The MOU and Existing Churchill Falls Power

What Does It Mean?

On December 12, 2024 the Government of Newfoundland and Labrador (GNL) and the Government of Quebec announced that Newfoundland and Labrador Hydro (NLH) and Hydro Quebec (HQ) had reached an agreement in principle on many new hydro developments in Labrador. Central to the Memorandum of Understanding (MOU) signed between them was the renewal of the existing Churchill Falls (CF) power agreement. The renewal of the sale of existing power from the CF plant is the focus of this article, however, I will touch on certain aspects of the expansion developments proposed on the Churchill River.

The market for electricity

In order to place the MOU in context, one has to first gain insight into the current and foreseeable market for electricity in Canada and North America. The transition from fossil fuels to green energy has only commenced – electrification of manufacturing, home heating, transportation, mining, construction and agriculture are about to add significant demand on power generation capacity throughout North America. In addition, there is a race by all major tech companies to revolutionize most everything about the way we live and work, the AI revolution. UBS analysts The MOU proposes to replace the term of the existing contracts and extend the period that existing power from the CF plant is sold to HQ to December 31, 2075. A term of 51 years with no provision for exit or renewal, under any circumstances.

Volume of Power

The MOU states “the annual contracted volumes to be allocated to each of NLH and HQ for each year are specified in Schedule E hereto;” The schedule outlines the annual volume of power from the existing CF plant for each year from 2025 to 2075. In 2025, the existing volume of power is 4,765 MW to HQ and 525MW to NLH. The table below shows the changes in the volume of power from the existing CF plant over the term to 2075:

As shown above the volume of power allocated to HQ from the existing CF plant declines over the term of the contract but each parties allocation is specified for each year of the 51-year term. This is important because it clearly establishes how much power is being contracted to HQ each year.

Price of Power

The price of power has always been the most contentious aspect of the contract between HQ and CF(L)co. It is noteworthy that the power is produced and owned by CF(L)co, not the GNL, or NLH. CF(L)co is owned by NLH (65.8%) and HQ (34.2%). NLH’s ownership resulted from the nationalization of BRINCO by the Moores Government in 1974. The price per kWh for existing power paid to CF(L)co is the same for HQ as it is for NLH, currently at 0.2 cents kWh. Unlike, NLH that has no right to transmit power through Quebec for export, HQ exports a significant amount of power annually to the US. In 2023, HQ’s power exports averaged 10.3 cents/kWh, a return 51 times the price it paid CF(L)co.

The MOU proposes that HQ will pay CF(L)co a forecasted price that changes annually. A price that will commence at about 1.6 cents per kWh in 2025 and increase to about 37.2 cents/kWh in 2075.

The GNL and NLH are celebrating the great price they have achieved under the MOU, while Quebec is in its glee because it has secured power for 51 years at a “remarkable” low price (CEO Sabia states). The Quebec Premier quotes, “For our part, it will first allow us to secure the availability of electricity for Quebecers until 2075 at a very advantageous price. It will allow us to guarantee that residential rates for Quebecers will not increase by more than 3% per year. Quebecers will continue to have the lowest rates in North America. For Quebec, this represents a saving of $200 billion compared to alternative projects.”

For our people the obvious question is who got the best of this deal? Let’s analyze that question closely.

The MOU answers that very question but it takes much analysis to get it. Schedule G of the MOU sets forth the annual “forecasted payments from HQ to CF(L)Co in the New CF PPAs for existing production (in $B current year dollars)”. These forecasted payments are the nominal dollar amounts HQ pays for power for each year of the 51 years. In other words, these $ values are inflated values reflecting year to year changes in prices.

The MOU goes on to say – “new pricing terms applicable to the amount of volumes attributed to CF as it currently exists …, which terms will be retroactive to January 1, 2025 …, which will have a forecasted net present value of $33.8 billion as it relates to payments to be made to CF(L)Co by HQ throughout the term of the New CF PPAs, as further specified in Schedule E, Schedule F and Schedule G and based on the assumptions set forth therein;”

What this means in price value terms is that the specified volumes of power from the existing CF plant as set out in the table above, for the entire 51-year period will have a net present value of $33.8 billion. This is the uninflated price value in 2024$ for the entire volume of power HQ is contracting from the existing CF plant, over the 51-year term. Put another way, HQ could write a cheque for $33.8 billion to CF(L)co upon signing of the 51-year deal and this would represent HQ’s full and complete payment for all the volume of power from the existing CF plant for the next 51 years.

The MOU is not quite as explicit as I just stated. It configures the pricing scheme in a much more complicated way. It describes how a series of market-based indices will be used to establish the annual price for blocks of power sold. But the underlying methodology is qualified by these further statements. The MOU Schedule F includes these further statements – “It is acknowledged by the Parties that a block pricing structure with a combination of pricing mechanisms will be used in respect of the volumes of electricity that will be sold to HQ and NLH from the CF plant (based on the existing configuration of CF). The block pricing structure, to be agreed upon in the coming months following the date of this agreement, shall be established to target the agreed upon annual schedule of forecasted payments. The total of the forecasted payments to be made to CF(L)Co by HQ is $33.8 billion (on a net present value basis) in respect of the volumes of electricity from the existing CF plant and assuming that NLH will be exercising all of its volume recapture rights …”

These statements confirm that HQ’s cost for its volume of power over the 51-year term is in effect capped at $33.8 billion on a present value basis. This means that if we take the total volume of power as contracted to HQ and the present value cost of $33.8 billion, then the present value price is on average 2.4 cents/kWh over the entire period of the contract. While the annual pricing is changing and increasing, the real value of the contract is fixed.

HQ has indeed negotiated a very low average price 2.4 cents/kwh over 51 years. No matter what happens to the indices of market price used to set the mechanisms for the year- by- year (nominal) pricing in the contract, the present value of all the 51 years remains fixed at $33.8 billion. It is a scheme to change the year-to-year price to reflect changes in market activity but it is of no real value as to gaining any further value over the life of the contract. The value and average price are fixed over the entire 51 years.

Cost/Risks to Produce Existing Power at CF

The cost to produce power at the CF plant is currently at about 0.2 cents/kWh. If inflation is assumed to be two percent annually then the cost would increase to 0.28 cents/kWh in 2041 and to 0.55 cents/kWh in 2075. In other words, even in 51-years, the cost of power will be only about one-half a cent per kWh from the existing CF plant. The risks at the existing plant are minimal. The plant is owned, there is no debt. The infrastructure and plant has proven reliability, it has operated for over 50 years without disruption.

HQ Benefits

HQ currently buys power for a fixed price of 0.2 cents/kWh to 2041. HQ sold much of the power in 2023 for 10.3 cents/kWh, the selling price was 51 times the cost of the power. In 2023, HQ’s financial gain on existing CF power was $3.1 billion. The financial benefits being quoted by Quebec ($200 billion) are related to the low price for the existing CF power through the term of the contract.  HQ reports an average cost of 6 cents/kWh. This is its combined cost including the high cost of new power from the expansion projects on the Churchill River. It reports a net subsidized rate down to 4 cents/kWh when it includes the profit they will make from paying a  “remarkable” low rate for existing power from the CF plant. The fact that 34.2% of CF(L)co is owned by HQ ensures that of the $33.8 billion value ($2024) it pays over the life of the new agreement, $11.6 billion of those payments accrue to themselves. This enables HQ to further subsidize their net cost down to only 4 cents/kWh over the 51-years. Their effective net average cost (in 2024$) for existing CF power is only 1.6 cents/kWh (2.4cents X 65.8%).

NL Benefits

NLH currently shares in the profits of CF(L)co however, profits are marginal as the cost of selling power is relatively the same as the revenue from the selling price i.e 0.2 cents/kWh.

According to Schedule G of the MOU, the forecasted payments from HQ to CF(L)co will be $19.8 billion (in nominal $ terms) over the period 2025 to 2041. These HQ payments are gross payments that replace current contractual payments of approximately $95 million annually. As the price of power is fixed and the GWAC has a payment that marginally improves the average annual revenue to 2041 from HQ, overall it does not change materially. Over 17 years remaining on the contract HQ would otherwise pay CF(L)co $1.6 billion ($95 million X 17 years). Consequently, the net additional payments from HQ under the MOU amount to $18.2 billion in nominal terms. As NLH owns 65.8% of CF(L)co, its net benefit from the nominal payments to 2041, is $12 billion over the 17 years. This is an average of $705 million per year. On a present value basis this benefit is $6.9 billion, or $406 million per year.

NLH’s remaining benefits over the period from 2041 to 2075 are the balance of what HQ pays over the life of the MOU. The present value of those payments to CF(L)co is $22.4 billion (2042-2075), and 65.8% of that is to NLH’s benefit, or $14.7 billion in present value terms ($432 million per year on average).

Who Benefits Really

In order to estimate the real benefits from the existing CF power sales one would have to know the future market value of the power. As this is unknown one would have to project the demand and price for power over the next 51-years. Clearly, demand for electricity is entering a new era. This demand and the high cost of developing new capacity will significantly affect the price of electricity. Unfortunately, significant prices increases are of no benefit to NL under the terms of the MOU. All the benefit of real price increases, for the existing CF power allocated to HQ, under the MOU for the term of 51 years, accrue only to HQ as the value of all the volume of power allocated has an established fixed value of $33.8 billion (2024$).

We can look at how much value NLH provided HQ under the MOU by considering the replacement cost of the existing power from CF plant. It is established that NLH is getting a present value benefit of $6.9 billion for the HQ payments to 2041. But what would be the cost HQ would pay if NLH stayed with the existing contract to 2041 and then HQ were to pay replacement cost for power from the existing CF plant for the period from 2042-2075. Under the assumption that HQ paid its lowest replacement cost as stated by Quebec at 16 cents/kWh for this latter period (inflated at 2% annually),then HQ’s present value cost for existing CF power would be $15.3 billion higher than the $33.8 billion (present value) it is paying under the MOU. In nominal terms HQ would have to pay over $88 billion more if NLH stayed with the existing contract to 2041. In other words, NLH gave up tens of billions to get a marginal benefit in relative terms for the period to 2041.

Summary

It is clear from any perspective, HQ got the much better deal for the existing CF power under the MOU. Existing CF power is being contracted at a steep discount to its real value under the MOU. This steep discount in price for the existing CF power is fundamentally unfair to the people of Newfoundland and Labrador.

The principles of the MOU are the same as the 1969 contract:

MOU is the Same Contract as the 1969 Contract

“Nothing Has Changed”

Special Note: There are many other aspects to the MOU that require in-depth public review. In totality, the MOU commits NLH to invest approximately $5.4 billion in equity into capital investments totally $35 billion. NLH’s total share of the debt financing for the MOU developments is a further $17.4 billion, making the total financing investments of NLH – $22.8 billion. The chief beneficiary of the investments is HQ. Do we really trust that NL Hydro has the capability to undertake these mega-projects on behalf the people of Newfoundland and Labrador without objective independent public review? This is really a rhetorical question, the Commission of Inquiry Respecting the Muskrat Falls Project byThe Honourable Justice Richard LeBlanc answered that question. The answer is clearly no. We need to move ahead immediately and engage the Public Utilities Board to conduct that objective independent review. There are no other options for the MOU.

Editor’s Note:

Mr. Gregory graduated from Memorial University of Newfoundland (B.Comm) in 1979 and received his certification as a CMA from the Society of Management Accountants in 1984.

He has extensive executive management experience working in various sectors of Canada’a Atlantic Fishery. He was Executive Vice President – Operations of Fishery Products International Limited responsible for managing the processing and harvesting operations during the period up to his departure from the company in 2001. Since that time, Mr. Gregory has worked independently as a management consultant in his own private business providing a wide range of consulting services to various public and private clients.

Mr. Gregory has served on the board of many public and private sector organizations and companies.