A technical review of the Churchill Falls (CF) Memorandum of Understanding (MOU) has dissected the MOU to assess the value proposition of the early CF renewal. The financial engineering lurking within it is actually an expensive loan NL Hydro has facilitated from Hydro Quebec.
There are a number of peculiarities observed in the MOU’s pattern of increasing cash flows over time that should be perceived as red flags needing study. The cost of energy commences at far below market value and its value remains suppressed, not just up until 2041, but until about 20 years later. Only in the final 15 years or so does the unit price appear to reach proper market value. The suppression is not only odd but the price curve appears oddly shaped over time suggesting something is hidden within.
Furthermore, the true market value of Churchill Falls is most likely not the energy trading prices being touted in the marketing blitz since the announcement of the MOU on December 12. The real and proper benchmark is an alternative new replacement project with a similar combination of large-scale firm power and energy which costs considerably more.
There is an easy to comprehend alternative scenario where the existing Hydro-Quebec contract would be left in place to run out on August 31, 2041. It would deliver virtually zero profit until then but upon renewal, starting September 1, 2041, the selling price would jump roughly one-hundredfold to the equivalent of a new replacement project. This is the baseline case to which the MOU must be compared.
Relative to that benchmark the MOU delivers a lot less revenue after 2041. This is the price of getting pre-2041 cash flows.
After considerable technical mapping of the numbers (to be addressed in a separate follow-up post), the renewal MOU is financially equivalent to keeping the existing zero profit contract in place and having HQ provide loan advances before 2041, financed out of the post 2041 revenues.
Don’t be fooled. Hydro Quebec has not generously decided to terminate the old contract and start paying billions more. Nothing of the sort has happened.
Hydro-Quebec has agreed to shift cash flows and spread them over more years pre-2041 to give the appearance of a grand renewal gesture that all parties are grandiosely parading as a detente in relations and a major lift to this province’s future.
Much of the public is no doubt perceiving this as new money. The reality is this deal is going to cost many billions in interest fees. The MOU cites the use of a rate of 5.822% which will allow HQ to earn a premium return on this very long duration lending program.
The total cost of interest hidden within the MOU is likely well past $20 Billion. That’s revenue that would otherwise be paid by Hydro Quebec and ultimately will not trickle through NL Hydro and to GNL as dividends. The premium on Hydro-Quebec’s relative to typical bonds might be in excess of $10 Billion – this is a new profit center for Hydro-Quebec and a loss to this province.
The review and debate over the MOU must begin with considerable challenge to NL Hydro and Government to be honest about the true nature of the MOU and the profit being paid to Hydro Quebec for facilitating it.
With that established it must then be asked, what else is hidden and unacknowledged in the MOU. Likely plenty that we all need to know.
The reality is the MOU is despairingly brief and leaves considerable room for misinterpretation, error and inequity prior to execution of final agreements. It is filled with so many holes that no metaphor of swiss cheese or leaky boats can do it justice.
That the MOU deliberately omits any reference to its most fundamental characteristic and mission – to execute a loan drawn down from future revenue – is a grievous act of misrepresentation by Premier Furey and NL Hydro.
To listen to the Premier, he’s found a pot of gold. But it’s fool’s gold. If that isn’t bad enough, the next level of imprudence is the interest rate. 5.822% interest is considerably above the typical cost of GNL’s debt.
If the Premier were to ever order Treasury Board to not select the lowest cost bonds available but take an unusual offer with 2-3% higher interest costs, the backlash would be severe. This MOU is no different except that it’s equal in magnitude to every bit of Government net debt today. This MOU is a major misstep and the consequences should be commensurate.
The best choice for this province today is to stop this charade and demand accountability. 2041 remains a long way off and there is plenty of time to create a renewal agreement that doesn’t involve a hidden high-cost loan. Independent project proposals for Gull Island and the Churchill expansion can still be developed as well. All of this must pass through a review process independent of political influence.
The whole process needs a complete reset. The stakes are far too high, the wager too great. The Premier and his key associates have misplayed their hand badly. For them, it should be game over.
