Cutting Through Nalcor’s Financial House of Mirrors Surrounding Muskrat Falls

The government of Newfoundland and Labrador is poised to roll the dice with a massive hydro-electric development proposed for Muskrat Falls on the Lower Churchill River. I have previously commented on the project here.The government of Newfoundland and Labrador has sunk in the order of $400 million into planning, reports and consultants. Some of this amount would have gone for power engineering, which might be considered real work. However, much of the spending on consultants appears to have gone into financial engineering.
Here is a reply from Nalcor to a sensible, straight-forward question that will give you a sense for the house of mirrors the government-owned utility has created to conceal the costs for consumers. The answer to this question is a work of art. I have witnessed a lot of utilities turning on their artificial snow machines, but in my experience nobody can deliver a blizzard of nonsense with the flair and panache of Nalcor.

The financial engineering surrounding the project has created a fog of confusion so murky that it has befuddled even the project’s supporters. Dr. Wade Locke, a prominent professor of economics at Memorial University of Newfoundland, gave a one hour public lecture last week on the project followed by a long question and answer session with the public throughout which he discussed the cost of power from the project. It wasn’t until the next day that he acknowledge that all his cost of power figures for the project failed to include the cost of transmission. Ed Hollet is bravely wading through Locke’s swamp here.

The financial engineers working on the Muskrat Falls project have modeled their financial design on an element of Bruce Power’s contract with the Ontario government. The Bruce Power contract relates to unregulated power production. Key elements of the Bruce deals were negotiated during a government-created power crisis that resulted from an electoral commitment to close all coal-fired generation in the province on what later became recognized as an unachievable schedule. The original Bruce Power contract has been the subject of an inquiry by the provincial auditor who found that the rate impact claims the government initial broadcast about the deal were substantially lower than the real cost to ratepayers. The commercial arrangements between the province and Bruce Power are generally recognized as exceptionally complex, even by the standards of power sector finance. My columns in the Financial Post section of the National Post are some of the only independent analysis of the Bruce deals publicly available. The fundamental business proposition in the case of Bruce Power — a leased facility that stays in Crown ownership — is so fundamentally different from the proposal for Muskrat Fall as to raise serious questions as to why Nalcor would consider applying it to Muskrat Falls development unless it intended to create confusion.

Here is a simple way to cut through all the financial engineering around Muskrat Falls so you can get a realistic sense for the rate impact of the project.

Let’s ignore the fact that Nalcor has not consistently included interest during construction. Let’s also assume no cost overruns. Let’s assume that Nova Scotia consumers, a miracle turn around in export markets, profits from vastly expanded sales to Labradorians, federal subsidies, and a generous sprinkling of pixie dust pick up $1.8 billion of the of the project’s forecasted $6.2 billion capital cost. Let’s assume that consumers on the island of Newfoundland have to cover only $4.4 billion.

Let’s assume a magical power development with zero operating costs, zero community support payments, and no depreciation.

Let’s assume that this is a low risk investment and that a 0% return on equity is appropriate. Nalcor assumes that the cost of borrowing will be 7.4%. Let’s assume that Nalcor can find enough lenders at this borrowing rate without the benefit of any equity to support the loans.

Under this absurdly optimistic rose-coloured glasses scenario, Newfoundland island consumers will have to carry an annual cost of $326 million to displace what is now about 1 TWh/yr of production from the only non-hydroelectric generator on the island — the oil-fired Holyrood station. Replacing Holyrood will cost 33 cents/kWh under the most rosy scenario that can be constructed. More realistic assumptions would drive this figure far higher.

The current cost of fuel at Holyrood is about $135M/TWh or 13.5 cents/kWh.

This simple example makes it clear that Muskrat is a shockingly expensive way to cut the fuel use at Holyrood, particularly since that station will probably still be needed for backup.

One Comment

  1. Actually, Holyrood produced only 803 GWh of energy last year (and I think that oil costs only worked out to just 12.5 cents/KWh).

    I have long said that this whole project has been ‘reverse engineered, not just the financially engineered.

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