of Director level for decisions such as Annual Budget, capital spending, disposition of assets, and other business activities. NLH must now specifically support the representatives put forward by Hydro Quebec, and vice versa. For example, Hydro Quebec is now entitled to two Directors and must have a Director on all Board Committees and be in attendance for all meetings and decisions, and the voting for certain major decisions must, in effect, now have approval from Quebec Hydro’s board representative.

2. The duties of the CFLCo Directors are now stated in the Agreement.

3. There is now a defined policy for the “payment of dividends”.

4. The issuance of new shares, transfer of shares etc., are now spelled out, and are quite complex. For example, it appears to grant each of NLH and Hydro Quebec a first right of refusal on each other’s shares.

5. The expiry of the Shareholders Agreement, in the absence of either Newfoundland Hydro or Hydro Quebec owning 100% of CLFCo’s shares, is August 31, 2041, when the Power Contract ends.

Appendix II

                        Main Elements of the 2016 Expiration of CFLCo’s Tax Exemptions

The following is a very brief outline of the original “tax exemptions” of CFLCo and the implications and potential opportunities that could follow from those exemptions expiring in August 2016.

Some of the taxes exempted, as detailed in the Water Lease Act, were:

1. The original 1952 “Social Security Assessment Tax”, which later became the Retail Sales Tax,

2. The 1962 Gasoline Tax,

3. The Lessee (CFLCo) shall be exempt, a.) any increase in existing taxes, b.) any liability with respect to any new or additional taxes that may hereafter be imposed, levied or authorized, and c.) any liability with respect to any new or additional charges, dues, fees, rents, levies, royalties or other assessments of whatsoever nature or kind, that are within the power of the Province or any municipality or subdivision thereof to impose.

According to the Notes to the CFLCo Financial Statements, under the Water Lease CFLCo is required to pay NL an annual rental of 8% of the consolidated net profits before taxes and an annual royalty of $0.50 per horsepower year generated, as defined in the Lease. NL received approximately $9.0 million in 2022. This annual rental and royalty are the only revenues the province receives for the use of the vast and valuable renewable energy water resources of the Upper Churchill River, because any other funds received by the Province are because of its investment and ownership in CFLCo!

The expiry of these tax exemptions could have triggered two possible future NL electrical power policy investigations as it relates to CFCO; 1.) the pursuit of increased provincial tax and fee revenues from the export of renewable natural resource electricity from the Upper Churchill River, and 2.) the potential strategic benefit of Canadian Constitution Section 92A for purposes of passing any increased taxes levied on CFLCo for the use of the Province’s hydro resources to the ultimate consumer, that being Hydro Quebec.

Since CFLCO no longer has any debt and mortgage obligations, and because the Act containing the Water Lease is NL Legislation and therefore under provincial legal jurisdiction, a rigorous analysis of these public policy options to extract a fair economic rent from the Upper Churchill water resources was clearly warranted, recognizing that there is still a Power Contract in place between CFLCo and Hydro Quebec.