Gull Island under MOU 2 ( Definitive Cooperation and Implementation Agreement)
The commentary below highlights the key components of the MOU 2 with regard to the proposed development of the Gull Island site. It compares MOU 2 to MOU 1 (December 2024) and outlines the failures of MOU 2 because of its similarities to the existing 1969 power contract. The Gull Island development requires construction of a large dam and powerhouse and flood of the Churchill river valley upstream to the Churchill Falls plant, a distance of some 225 kilometers. This will create a run of the river reservoir that will have an average width of approximately one kilometer and flood about 85 square kilometers of the river valley over its length.
The height of the dam is expected to be about 100 meters and some 1.3 kilometers long. The generation plant is proposed to have 2700 MWs capacity (an increase from 2250 MWs under MOU-1). In addition, the development involves high voltage transmission to connect the plant to Churchill Falls (CF) and to build new transmission to the Labrador /Quebec southern border. Further Quebec based transmission will be required to carry the energy produced onward to Quebec markets and beyond. The annual power generation expected at Gull Island is forecast to be about 12 terawatts.
The key components of the Gull Island development are the environmental impacts, the volumes of energy to each of the owners, the capital cost and financing for the development, the pricing, the term of the contract, and the benefits to each of the owners.
- Environmental Impact
The environmental impact of the Gull Island development was included in the Lower Churchill Development project, the joint federal/provincial review of which was registered in December, 2006 and referred to a joint review panel in 2008. Conducted over the period from 2008- 2011 the Panel issued a final report in August 2011. The review panel did not approve the Gull Island project. The panel concluded that Nalcor at that time provided inadequate analysis for the developments and recommended comparing Phase 1 (Muskrat Falls) against other energy alternatives. It recommended additional independent analysis. Possessing only advisory authority, the federal and provincial governments chose to ignore the panel’s recommendation.
The provincial government sanctioned the Muskrat Falls project in 2012. Nearly fifteen years later the Gull Island project can proceed without additional review or analysis. This is concerning because the initial proposal was based on a dam sized for power generation capacity consistent with the annual energy targeted from the site at approximately 12 terawatts- a five turbine/generator plant of 2250MW.
MOU 1 and MOU 2 included much change in the use of the water on the Churchill River. MOU 1 contemplated the construction of an adjacent plant at Churchill Falls of new capacity of 1100 MWs. In addition, the proposed upgrades to the existing turbine/generators at CF added 550MWs, for a total additional capacity of 1650MWs of capacity at CF. MOU2 proposes adding new capacity at CF of 1275 MWs through upgrades of the plant’s turbine/generators and additional capacity at Gull island of 450MWs, for a total additional capacity of 1725 MWs. While MOU 2 plans for higher overall capacity increases (1725MWs versus 1650MWs), the initial MOU required much less water flow at peak generation, suggesting a greater environmental impact than under MOU 1. The hydraulic head at CF is much higher than at GI, so equivalent power generation is achieved more efficiently. Because hydraulic head directly multiplies the potential energy of falling water, each unit of water flowing through Churchill Falls produces more than triple the energy compared to the same volume of water at Gull Island.
The additional capacity enables the generation facilities to be used for peaking power through the HQ network while providing little extra energy on an annual basis. NLH has no requirement for additional capacity in Labrador. To the extent NLH requires additional energy, it requires firm base load power to attract new industry and growth within our Province.
The effect of adding all this new capacity and little energy will cause the power generation at both CF and at GI to experience wide variations in production. Huge changes will occur in the flow of water at both CF and GI. For example, if the expansion project proceeds, the capacity at CF will have increased from its current peak by almost 25%, reaching over 6700MWs. Therefore, the water flows through the plant will also experience the same increase in flow. This will cause enormous short-term variations in the down stream flow of water. The effect will be much more erosion in the river valley and frequent instability in the entire river – its environmental effects unknown. The same changes in water flows and variation will occur at GI when the plant operates at peak capacity. These environmental effects have not been considered and are not being subjected to any review. This will have unwelcome effects on all natural biological systems within the river valley and will negatively affect human interactions and users of the river.
Unfortunately, neither the federal nor the provincial government acknowledge the potential environmental implications of the higher water flows. The public have neither been consulted nor informed how these developments may affect them. The risk is that the environmental consequences of the arbitrary enlargement of the capacities of the two plants will only be understood long after construction is completed. Normally, responsible governments research and conduct studies into potential consequences first. The process includes consultations with the public, compensatory provisions, and the requirement for formal approvals in advance of construction. This did not happen in the 1960s; people were discounted and ignored. But now, in the 2020s, some sixty years later, we are about to do the same thing all over again. Why are governments not being open and transparent with the indigenous peoples and the public?
2. Energy volume- Capacity (MWs) Gull Island
HQ was to receive 90% of the total energy over a period of 50 years if it chose to develop Gull Island under the 2024 MOU. That allocation is marginally reduced to 84% under the MOU 2. The term remains unchanged at 50 years. Under MOU 2 the government of NL was seeking additional power to support economic development in Labrador, a recommendation of the Independent Review Commission. However, NL was unsuccessful in gaining additional access to low-cost CF energy, finally conceding that it would acquire marginally more high-cost energy from the Gull Island development – if HQ decides to build.
The NL government claims it is getting more energy. That is untrue. The government secures more energy from the Gull Island (GI) development, provided HQ decides it is economical to develop GI. There is no commitment or obligation for HQ to construct GI. In fact, if GI does not get built by HQ, then NL’s allocation of energy from CF will increase from its current allocation of only 300MW to 825 MW. Otherwise, we will not get the additional energy to the 1630MW level that the government has claimed. This was reported by the IRC in its review to be “an unacceptable risk”. In other words, the IRC advised that without a commitment to the GI project by HQ, it was not reasonable for the government to accept that low allocation of energy from the existing CF plant. Our government has done nothing to change our allocation of low-cost CF energy under MOU 2 and the allocation is dependent upon HQ decision to build GI.
In addition, HQ has the option to decide whether to build GI for a period of 12 years – after the definitive agreement is signed. Therefore, it could be twenty years or more from now that it gets further allocations of energy, a period well beyond the expiry date of the current contract in August 2041. It is illogical that the government is prepared to accept this “unacceptable risk” as characterized by the IRC.
3. Capital Cost and Financing
The capital cost of the Gull Island development is estimated at $29.1 billion, accounting for the value of the federal loan guarantee. The NL transmission system associated with the development in Labrador is estimated to cost a further $5.9 billion. The GI development will be owned 60/40 through a new joint venture between NLH and HQ. The Labrador transmission will be owned 100% by NLH.
The entire GI project and related Labrador transmission is planned to be developed and managed by HQ. NL will be required to invest 60% share of the equity in the development if HQ decides to proceed. The federal ITCs available to the development are significant and will be available up to the year 2040 to assist the GI construction. The financing for the project is the responsibility of HQ during the entire 50-year term of the initial PPA.
Government and NLH have not released the forecast cost for energy produced, which will dictate pricing terms per kWh. Yet, they have included the return on the Gull Island project of some $3 billion NPV over the 50 year term. The absence of transparency in relation to the issue of price arrives from the fact that the price will be fixed at intervals and based on costs to produce energy (no market value for energy and no escalation) over the entire term. This pricing a very similar to the current 1969 contract. It commits NL to invest in a project where it earns very limited returns while a minimum of 86% of the energy at cost is committed to HQ for a 50- year term. The project has every prospect that within the first decade following the completion of GI, the people of the province will experience a situation – similar to the present situation – where market prices for electricity are significantly raised due to inflationary change. For NL, this will mean that the government is committed long-term to supply energy to Quebec-Hydro at highly subsidized rates (lowering fixed cost-based prices) without recourse for decades to come. This is exactly a situation that successive NL governments – including the Wakeham administration – have committed not to repeat. The GI pricing arrangement is the 1969 contract all over again. NL will be subsidizing energy to HQ for the entire term of the deal.
4. Pricing of Gull Island energy
The table below outlines the comparative pricing of energy from Gull Island assuming HQ decides to construct the dam and transmission necessary:
As shown above, MOU 2 has much lower indebtedness at the end of the 50-year term (about $5 billion as compared with over $30 billion). The pricing, however, will be much higher in real terms in the initial years of the contract. Similar to the 1969 contract, prices will be established as fixed prices based solely on costs to produce energy with established returns on the equity portion of the financing. Costs will be higher in the initial years because interest on debt will be much higher early in the term. As interest costs decline over the term then cost-based pricing will also decline similar to the 1969 contract.
Unlike MOU 1, this cost-based pricing will enable the retirement of debt as it comes due. MOU 1 had lower real cost pricing in the initial years of the contract and there was less cashflow in those years to service debt on the project. Consequently, at the end of the term there was more debt (nominal value) outstanding than the entire initial capital cost.
The IRC recommended that such a pricing structure was not prudent. However, it also recommended that the ownership structure of the GI project was not in the interest of our Province because of the cost-of-service pricing model. The project is not in our interest because NL has no need for the GI energy and the energy is virtually all for export to HQ.
In addition, the ownership structure placed the Province in a very same position that it is in currently with CF. Clearly, the structure is favourable only to one side. The IRC recommended that the Province pursue other alternative structures for ownership, financing and operation of GI, yet the government failed to research or undertake any change of structure for the GI project.
The major problem with the GI is that the project is for energy export and it has cost-of-service pricing. It is necessary to explain cost-of -service pricing and its meaning for the sovereign jurisdiction that owns the development. This pricing mechanism is exactly the same problem that exists with the current 1969 contract.
Cost-of -Service Pricing
Sovereign nations or sub-national jurisdiction (like provinces) develop capital-intensive energy projects to secure a combination of high-margin export revenue, localized energy security, and jurisdictional economic growth. In order to achieve high-margin export revenue the jurisdiction (NL) needs access to market-based prices for energy. Developing high risk hydro energy, for export at cost-of-service pricing, as is the case with GI (and was the case with the initial CF project) – means the buying jurisdiction (Quebec) pays only what it costs to generate and transmit the electricity, without any markup or premium— this violates the fundamental concept of resource sovereignty.
No sovereign jurisdiction would intentionally dam a river to export energy based strictly on the cost of the project because doing so yields zero economic profit, strips the host jurisdiction (NL) of its resource wealth, and forces it to shoulder 100% of the severe long-term environmental, social, and much of the financial risks.
If one were to ask if HQ or any jurisdiction exports energy to other jurisdictions at cost-of-service rates? The answer is no. It does not happen because it is rightly risk-averse and it is not an economic investment. HQ instead, sells its surplus electricity on wholesale and open markets at market-based prices. Export pricing works because exports to neighboring provinces and U.S. markets (like New York and Massachusetts) are priced according to prevailing market conditions and negotiated longer-term contracts. These export prices are often significantly higher than domestic regulated rates (which are based on cost-of service rates), sometimes fetching 3 to 5 times what HQ charges its domestic customers, therefore it realizes much higher market-based returns. In fact, the only example of the unintended “cost-of-service” or below-market export arrangement is the current 1969 Churchill Falls contract.
Unfortunately, the MOUs with HQ are founded on the same principles as the 1969 contract. HQ wishes to sign a 50-year contract to buy nearly all the power from GI at fixed, declining rates (which will be well below market value over the longer term of the agreement). The outcome will be as global energy prices increase, HQ buys the energy at its nominal cost of production. It will be free to sell the energy to the U.S. at premium market rates, reaping tens of billions in profits.
Meanwhile, Newfoundland will be left with virtually no financial upside despite having dammed its own river. This case is widely cited as the international cautionary tale of a sovereign jurisdiction entering a contract that effectively strips it of its resource value. GI is that example 60 years hence. We are doing the same thing again. But there is one feature that makes current proposed deal worse that the original 1969 contract. NL, as majority owner, is making the investment possible by putting up 60% of the equity in GI and accepting 60% of the debt risk (the debt risk has been minimized by the federal loan guarantee) while it only gets 16% of the energy over the life of the 50 year term.
There is only one reasonable proposition for NL, the exporting jurisdiction: pricing has to be market-based for any electricity sold to HQ. If we are unable to obtain market-based pricing then NL must have a use for the energy within our Province. There is a high likelihood that NL will not use a large block of relatively high-priced energy from GI. This alternative is completely undesirable when compared with the current option, which is to obtain access to the much lower cost energy from the existing CF plant. On this basis, it is reasonable to conclude that if NL wishes to attempt to secure the development of GI, it should not invest its scare resources in a cost-of-service priced project that is designed principally for HQ’s export use. As an alternative, HQ should put up all the capital for GI as it did in the 1969 agreement and NL should get its resource value directly through water rents and royalties. This was also the clear conclusion of the IRC review; it advised our government to take the time to complete an in-depth analysis to determine other alternative ownership structures for the GI development. The Government failed to undertake this necessary analysis.
5 Term of CF contract
A summary of the contract term attributes for GI is described in the following table:
The IRC review confirmed that in situations like GI, there would be significant debt to service, and that a long contract for energy is required. However, it noted the fact that even after fifty years there would be substantial debt remaining on GI given its 65-year amortization. By comparison, the CF development was debt free after 40 years.
The IRC also noted the challenge of NL forming another shareholder arrangement with HQ. It explained the risks and cautioned NL regarding entering another long-term acrimonious business deal with a partner that it has so much confrontation with over the long-term. NL obviously paid little attention to this caution because when one steps back and reviews the foundational principles of the GI development within MOU2, it has all of the same trappings of ownership, control, cost-of-service pricing where the shareholders have an inherent conflict of interest. There are no provisions for exit within the proposed arrangements or dealing with such shareholder conflicts. NL has no rights to buyout HQ interests at any future point or to regain control.
Summary
In summary the GI development when and if HQ decides to build:
- will repeat all of the fundamental mistakes of the 1969 contract;
- a 50-year term with fixed interval cost-based pricing that declines over time;
- 86% of the long-term value of market upside will accrue to HQ even though NL will have financed 60% of the total capital costs in Labrador estimated at $35 billion;
- It will be subsidizing GI rates at prices below market value through its 50-year term, the subsidies will be in the tens of billions; and
- it will transfer sovereign control over the entire Churchill River assets at CF and GI.
- NL is not the principal beneficiary of GI or any of the developments proposed under MOU2. MOU 2 should be resoundingly rejected by the people of our Province.