Muskrat Folly

(A draft of this commentary was presented here on December 15. The original of preserved below. What appears first in this post is the version published in the National Post newspapers on December 19. I have added some notes to assist reader seeking more background and factual support for the arguments presented.)

The governments of Newfoundland, Nova Scotia and Canada have teamed up to deliver what may prove to be the worst hydroelectric project ever in Canada — Muskrat Falls.

The plan involves building a dam and generating station on the Churchill River near Goose Bay, plus transmission lines to deliver power from Labrador to the island of Newfoundland and on to Nova Scotia. In 2010, the price tag was pegged at $6.2-billion with a modest contingency. Today, the price has ballooned to $7.7-billion, a figure that would be higher except that the contingency allowance was slashed by $370-million. Neither figure includes interest during construction that will add over a billion more.

(Here is the reference for the delta between the 2010 numbers and current estimate. As the reference makes clear, I understated the extent to which the current capital cost estimate covered up the increase by shifting around contingency. I didn’t have the complete into on the change in the Maritime Link, so I used just the contingency shift for all the project components within the province of Newfoundland. During the heat of editing, I was afraid that explaining all this would kill too many newspaper readers.)

To smooth what would otherwise be a drastic rate impact for Newfoundland consumers if conventional utility finance models were applied, the government plans to use a unique financial structure that shifts the main financial burden of the generator portion of the project up to 57 years into the future.

(Here is a discussion of the unique Power Purchase Agreement that Newfoundland plans to use, an approach that transfers the cost burden to future generations.)

A joint federal-provincial review in 2011 refused to endorse the project.

During hearings conducted by Newfoundland’s Public Utility Board (PUB), also in 2011, Premier Kathy Dunderdale’s government prohibited the PUB from reviewing reasonable alternatives to Muskrat Falls, denied the PUB’s request for an extension to review evidence, and then publicly proclaimed its lack of confidence in the PUB after the regulator failed to endorse the project.

(Here is documentation for the Newfoundland government’s unprecedented attack on its own public utility regulator.)

The governments pushing the project justify it with global warming and peak oil theories, short-term employment gains, and nation-building bromides. Economics takes a back seat. Little wonder why. Muskrat Falls benchmarks badly.

(Here is the Prime Minister’s vacuous justification for subsidizing this project. The Prime Minister appears to have been motivated to make this announcement in an effort to prop up his embattled minister from Labrador Peter Penashue.)

Hydro-Québec is constructing a comparable hydroelectric complex on the Romaine River, 350 kilometres closer to southern markets. It will produce about twice as much power, but require a total investment less than the current estimate for Muskrat Falls. Romaine will start up before Muskrat Falls construction can begin in earnest. For all its competitive advantages relative to Muskrat Falls, Romaine will need a massive turnaround in electricity markets to break even.

The costs of getting power underwater from Newfoundland to Cape Breton alone will be prohibitive. Unless new, as yet unidentified, markets for the power are found, the life-cycle cost of the submarine transmission from Newfoundland to Nova Scotia will approximately equal the cost today of power delivered from new natural gas generation.

The only reason the local utility in Nova Scotia — Emera — is considering the project is because the provincial government has ordered the utility to source more supply from renewable generation. This week Emera conditionally approved joining the project. Emera has to overcome the challenges of both getting a credit rating for the project and regulatory approval from the Nova Scotia utility board. Unlike the Newfoundland review processes, credible alternatives will be on the table.

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Hydro-Québec, Newfoundland legislation and the 2010 Water Management Agreement itself all agree that the Water Management Agreement has no impact on Hydro-Québec’s rights under its Upper Churchill power contract. The Dunderdale government claims to have engineering studies and legal opinions that support its ability to utilize the Upper Churchill reservoir and generation assets, now used to serve Hydro-Québec. These studies and opinions have not been publicly disclosed.

Despite this uncertainty, Newfoundland has sunk in the order of $500-million into the scheme. (This figure is not up to date.  In October alone, NL spent $38 million on the project.) Dunderdale’s government has changed the province’s Freedom of Information law to ensure secrecy for the Muskrat Falls project. She also has legislation now before the House of Assembly banning competition from other power generators and extinguishing regulatory oversight over the project. (Here is a valuable analysis of how the government’s monopoly deregulation legislation, Bill 61, might transgress national and international law.)

Throughout the political marketing of the Muskrat Falls project, Dunderdale and her predecessor Danny Williams have appealed to anti-Quebec sentiment. Stirring up resentment over the poor result that came of the province’s 1969 deal involving Hydro-Québec, they promised to “get around Quebec.” Dunderdale has warned, apparently in recognition of Quebec’s strong bargaining position, “if Muskrat Falls does not go ahead, what happens in Labrador from that point on lies squarely in the hands of Hydro-Québec and the people of Quebec.”

During the election of 2011, Stephen Harper promised a federal loan guarantee for the project. The Constitution puts electricity squarely in the provincial sphere, so he justified his actions largely by claiming climate change benefits. Earlier this month, Harper committed federal taxpayers to subsidize loans for the project totalling US$6.3-billion. Predictably, and with every reasonable justification, the Quebec government has cried foul.

Muskrat Falls is wildly uneconomic, has no known export markets and no prospect of Labrador mining customers prepared to pay anything close to the actual cost of power. It potentially injures Quebec’s contractual interests and risks fomenting interprovincial conflict. Its biggest rate impact kicks in as the 1969 deal with Quebec expires in 2041, extending Newfoundland’s electricity pain into the later years of this century.

Financial Post
Tom Adams is a Toronto-based electricity consultant.

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(Earlier draft posted December 15)

The governments of Newfoundland, Nova Scotia and Canada have teamed up to deliver what may prove to be the worst hydro-electric projects ever in Canada — Muskrat Falls.

The plan involves building a dam and generating station on the Churchill River near Goose Bay plus transmission to deliver power from Labrador to the island of Newfoundland and on to Nova Scotia.

In 2010, the price tag was pegged at $6.2 billion. Two years later, it has ballooned to $7.4 billion (correction: this figure failed into include the updated cost of the Maritime Link and should be $7.7 billion). Neither figure includes interest during construction which will add close to a billion more.

To smooth what would otherwise be a drastic rate impact for Newfoundland consumers if conventional utility finance models were applied, the government plans to use a uniquely risky financial structure that shifts the main financial burden of the generator portion of the project up to 57 years into the future.

A Joint Federal-Provincial Review in 2011 refused to endorse the project.

During hearings conducted by Newfoundland’s Public Utility Board (PUB), also in 2011, Premier Dunderdale’s government prohibited the PUB from reviewing reasonable alternatives to Muskrat Falls, denied the PUB’s request for an extension to review evidence, and then publicly proclaimed its lack of confidence in the PUB after the regulator failed to endorse the project.

After the 2011 review, the government extinguished the authority of the provincial PUB from overseeing the rate impact of Muskrat Falls.

About 350 kilometers of rough country closer to southern power markets, Hydro Quebec is constructing the Romaine hydroelectric complex. Romaine will produce about twice as much power but require a total investment less than the current estimate for Muskrat Falls. In addition, Romaine will start delivering its first revenue before Muskrat Falls construction can begin in earnest.

For all its competitive advantages relative to Muskrat Falls, Romaine will need a massive turnaround in electricity markets to break even.

Even if Muskrat Falls power and all of its transmission from remote Labrador to the south coast of Newfoundland was magically free, the costs of getting the power underwater from Newfoundland to Cape Breton alone will be prohibitive. Unless new, as yet unidentified, markets for the power are found, the per kilowatt-hour cost of the submarine transmission alone from Newfoundland to Nova Scotia will approximately equal the cost today of power delivered from new natural gas generation.

The only reason the local utility in Nova Scotia — Emera — is considering the project is because the provincial government has ordered the utility to source more supply from renewable generation.

The Muskrat Falls project critically depends on using upstream reservoir storage and generation capacity to ‘save’ energy produced at Muskrat Falls that would otherwise be wasted, especially during the spring runoff. This upstream reservoir storage and generation capacity — Upper Churchill — is today almost all dedicated to serving Hydro Quebec under a legally binding but locally resented contract signed in 1969.

When pressed to explain how the Muskrat Falls power production plan will work, given Hydro-Quebec’s contractual rights to the Upper Churchill, the Dunderdale government relies on a provincial Water Management Agreement established in 2010.

Hydro-Quebec has publicly stated the Water Management Agreement has no impact on Hydro-Quebec’s rights under its Upper Churchill power contract. Newfoundland legislation and the 2010 Water Management Agreement itself expressly confirm Hydro-Quebec’s position.

The Dunderdale government claims to have engineering studies and legal opinions that support its ability to utilize the Upper Churchill reservoir and generation assets, now used to serve Hydro-Quebec. These studies and opinions have not been publicly disclosed.

The government has recently changed the province’s Freedom of Information law to ensure secrecy for the Muskrat Falls project.

Throughout its political marketing of the Muskrat Falls project, the Dunderdale government has openly appealed to anti-Quebec sentiment. She has stirred up resentment over the 1969 contract and promised to “get around Quebec.” Dunderdale has warned, “if Muskrat Falls does not go ahead, what happens in Labrador from that point on lies squarely in the hands of Hydro-Quebec and the people of Quebec.”

During the election of 2011, Stephen Harper promised a federal loan guarantee for the project. The constitution puts electricity squarely in the provincial sphere so he justified his actions largely by claiming climate change benefits. Two weeks ago, Harper committed federal taxpayers to subsidize loans for the project totalling $6.3 billion. Predictably, and with every reasonable justification, the Quebec government has cried foul.

Muskrat Falls is wildly uneconomic, has no known export markets and no prospect of Labrador mining customers prepared to pay anything close to the actual cost of power. It potential injures Quebec’s contractual interests and risks fomenting interprovincial conflict. Its biggest rate impact kicks as the 1969 deal with Quebec expires in 2041, extending Newfoundland’s electricity pain into the later years of this century.

But hey, everyone knows that infrastructure spending is good, right?

15 Comments

  1. Thanks for the clarification track Tom. If all goes right we, the members of NuntuKavut and others against this project will stop this thing on the ground. On fact it must be quite clear by now if this Project is going to affect the budget, the Dunderdale Government will be happy to have an excuse to blame someone, or something else for interfearing with this miserable excuse for a Project. Cornerbrook is waiting for a hoppital, Nalcor spent it last summer. You have to ask is, Penashue is stuffing dollars from this money into off shore banks and investments? Who is accounting for what SNC might be up to? These are the questions we will be asking from our jail cells as we break Nalcor’s rediculous sweeping injunmction against us, and push their food away as they bring it to our cells. They have bitten off far more than they can chew on this one. Could Mr. Williams be going down on this fiasco, no name on the brass plate, attached to the no dam? We should ask.

  2. As far as Nova Scotia is concerned, it will be interesting to see the cost comparison between the Maritime Link and a properly sized CCGT in-province. Considering the fact that 6 out of 8 coal units have be decommissioned before 2030, natural gas will be part of NS future sooner or later. Another thing to look for is the development of the transmission grid in Nova Scotia and New Brunswick as an alternative to the 500 MW from Labrador. NB Power needs revenues to pay for the botched refurb at Pt Lepreau and is eager to make a deal to unload some if this expensive energy in neighboring markets. With the current low New England prices and on-going surplus in Quebec, NB could import some of its internal demand and turn east to unload some Lepreau electrons.

    For this to happen, two things will need to be addressed in the next 5 years and will require the cooperation (and significant investment) by NB Power: first they need to fix the congestion around Moncton and southeastern NB, then Emera and NB Power will need to twin the 345 kV tie between Salisbury and Onslow to raise the transfer limit between the two systems.

    As for the Romaine hydro development (and further developments on Quebec’s North Shore), I see it more and more as an insurance policy in the context of the assuredly contentious renewal of the CF(L)Co contract. Last night, I stumbled on Order-in-council 352-2012 awarding a 500 MW block of power for the expansion of the Alouette smelter in Sept-Îles. What’s significant with this contract is the expiry date: August 31, 2041.

    Another factor to consider is the overbuilding of the Romaine transmission project (built to 735 kV standards but operated at 315 kV). You just don’t build 735 kV to transmit 700-800 MW. With the the eventual shutdown of Alouette smelter (1,335 MW), the Romaine development (1,500 MW) and the planned Petit Mécatina (1,200 MW) and Magpie projects (835 MW), Hydro-Québec would be able to replace 4,920 MW at Arnaud TS on Sept. 1, 2041, thus strenghtening HQ’s hand in future talks with Nalcor.

  3. I was wondering if you were an idiot or something worse and was leaning towards the latter. I am now leaning toward idiot because if you still haven’t figured out how the water management agreement works you are clearly less intelligent than my eight year old daughter whom can understand it fine. (email me and will explain it to you)

    As for the cost to market, you do realise we need this power in Newfoundland and are not doing this as a project to sell power. (yes there are plans to monetize the excess but not a requisite for the project) Nova Scotia is acquiring a portion of the power for their needs and for their own reasons.

    Quebec, they don’t play fair with anyone, especially Newfoundland, and don’t really enter into the Muskrat Falls project at all so why bring up their Romaine project?

    Federal taxpayers are subsidizing nothing! They are co-signing a loan with the provinces to help obtain better financing rates.

    Seriously why are you so against this project which has no impact on you at all?

    Ted H

    • Ted,

      I’m glad you have rejoined the debate, although your rudeness is out of place. Your suggestion of malice on my part is particularly distasteful. Your logic is on the same level as your civility.

      Andrew Coyne demolished the notion that the federal load guarantee is not a subsidy here: http://www.calgaryherald.com/opinion/columnists/Coyne+feds+should+avoid+Muskrat+Falls/7659042/story.html

      As for your assertion that Quebec doesn’t “play fair with anyone”, how do you square that with Quebec allowing NL to wheel its excess recall power and Quebec waiving its rights to the TwinCo block when it expires in 2014? Both of those look to me like exemplary fairness on behalf of Quebec.

      As for your assertion “we need this power in Newfoundland”, you can’t be referring to rising load since load peaked in 2004 and has fallen since. With a further decline in the forestry sector likely, the new Vale smelter load won’t change this trend. Let me put the best possible spin on your meaning. The Island is currently dependent for a small portion of its annual production on oil-fired generation and there might be an economy in finding ways of reducing that requirement. I think everybody using oil for power should be working hard to do something smarter. If official Newfoundland took the problem of reducing oil-fired dependency seriously, the first step would be marginal cost pricing along the lines proposed by Jim Feehan here: http://www.cdhowe.org/pdf/ebrief_129.pdf. Official Newfoundland’s reliance on strawman arguments, claiming that Feehan’s sensible and efficient suggestion would hurt consumers, speaks volumes about the intellectual integrity of the debate.

      I understand that you have rock solid confidence in the government’s secret studies and opinions that claim the water management plan for Muskrat Falls, which depends on using Upper Churchill storage and generation, is going to work. Keep in mind that the folks organizing this are the same bunch who accidentally nationalized the toxic waste sites at Abitibi. http://www.cbc.ca/news/business/story/2010/04/23/accidental-expropriation-abitibi-423.html

      My own motivation in studying this project initially arose from my interest in how trash thinking around peak oil and global warming hysteria is used by politicians as a power grab. As I got further in, I came to realize that whereas the 1969 Upper Churchill debacle is merely a missed opportunity for Newfoundland, Muskrat Falls is becoming a direct financial loss far more punishing to the future of Newfoundland than Upper Churchill.

      • I apologize for being rude. As you continue to ignore some clear arguments I let my frustration show.

        Andrew Coyne’s ‘column’ is a waste of time to read but so be it. He starts by stating in the second paragraph that if the borrowers pay their debts “the federal government won’t have to pay out a nickel.” Really demolished the notion that there is a subsidy, didn’t he? He then goes on to say how it is costing taxpayers a billion dollars but never really says where the cost is. It is actually costing the banks that money if you are looking. All lending institutions base interest rates on risk of non-repayment. Since the federal government is a lower risk they get a better rate. Passing this rate on to the provinces when they can and the risk is low will cost them nothing. Many a parent has co-signed for a mortgage and never had to pay a penny for it. Yes there is a risk but if you have read the terms of the loan guarantee you will see the federal government has made sure there is very, very, little risk. You can’t equate risk to cost for the federal government as Coyne does. Coyne’s other argument about the project not going ahead without the loan guarantee is wrong, as it has been made clear and been stated publicly that this project is going with or without it. It is just cheaper to proceed with it.

        By the way, Coyne doesn’t see Quebec as playing fair either.

        By saying we need the power in Newfoundland I meant this is not being developed as a power for sale project but as a power for our own use project. Excess will hopefully be monetized through export sales but that is not the primary goal of the project. You can’t equate this to the Romaine for this reason. The current island of Newfoundland energy requirements and peak demand requirements have risen to nearly equal to the peaks of 2004 when the forestry/paper industry was in full swing. Since that industry has not returned it is clear that other growth has made up for this loss of load. There is less of the paper industry left than what was already lost so future loss of load as a result this industry failing will be less significant than in the past. The Vale smelter might not add to the load so significantly as to make all the difference but it WILL add to an already increasing demand. As it stands now any increase in demand will have to come from expensive, not to mention polluting, thermal production from Holyrood.

        Jim Freehan’s brief is correct that through efficient pricing and conservation efforts the cost of an isolated island option is reduced. It is not reduced to less than the Muskrat Falls option with the interconnected option having a cost benefit of $0.75 billion. He then makes a big mistake to arrive at his conclusion. His flaw is that the billion dollar costs beginning in the 2020s are not only for new thermal generation but mainly to replace the ageing Holyrood generation. The Holyrood thermal generating station will be reaching end of life at around that time and will need replacement in the isolated island option. Jim loses his billion dollar savings and the interconnected option is the least cost. His idea that the need for Holyrood is only in the winter is also flawed. Holyrood is needed in the winter for peak demand but it is needed for annual energy requirements as well. The energy requirements do not need it to run at any specific time but they are met in the winter when the plant is run for peak demand. If the demand was flat across the entire year but the energy requirement was the same, Holyrood would have to run nearly the same amount as now. Shifting load from winter to summer would therefore not give any benefit and it is the energy use in the summer as well as the winter that necessitates the running of Holyrood.

        Holyrood is getting old and will need refurbishment soon and replacement in the not too distant future. Any money spent on this will only tie the province to expensive fossil fuels for a very long time. The cost for this in the long run will be enormous. Spending a large amount of money now and having a very stable low cost power supply for a very long time is a better option. Rent or buy? It is that simple.

        You bringing up Abitibi is like me saying that since you have made mistakes in the past then everything you say must be wrong. Poor form on your part.

        The water management agreement that you seem to think is some sort of voodoo is actually very simple. If you will bear with me I will use a very simple analogy. Let’s say you have a barrel in your yard and you collect rainwater to water your garden. I want to collect rainwater to water my garden but have nowhere to put a barrel. Municipal regulations say I can use your barrel but I cannot interfere with your use of it. Every drop of water that goes in or comes out of the barrel is measured. If I only use the water that I put in it and only when you are not watering your garden then there is no problem.

        Churchill Falls has a very large reservoir and an enormous generating station attached to it. The reservoir is never completely full or empty and the generators are very rarely if ever run at 100% capacity, even in winter. Water storage and use is tracked very carefully. The water management agreement simply allows the Muskrat Falls plant to store excess energy, in the form of water, in Churchill reservoir and take it back at a later time when Churchill Falls is running at less than 100% capacity. Not complicated, does not interfere with current agreements, and will allow much more efficient use of Muskrat Falls.

        I hope you can finally understand how the water management agreement works.

        There are risks and costs but they are less than with the other options. Will everything go perfectly? No. No project of this size, especially with politicians involved, could. The alternatives fall into this category as well.

        As an informed and educated Newfoundland and Labradorian I think this is the best choice for our province.

        Ted H

        • The point of the comment on the Water Management Agreement is that the flow in the river combined with the reservoir will be significantly less during the winter than during the summer and spring at Muskrat Falls. This is the time which requires the peak amount of power on the island from the Muskrat Falls generating plant. This is also the time when the Upper Churchill plant has to provide the most power. The issue here is that there is no proof that at peak times Quebec will provide the extra water to Muskrat Falls. Quebec will look after Upper Churchill First and Foremost and has a legal right to – they have no requirement at all to provide this power if there is any impact on the generation at the Upper Churchill station.

          All the documentation to support the province’s position on this matter are now unable to be accessed through FOI.

          • I don’t know if this is understood, but any water used in CF generation will 100% become water for Gull Island and Muskrat Falls downstream. In other words, the more power HQ draws, assuming all 11 CF units are running, the more water is being supplied to the downstream power projects we are talking about. It isn’t an either/or situation at all. There is no other path the water exiting the CF tailrace tunnels can take – it will certainly go downstream to Muskrat Falls. The only concern could be if CF generation shut down a number of units (which would run at less than the HQ contract requires, so it wouldn’t be done unless there was a major problem) and didn’t spill water. That and other scenarios is what the water management agreement handles.

    • In a way, that’s pretty good news for Hydro-Québec. With this bill, I wonder how Nalcor (or its subsidiaries) will get a licence to sell power at market rates in the United States, since they won’t offer non-discrimatory and reciprocal access to their power grid.

      • http://www.releases.gov.nl.ca/releases/2012/nr/1218n02.htm

        The Province really had no choice but to bar all other wholesalers as a result of the take-or-pay arrangement in the power purchase agreement between Nalcor and NLH. They must have their ratepayers captured. And so, the real interesting question for me is whether ratepayers will like being captured and will actually continue to purchase electricity from the grid as the cost of Muskrat Falls power continues to increase over time (the cost increases are built into the PPA).

        As the cost of conservation, efficiency, storage and self-generation technologies continue to fall and the Muskrat Falls costs continue to rise (as they are guaranteed to do under the PPA) and drive up rates, the line of the conservation and self-generation alternatives coming down will eventually cross the line of Muskrat Falls continually going up. Nalcor is betting close to $10 billion that day is a long ways off.

        • In the residential and commercial sectors, research shows electricity demand is pretty inelastic, more so when if homes (more than 80% of new dwellings built since 2001 use electricity to heat) cannot easily substitute baseboards for a central heating system. As for technological changes, it seems this is accounted in the econometric model used by Nalcor, according to MHI’s review of demand forecasts.

          • My home is very typical of many others in Ontario. My electricity consumption from 2005-2007 was 900 kWh per month. In 2013 it will be less than 300 kWh per month. I heat space and water with instantaneous natural gas but everything else is electric. I did nothing that any other homeowner could not do by using readily available technologies. I made no changes to the number of people in my household or to the kinds of appliances and services. My estimated return on investment is greater than 5% per annum over the next 15 years, and about 8% with the subsidies. Is that what you mean by inelastic?

            Is any of the research you refer to done in NL? For example, the former premier of NL installed a ground-source heat pump in his home (as have several other NLers, schools and commercial buildings) but the industry is entirely unsupported in the Province. Unlike almost every other Province, including Quebec, NL did not match the feds heat-pump subsidy a few years ago. Nalcor does not like conservation, period. NL conservation in 2010 was 1/30th (!) of the per capita rate in Vermont, a jurisdiction with a long history of conservation unlike NL which has no history. Nalcor publicly testified that “Newfoundlanders are not ready for conservation”, and Nalcor hopes it stays that way. The Province has enormous conservation potential in both the residential and commercial sectors as there is no provincial building code in NL, many old homes remain uninsulated, and new homes are not well built.

            I have not seen that particular report by MHI, but Nalcor’s prior reports also accounted for conservation and self-generation. They did so by assuming that conservation was minimal and self-generation was zero indefinitely.

  4. “The constitution puts electricity squarely in the provincial sphere so he justified his actions largely by claiming climate change benefits.”

    Harper has no justification there, IMO. My vote of confidence goes to Vaclav Klaus.

    “But hey, everyone knows that infrastructure spending is good, right?”

    That depends on how you define “infrastructure”, these days… just ask anyone who is tracking how implementation of the UN’s Agenda 21/ Sustainable Development lunacy is being funded in Canada. This also explains why our roads and bridges continue crumbling.

  5. Great article. I would add that it is not wholly accurate to state that the only reason Emera wants to pursue this project is because of stringent 2020 environmental regulations. The intention is to dump the submarine cable link into Nova Scotia Power’s ratebase, and if approved by the regulator, create nearly $2 billion of additional earning assets that may generate a regulated return (over 9%). No other renewable alternative will ensure that this monopoly franchise is as protected. If the regulator rules the ‘link’ is not in the best interest of ratepayers, Emera will likely eat their losses and walk from Muskrat as opposed to transfer that risk to investors. Unlikely this would ever happen though — the NS regulator approves nearly everything that NSPI files. But as you rightly point out, at least the investment is subject to some outside scrutiny.

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