Kathy Dunderdale is right

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Muskrat Falls has nothing to do with the deficit. Anyone who says otherwise is wrong. Period.

Premier Kathy Dunderdale is right.

Yup. You heard me.

Last Thursday, she got a bit exasperated with me when she was talking to reporters following question period on the opening day of the House of Assembly. We were pressing her on the deficit, public sector job cuts and Muskrat Falls. Basically, we were asking the same question a lot of people in the province have been asking recently: “How can we afford to spend a few billion dollars to build a massive dam in Labrador when we're staring down a $1.6-billion deficit?”

Or, phrased another way, “You really want me to believe that we're going to spend a couple billion dollars on Muskrat Falls this year, but somehow that won't contribute to our massive deficit? Seriously? How dumb do you think I am?”

Dunderdale was saying that Muskrat Falls won't contribute to our deficit. Not at all.

And it turns out that Dunderdale was right. She was also wrong. Sort of. But I think she was more right than wrong. Sort of.

 OK, this is going to take a long time to explain, so settle in.

 On Thursday, I asked why regular capital expenditures – like the Placentia lift bridge or a new school – are included in the budget process, but Muskrat Falls isn't. Here's Dunderdale's answer:

“No, no, no. James, I will arrange a briefing for you if you want with the Department of Finance that will show you the difference between the current account budget, which is a budget we bring down in April, and our capital budget. And they're two separate entities. They are two completely separate ways of dealing with finances in the province and one doesn’t equate with the other.”

At the time, that little part about “I will arrange a briefing for you” was just a bit of a rhetorical flourish – sort of the premier's way of saying, “If you can't understand this, James, you're welcome to stay after class and keep studying it until you get it right.” But a few hours later, I got a call from a communications official in the Department of Finance asking me if I'd really like to come in and sit down with some officials to go through this stuff. I said yes.

On Friday morning, I and another reporter sat down with some of the top officials in the Department of Finance, and we chewed through this stuff. I learned a few new things, and I understood why Dunderdale is essentially right about what she's saying. Muskrat Falls has nothing to do with the deficit. Nothing.

The folks over in finance did a pretty good job of explaining it to me. Now, I'll try to explain it to you. (This is a bit tangly, and I'm neither an economist nor an accountant, but I'm doing my best.)


Right off the bat, let's define a few terms here.

There are two critical budget documents every year that form the basis of the government's spending plan: “The Estimates” and “The Budget Speech.”

These are really bloody important documents. How important? When I sat down to write this blog post, I retrieved a a copy of the 2012 Budget Estimates document which was sitting on my dresser in my bedroom. For a while, this book lived in the back seat of my car. Seriously. In my world, it's always helpful to have a copy of Estimates handy. It's probably the No. 1 document I use as a political reporter, and it's more useful than any other single resource.

The Estimates details how much cash is coming in to the government, and how much cash is going out. As the name suggests, The Estimates isn't an exact thing. Every line item includes three numbers: how much the government budgeted for something last year, how much cash they actually spent on it last year, and how much they're budgeting for it this year.

So, for example, the Animal Health Division of the Department of Natural Resources (Page 194 of the PDF copy of Estimates) had a budget of $159,000 for “Professional Services” during the 2011-12 budget year. When the 2012 budget came out, the Estimates document shows that they actually only spent $93,000. In 2012, the Estimates are budgeting for another $159,000 again for “Professional Services.” We'll find out in a few weeks whether they spent that much or not when the 2013 budget comes out.

The important thing to understand about this is that the Estimates deals with cash. How much cash the government is expecting to take in. How much cash the government is budgeting to spend on stuff. Cash. Got it?

The Budget Speech is different. The Budget Speech is a much shorter book. This one I don't carry around, because all the really important bits I've got memorized, or I can quickly and easily look them up. The backbone of the Budget Speech book is, naturally, the speech that the Finance Minister gives in the House of Assembly on budget day. This is where he lays out the vision, direction, and broad strokes of what the government is doing with taxpayers' money. But the budget speech also includes a number of very important charts and tables. For example, if you flip to page nine of the budget speech (Page 12 of the PDF document) you'll see a table titled “Statement of Operations 2012-13.” The table lays out how much revenue the government is getting and how much income is coming from Crown corporations. It also details how much money we're spending on programs and services and keeping the lights on in Confederation Building and stuff. Subtract the expenses from the revenue, and there you have the forecast deficit of $258 million at budget time last year.

Here's where it gets confusing though. The Budget Speech and the statement about deficit is done by accrual accounting, as opposed to cash accounting in the Estimates. Here's a website that does a good job explaining the difference.

This is really important. To oversimplify the situation, say the province is building a school that's going to cost $300 million. The school has an estimated lifespan of 30 years. The government is going to pay out basically the whole shot during year one when they build the school, so from a cash perspective it's a $300-million expense in the year when the school is being constructed. But for the purpose of accrual accounting, they'll split the capital expense over the life of the project, and consider it as a $10 million cost per year over the 30-year lifespan of the school.

It's massively more complicated than that, but let's try to keep things simple here. I think that's what Dunderdale was getting at in that quote off the top when she talked about “the difference between the current account budget, which is a budget we bring down in April, and our capital budget.”

But as it turns out, Muskrat Falls is another beast altogether.


For the purpose of this discussion, Muskrat Falls is neither a capital expenditure nor a current expenditure. It's an equity investment.

Now, the slick folks up in Confederation Building who write press releases have kind of screwed themselves over here. Every time they issue a release talking about government spending money, they refer to it as an “investment.” It's a semantic difference, but from an accounting point of view, spending $60 million dollars paving roads isn't an “investment.” It's just spending money.

Muskrat Falls, from an accounting perspective, actually is considered an investment. (On the other hand, from a folk music perspective, Muskrat Falls is not considered an investment.) Basically, the provincial government is investing cash into something called "Muskrat Falls" for which they're receiving an ownership stake valued at the same amount as the cash they'll put in.

Let me try to explain it another way.

Imagine the provincial government announced it was going to start a Crown Corporation to make toilet paper. Let's call it the Crown Resource Asset Project. Wait, no. Let's not call it that. Let's call it the Newfoundland and Labrador Toilet Paper Corp. or NLTPC for short.

For the sake of argument, let's say that the provincial government has decided that toilet paper is just too important to leave to the private sector, and they've determined that the least-cost option is to massively overhaul the paper mill in Grand Falls-Windsor, and use a series of huge conveyor belts to transport the toilet paper to St. John's and other parts of the province. But the toilet paper factory is going to be 60 per cent bigger than we really need it to be. So we're going to give some of our toilet paper to Nova Scotia in exchange for building another underwater conveyor belt that'll carry toilet paper to the mainland, and even into the needy bathrooms of the northeastern United States. To make this scheme work, the government has passed a law that says it's illegal to buy toilet paper from anybody else. But don't worry, the government says, the toilet paper we're selling is cheaper than any other source of toilet paper out there anyway. Also, it's two ply, and quilted and stuff! Better still, now that we've got our own secure supply of toilet paper, we'll no longer be at the mercy of the wild fluctuations of the international toilet paper market.

Everybody needs toilet paper, and the government has a captive market, so NLTPC is basically a guaranteed source of revenue for the government. But NLTPC has to spend about $7 billion refurbishing the Grand Falls-Windsor mill, and building all those complicated conveyer belts.

So here's what the government does. The government transfers $2 billion to NLTPC as an equity investment. Imagine it like the government is buying a hundred shares in NLTPC for $2 billion. The government is a 100% owner of our little toilet paper company here, but it's transferring cash to the company, which is increasing the equity value of the company. The government puts $2 billion worth of cash into NLTPC, but it is the 100% owner of a corporation that now has $2 billion in the bank, so basically, the taxpayers still have their $2 billion.

Now, NLTPC spends that $2 billion on refurbishing the paper mill and the other infrastructure, but then it says that the assets it has fixed and built are worth $2 billion as well. It's not in cash any more, it's in physical assets like the mill and the conveyor belts. But NLTPC says it's still worth $2 billion, and since the government still owns NLTPC 100%, they still have the same $2 billion on their books. The cash is gone but the provincial government is still holding onto something that they say is worth $2 billion, so we haven't really lost any money.

Now, it's up to you to decide whether this is accounting mumbo jumbo or it's totally legit. The best I can say is that the accountants of the world seem to think it's legit, so it's got that going for it.

Of course, the government isn't building a toilet paper factory, it's building a hydroelectric dam.

The important thing to understand is that while a whole lot of cash is getting shuffled around here, none of this contributes to the accrual accounting system. Because none of this is counted as part of the accrual accounting system, it isn't reflected on the deficit.

OK, so let's jump back to reality. If you go to page 200 of the Estimates book you'll find a line item where the government was planning on transferring $664 million to Nalcor for “Energy Initiatives.” The vast majority of that money is meant for Muskrat Falls. (A little bit of it is for offshore oil stuff.) I've heard various people say that the $664 million payment to Nalcor is the single largest factor in the $725 million deficit that the government is running this year. In this tweet, Federation of Labour President Lana Payne makes essentially that point on Twitter: https://twitter.com/Lanampayne/status/309815308116439042

Tory MHA Steve Kent says Muskrat Falls has nothing to do with the deficit. (He's correct.) Then Payne brings up that $664 million line item and seems to suggest that it's part of the deficit. Payne also says in that exchange the deficit is a “manufactured crisis” and “austerity for austerity's sake” as well as “how we pay for MF (Muskrat Falls.)” Payne made the same connection during the panel discussion portion of this week's episode of On Point with David Cochrane. (The whole thing is worth watching, but skip to about 15 minutes in for the relevant comment.)

I'm picking on Payne here a little bit, because she's saying it on Twitter and in the media where it's easy to link to it, but she's not the only one talking this way. I've heard the same sort of language coming from the public sector unions in the context of collective bargaining. Heck, I've heard the same thing on Open Line too. Essentially, there's a perception that the government is spending a bunch of money on Muskrat Falls, and therefore it's running a big budget deficit. Then the government is using that budget deficit as a justification to lay off workers and squeeze the unions when it comes to negotiations over wages. All of that is patently false, at least as far as any connection between Muskrat Falls and the deficit is concerned.

Money spent by the provincial government on Muskrat Falls is not being included in the deficit calculation. Period.

On a side note, Payne's argument doesn't hold a drop of water anyway, because Department of Finance officials tell me that the vast majority of that $664 million was never transferred to Nalcor, and never spent because the decision to sanction Muskrat Falls happened much later than they anticipated. When the 2013 budget is released in March or April, it will reflect the fact that $245 million (NOT $664 million) was actually transferred to Nalcor. What's more, because of all of the accounting stuff I've explained here, even that $245 million won't be included as part of the deficit calculation.


I think it's safe to say that most people understand cash accounting a lot better than accrual. When I buy lunch, I don't amortize it over the duration of the afternoon. I just know how much money is in my wallet, and how much is in my bank account. So, how much money is in the Newfoundland and Labrador government's bank account? Not as much as there used to be.

When Finance Minister Tom Marshall delivered his budget speech last April, he said the government would be running a $258-million deficit. Remember, that's on an accrual basis. But if you look on page 11 of the Estimates book, there's a table titled “CONSOLIDATED REVENUE FUND SUMMARY OF CASH (REQUIREMENT)/CONTRIBUTION.” It lists all of the expected cash revenue that the government expects to get in 2012-13. It also lists the total cash expenses that the government expects to pay out in the budget year. Combine the two numbers together, and you're either going to need to take money out of the bank to pay all the bills, or you're going to have money left over, which you'll deposit into your bank account. (In the case of government, we call the chequing account the “Consolidated Revenue Fund.”

Look at the bottom of the page, and you'll see that when you take into account capital spending, investments and all manner of other cash transactions, the government was forecasting a need to take $1,061,355,000 cash out of the Consolidated Revenue Fund. Phrased another way, on a cash basis, the provincial government was running a $1 billion deficit last year. (And that's before the price of oil dropped.) For a bunch of completely legitimate accounting reasons, that's arguably a bit of a misleading figure, but the fact of the matter is on budget day, the government was forecasting paying out $1 billion more in cash than it'd take in.

By the end of 2013, at the rate the government is spending, the consolidated revenue fund will be empty. What happens when your bank account is empty? Whip out the credit card. You may recall Marshall loves to say, “We have not borrowed for operational purposes since 2004.” What that means is that even when the government runs a deficit, it can pay it using the cash in the bank. Starting in 2013, the province will have to start issuing government bonds to come up the cash it needs to pay all its bills. One of those bills will be the equity contribution to Muskrat Falls.

Make no mistake: in the next couple years, the provincial government is going to be spending a lot of money on Muskrat Falls. And the government is going to have to borrow money to do that.

But the whole accrual accounting thing comes with a neat little trick. Because all of the Muskrat Falls spending will go towards that equity investment we talked about, it won't actually drive up the government’s net debt.

Net debt is your total outstanding liabilities, minus assets. So say you've issued $12 billion worth of bonds over the years, and you'll have to pay those people back. But you've got $4 billion cash sitting in the bank. Most government bonds are for a fixed period of time, say five-year or 10-year obligations. Because you can't pay them back sooner, so you just sit on the cash in the bank until the bonds come due. So your total debt is $12 billion, but because you're sitting on the $4 billion cash in the bank, your net debt is $8 billion.

The same principle is being applied to Muskrat Falls. It won't increase the net debt even though we're going to borrow a bunch of money to build it. In the case of Muskrat Falls, say we borrow $5 billion to build the thing. But now we've built a dam worth $5 billion, which we're counting as an asset on our books. So while we've taken out some big loans to build it, the whole thing doesn't contribute to the net debt.

There is a side effect of all of this, though. Since we're actually taking out the loans, we've got to pay interest on them. So even though our net debt won't go up, our debt servicing costs will increase.


 This stuff is really bloody confusing.

Off the top, I said Dunderdale was right. But she also seemed to be confused about this stuff too. Her core point was that Muskrat Falls is not a factor in the deficit, and on that point she's absolutely correct.

But let's revisit that quote from Dunderdale I used at the top:

“No, no, no. James, I will arrange a briefing for you if you want with the Department of Finance that will show you the difference between the current account budget, which is a budget we bring down in April, and our capital budget. And they're two separate entities. They are two completely separate ways of dealing with finances in the province and one doesn’t equate with the other.”

As I've explained, capital spending actually is included in the annual budget that the government delivers every spring. The capital spending is amortized over the life of the capital project, but it is included. Muskrat Falls actually isn't capital spending at all, for the purpose of our accounting definitions. It's an equity investment.

Let me use one more analogy. When I explained all of this to a friend in an e-mail, he wrote back and said:

"It won't contribute to the deficit... but how much does that fact really matter? The financials of it are still peculiar. Essentially, it's like me going and investing in Microsoft, but then coming home and telling my girlfriend I can't pay the rent. While I still have the assets of the shares in Microsoft, and my net worth is still the same as it was before, my girlfriend is still going to be displeased with me because we can't go get groceries."

I explained to him that his analogy isn't quite correct. I wrote back and explained: 

"Basically, we have a structural deficit over here, and that's one thing. And then over there we have a massive project that we're borrowing billions of dollars to finance. Muskrat Falls is cost-neutral, and will actually make us money in the long run (assuming everything goes to plan.) To use your metaphor, we're borrowing $100,000 from the bank to invest in Microsoft, but our regular 9-5 job doesn't pay well enough for us to afford the rent on the apartment we're living in. If that investment turns out poorly, well then we're in extra trouble. But if it provides a healthy return, well then, it didn't harm our living situation any, and maybe it'll contribute a bit of money to the household income down the road."

Make sense? No? Oh well dammit then. I give up.

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Recent comments

  • Maurice E. Adams
    April 08, 2013 - 08:54

    James, it is the making of a simple issue very complex that is what is creating the confusion --- and intentionally so. Once people are confused, it is easier to mislead, to hide the truth, to put opponents or those who might have a glimpse of the truth off balance and thereby easier to move ahead with one's own agenda...... That is what we have and that is what we have with all this talk of "net debt", whether MF affects "net debt", etc. etc. etc. ..... Obfuscation, at its best. If you had focused more on the value of this so-called 'investment', you would have been getting closer to the heart of the matter, and thereby at the very least you would have skirted nearer the edges of the truth

  • Maurice E. Adams
    April 08, 2013 - 07:20

    It seems James that you cannot see the woods for the trees. You have allowed yourself to be hoodwinked by gobbledygook --- purely accounting terminology --- all of which may be technically correct, but only "from a purely accounting perspective". I could go on and on and explain how Muskrat Falls is not a good investment, how practically all 'revenues' are from ourselves, how objective evidence shows that demand will fall (not rise), etc, etc., but that is not really needed. Other posters have already gotten to the heart of the matter and see the deception for what it is.

  • Michael
    March 19, 2013 - 17:09

    Of course the investment in MF doesn't add to the deficit...as long as the investment is never impaired. What this also doesn't consider if that if the government spends money on MF, then they have less cash available for other expenditures. This means they may have to borrow/incur debt to finance other projects, pay the bills, etc. This means interest expenses which vary depending on your level of debt could be high or low and would most certainly would add to a deficit. An investment made in MF today would not increase a deficit in this fiscal year (most likely) but it could definitely have an impact in future years if the investment is revalued and falls below its current book value.

  • Blue PooP
    March 18, 2013 - 09:01

    No, dunderdale only needs enough money to give to nalcor and to get a loan. 2 Billion i thunk. Now the province will make make 20 million back over the life of the project, so says Tommy Marshall. Then she'll tick the rest of the money on behalf of the taxpayers of the province and unborn NL's to come for almost 60 years. Now don't forget the perks and the instant wealth to be given away.

  • James G. Learning
    March 12, 2013 - 17:11

    I don't see Mauruce chiming in here. So I do believe MF is still pee and shell game. After all, how can Nalcor compete with Hydro Quebec? Nope it can't be sold compeitively on the North American Market unless the NL Taxpayers hold it up. So yes it is an expense.

  • Dave
    March 12, 2013 - 14:35

    It certainly seems shady even if you can follow the accounting rhetoric. The issue I see that remains is that assets aren't worth full value in reality when it comes time to cash in. If I buy a $2 billion car, that car's only worth half to the next buyer as soon as I take it off the lot. Plus, while I own the car, there are further expenses to keep it on the road, like tires, gas, repairs, and so on. Similar costs will come with a megaproject, and it will increase the price. So, for the $2 billion invested, I would think we lose half the value right away and then we'll be expected to cover an incidental costs on top of that. It's highly misleading for our government to spin it like they do.

  • jockoontherocko
    March 12, 2013 - 12:17

    You're wasting your time James b'y. No matter how you explain it, the ones that supprt MF's will understand and the one that oppose it will call you a liar and a PC supporter. No one wants to read this and try to understand it. They hate the government and that's all they see. Lots of ignorance floating around and to many are making assumptions based on partisan politics.The people who oppose this would not or cannot see anything good in this. What a shame that we have a chance to better this province and partisan politics and ignorance might ruin it. I for one will give the benefit of doubt and I am trying to understand this in hopes it can benefit NL. I might be wrong but I hope not. Unlike others I don't want this to fail. It seems some are wringing their hands in hopes that it all fails so they can say I told you so and have something to lay at the feet of PC's. So much for NL's future if that's how it's going to be.

  • doug
    March 12, 2013 - 11:42

    You/ve been duped, Jimmy.

  • Tom
    March 12, 2013 - 11:22

    This excellent thanks for this. Of course, this means the budget situation is even worse than I thought - we are running billion dollar deficits on top of all the money we are blowing on Muskrat Falls. I wonder if the bond market considers Muskrat Falls spending is debt neutral transaction.

  • Concerned
    March 12, 2013 - 11:13

    James... The issue is that the department of finance believe that the money they spend on the Muskrat Falls plant and the Labrador Island link is what the "book value" will be. I personally would like a third party auditing company (PWC, DEloitte, E&Y) to confirm this. The value of this combined asset should not be based on the value of the power for what it is to be sold in Newfoundland (which is their assumption). Rather the book value should be based on what this asset is worth on the open market. On the open market the power is sold for about 50$/MWhr, it is being sold to Newfoundlanders at 200 $/MWhr. If things go to sh$t then the value of this asset is ~200 million a year (once you remove the 1TWhr of energy being provided to Nova Scotia). The debt payment alone (on debt and equity) is about 400 million. I can not see how any accountant can recognize the full book value on the asset, when really it only has 25 cents on the dollar on the open market. What happens if NL Power dont need all this additional power from Muskrat? As an analogy it is if I spend 500 thousand to build a house in Flowers Cove. It may have cost 500 k to build, but is it truly worth 500 k if it could only fetch 150 k in the local market. I am not an accountant, but this makes no sense to me.

    • concerned
      March 12, 2013 - 13:43

      In 5 minutes of reading the Generally Accepted Accounting Rules the value of the asset may originally be taken as the initial cost. This is what the government is assuming in this explaination. There is no net deficit/debt as the value of the asset is placed on the book value. However, the level that the asset should be depriateced would objectively be determined by the earning power of the asset. http://pages.stern.nyu.edu/~adamodar/New_Home_Page/littlebook/assetvalue.htm I hope that the province has retained the services of their bonding agencies to confirm this assumption. As the earning potential of Muskrat Falls on the open market would only provide a equivalent value of half of what we are paying for how does this work? This is all smoke and mirrors in any regard. The people of the province has to pay off this elephant. JAMES -- A great blog post...

  • steve
    March 12, 2013 - 08:30

    Question for you James - the $245 million that was given to Nalcor, even if I agree with you that that amount doesn't contribute directly to the deficit, isn't it true that when you subtract $245 million from your available funds and park it somewhere, it isn't available for expenditure on other programs and services? Isn't that $245 million that the govt. now has to borrow in order to pay for those services, so isn't it now part of our deficit indirectly?

  • Are you serious
    March 12, 2013 - 08:09

    That has to be the worst explanation that I have ever heard. The truth of the matter it's smoke and mirrors. What about the financing costs? Where are those coming into play? The simple fact they are playing with reporting methods and hiding behind this type of garbage is to deceive the people of this province. If they included muskrat falls in the budget figures people would puke more than they are now.