A power plant producing over 5,000 MW of electric powerand located on the grid in Ontario might expect to be courted by Hydro Quebec to supply power to meet Quebec’s growing demand. The plant would expect Hydro Quebec to make an offer based on its marginal or incremental cost to produce power in Quebec, not its average cost, which is the lowest in all of Canada. However, the MOU signed by NL Hydro calls for Hydro Quebec to pay CFLCo a rate based on Hydro Quebec’s average cost, not its marginal, incremental or replacement cost.
The December 12 MOU on Churchill Falls was disappointing to Newfoundlanders and Labradorians. They had hoped the announcement would have ended the denial of benefits from real energy prices over the past 55 years since the signing of the power contract on May 12 of 1969. They were wrong. The MOU is unlikely to deliver the promised revenues.
They had expected that any new power contract signed almost 17 years before the expiry of the 1969 contract would reflect current and prospective market prices and that the 1969 power contract would be terminated on January 1, 2025. Instead, as former Hydro CEO Bill Wells has pointed out, they have learned that all increased revenues before September 1st, 2041, are simply revenues advanced from a future power contract, covering power sold subsequent to September 1st, 2041. In other words, the 1969 contract remains in play until the old contract expires, at midnight on August 31, 2041. None of the economic rent earned by Hydro Quebec before that date will be shared with NL Hydro.
They had expected that any new power contract, with Hydro Quebec or another third party, would contain an escalation formula which would enable us to share increased revenues, along with a floor price to protect us from falling rates. The MOU delivered only a flawed concept of escalation and no minimum price. That is the subject of the current post which deals only with revenues from the existing plant.
One of the fatal flaws of the 1969 power contract was the lack of a formula to adjust revenues when power rates escalated. It took only a few short years after 1969 before energy rates rose, triggered in October of 1973 when Egypt and Syria invaded Israel. This was known as the Yom Kippur War and it was followed by the 1979 revolution in Iran. Oil prices surged, as did electricity rates. The power rate paid to the Churchill Falls Labrador Corporation Limited (CFLCo) was set initially at 2.9645 mills and from September 1st, 2016, to the present it remains at 2.0 mills/kWh, one fifth of a cent, while on the Island we pay a retail energy charge of 142 mills/kWh or 14.2 cents/kWh.
Schedule G of the MOU shows projected revenues from the existing power plant. It is a forecast based on certain assumptions. We do not know what the assumptions are, but we have enough evidence on hand to conclude that they are understood and agreed between the negotiators but not shared with the public. The assumptions relate to technological change, to future energy prices, to load growth and to market dynamics. They also relate to regulatory changes and the freedom to trade in energy products and services across national and provincial boundaries. Built into the MOU is a concept for measuring changes in energy prices, using a variety of indicators or indices. The MOU speaks to three of these.
The MOU (Schedule F) offers three potential components of an escalation formula: “wholesale electricity market value in Québec; replacement costs in Québec; and wholesale electricity market value in northeast export markets”. The wholesale market price in Quebec for power produced from the “Heritage Pool” of 165 TWh, 3.08 cents/kWh in 2021 and close to four cents/kWh in 2025, is not a measure of opportunity cost or market value. Instead, it is based on the historical cost of building generation and transmission assets and its low price is attributable in part to the low cost of power from Churchill Falls. It is not an appropriate component for any formula which measures alternatives to Churchill Falls power.
The “wholesale market value in northeast export markets” is more relevant and appropriate but its value is heavily influenced by spot market transactions, which do not recognize the high value attributes of Churchill Falls power. Churchill Falls power is renewable and dispatchable and it can be supplied on a firm basis during periods of peak demand.
Replacement cost is a better measure of the value of Churchill Falls power. At the House of Assembly on January 8, 2025, Jason Chee-Aloy of Power Advisory used an estimate of 16 cents/kWh for the replacement value of Churchill Falls power to Quebec.
The MOU is silent on the weights assigned to each of these three components. The CEO of NL Hydro has not explained what weights were assigned when the revenue and rates were forecasted under the MOU. We have to look to an article by Francis Vailles in La Presse on January 6, 2025, where he described price indexation as follows:
“In the case of the old plant, the price indexation will not be 2%, as for the new energy. The formula will be based 90% on the price of Hydro’s supplies in Quebec – including the heritage block – and 10% on the price of the electricity market in the American Northeast.”
This description of the index has not been refuted by NL Hydro. The principal weight appears to be the “heritage block”, which has the dominant weight, even though it is the least relevant component, with only 10% assigned to American spot markets and zero per cent given to “replacement cost”, the cost to Hydro Quebec of replacing Churchill Falls power. The adjustment formula was hidden in plain sight: it is the average cost of supplying Hydro Quebec’s electric power load, not its marginal, incremental or its replacement cost. It is dominated by the low cost “heritage” pool or block which amounts to 165 TWh of Quebec’s power supply of 214 TWh, measured in energy, and 37.4 GW out of 48 GW (including power purchase agreements) measured in capacity
The weights will change over time. Replacement cost enters the index only when major projects are completed in Quebec and on the Churchill River. We do not know how the three indexation components were used to establish the base price, nor do we know the assumptions made in Schedule G to forecast revenues and power rates paid by both Hydro Quebec and NL Hydro to CFLCo. The forecast average price in cents/kWh appears to jump to six cents only in 2036, after Gull Island is projected to reach full power.
On January 6, 2025, NL Hydro CEO Jennifer Williams told the House of Assembly that “Today, it looks like the replacement cost is probably going to be the biggest driver of the price into the future. If that number goes up, then we’re not stuck to a prescribed replacement cost; whatever the replacement cost becomes, it will be reflected in the price. That’s what we would then define as fair, going forward, is to make sure that we’re not stuck with one metric only or only index only or one price only. It will change over time.”
Where does all of this leave us, with an undisclosed, unknown formula? It leaves us without a formula which can redress the inequities of the past and, more importantly, correct them for the future. The MOU does not deliver a formula with acceptable weights. We have a formula, as reported by Francis Vailles in La Presse, which places the greatest weight on the rates paid by residents for 165 TWh of Heritage Pool power, the core of Hydro Quebec’s hydroelectric fleet, of which Churchill Falls is already a big part. This is circular reasoning.
Maurice Adams (The Telegram February 20, 2025) points out that Quebec’s intervention or management of domestic power rates makes them inappropriate for inclusion in the adjustment formula. “Quebec has a history of government intervention to keep electricity rates low, such intervention artificially suppresses prices.”
Canada’s equalization formula creates an incentive for Quebec to keep its water rentals and its profits from electric power low. A November 2024 report by Louis Lévesque states that
“Quebec has both the largest hydro resources and the lowest electricity prices in Canada. A case can be made that the current measurement of resource revenues in equalization encourages hydro producing provinces to maintain low electricity prices…”
What we need is a concept of opportunity cost which reflects the decisions which Hydro Quebec, or any third-party buyer of Churchill Falls power, must take to respond to changes in demand. The true benefit of Churchill Falls to Hydro Quebec is its replacement cost, estimated at 16 cents/kWh, for new generation capacity or expansion of existing generation projects.
If the four Development Projects do not proceed, particularly the largest, the Gull Island development then we are left with 90% of the weight assigned to the Heritage Pool which supplies energy at a wholesale rate of about 4 cents/kWh, hardly indicative of what Churchill Falls power is worth. Spot market rates in the US are unlikely to lift rates above six cents in today’s dollars. The projected rise in rates to 37.24 cents/kWh ($ of the day or nominal) in 2075 depend on the Development projects going forward.
The Schedule G revenue projections may well be too optimistic, with more downside risk than upside growth. These are projections based on certain assumptions, potentially with some small but growing weight assigned in later years to replacement cost. Discounting of future rates will reduce the present value of growth in revenues. Technological change may displace high-cost projects and reduce replacement costs below the currently estimated 12-16 cents/kWh.
A tariff war with the Trump administration may curtail industrial demand for energy in Quebec, particularly the 25 TWh of energy used by the energy intensive aluminum industry and the 7.4 TWh used by steel, industries which are the target of a 25% tariff. Curtailment of demand may lead to deferral of the major new projects which drive “replacement cost” in the rate adjustment formula, which is firmly grounded in energy supply costs in the province of Quebec.
What we have is a set of forecasts, without the underlying assumptions and without any clarity as to how future revenues will be adjusted to reflect changes in energy markets, leaving us no better off than we were on May 12, 1969. We are also left with no floor or minimum price. The MOU is unlikely to deliver the flow of revenues promised.
The adjustment formula must be renegotiated. The formula, as it relates to power used in Quebec, should include only new projects and upgrades in Quebec and on the Churchill River which come on stream in 2025 and beyond. It should include power which has the attributes of Churchill Falls power, its dispatchability (ruling out wind and solar), its high capacity and its ability to supply firm power under long term contracts and when diurnal and seasonal loads are high. For markets outside Quebec, such as the New England market, the same should apply, namely that the index should include dispatchable, firm power with the particular attributes that make Churchill Falls power most valuable. The index should include power sold under long term contracts and not only power sold into spot markets.
With such great uncertainty surrounding the revenue forecasts the province should avoid any growth in expenditures based on the prospect of revenues from the MOU. It is highly unlikely that the revenues will be sufficient to eliminate the existing current account deficit of over $2 billion and rising.
David Vardy
Note: These observations will be shared with the Churchill Falls Negotiation Team the Churchill Falls Oversight Committee with a request that they review and offer comments.
Editor’s Note: David Vardy is a Princeton trained economist who served in senior executive positions in the province including Secretary to Cabinet, President of the Marine Institute, Deputy Minister of Fisheries and Chair of the Public Utilities Board.