Why it pays to read the fine print

Send to a friend

And read it fast, because time is running out

Russell Wangersky

I wanted to write about the seagulls, honest I did. Tuesday night, against the deep blue of the last moments of evening sky, five or six flights of seagulls headed for the harbour. Lit from beneath by the streetlights, and ghostly silent, they were like some sort of avian apparition.

But time is a fleeting thing, and we are charging headlong towards the next decision-point on the Muskrat Falls project, a timeline so critical that the provincial government won't give the Public Utilities Board even 90 extra days to do a full report.

So instead of seagulls, let's talk about the concept of cost of service billing and then, about a different utility being skewered by its own hydro plans.

By definition

Here's one definition of cost of service billing: "In cost of service regulation, the regulator determines the revenue requirement - i.e., the 'cost of service' - that reflects the total amount that must be collected in rates for the utility to recover its costs and earn a reasonable return."

Another? "A traditional electric utility regulation under which a utility is allowed to set rates based on the cost of providing service to customers and the right to earn a limited profit."

It works by referring to a relatively simple formula: rate base times allowed rate of return equals required return, plus operating expenses equals revenue requirement.

Right now, the provincial government and Nalcor argue that Muskrat Falls power will cost 7.5 cents per kilowatt hour (kW/h) to produce, plus seven cents or so to transport to the Avalon, and then - with markups for Newfoundland Power's rate of return for distributing the power - will reach something like 16.4 cents per kW/h.

That, the government says, will actually mean cheaper electricity, compared to burning oil to make power and refurbishing the Holyrood plant.

Fun with numbers

But not without a little hocus-pocus - because that's not really what the service will cost.

Recently, Nalcor was asked by the PUB to calculate the cost of Muskrat Falls power using the traditional cost of service method.

The answer? At Muskrat Falls, it will cost 21.4 cents per kWh, then add seven cents or so cents for transmission, for 28.4 cents per kWh. Then there's Newfoundland Power's markup, but we'll leave that aside for now.

The 7.5-cent figure came about because Nalcor chose a different way to calculate the cost of the power.

From a PUB application, exhibit 46, here's Nalcor's rationale:

"In the context of the Muskrat Falls development, the island ratepayer energy requirements at the time of plant commissioning is projected to use only about 40 per cent, or 2 (terawatt hours) TWh, of the plant's average annual production of 4.9 TWh.

"While the island's energy requirements increase over time in line with economic growth, the early-year (cost of service) COS rate for Muskrat Falls power would be a significant burden for ratepayers in those years, as the required COS revenue for Muskrat Falls would be at its maximum and the power required by ratepayers would be at a minimum.

"To address this issue, an alternative approach to Muskrat Falls power pricing was developed which affords a number of advantages for ratepayers. ... This escalating supply price is lower than would be indicated initially by the COS framework. It escalates evenly over time, and is applied only to power actually used by ratepayers - the early-year burden placed on ratepayers at that time is minimized.

"This is accomplished essentially by requiring that the equity investor 'wait' for its return over the project life. It should be noted that the equity investor is not forgoing any return for waiting; it still earns its rate of return on the entire investment over the course of the term ..."

That's reasonable enough - it backloads a block of the large initial costs onto users years later. It's essentially "buy now, pay later" - but for it to work, other things have to happen.

Increases must continue

Power rates have to continue to increase by two per cent per year, and the amount of power being used by island residents also has to increase to match the utility's projections. If either of those forecasts don't come true, big financial chickens will come home to roost on our kids.

Why this is important will come later - just remember that 28.4 cents per kilowatt hour. Because that lets you look at apples and apples.

Meanwhile, in Manitoba...

For interesting reading about how projects can go sideways, you might look at the Manitoba PUB's examination - and rejection - of Manitoba Hydro's latest rate application.

(Interestingly, a division of Manitoba Hydro is acting as an independent consultant for this province's PUB in its review of the Muskrat Falls project.)

You can find the Manitoba PUB decision online at http://www.pub. gov.mb.ca/pdf/12hydro/5-12.pdf.

Now, the whole thing is 232 pages, filed 11 days ago, but boy does it flag some critical points about how electricity sales are changing.

"Since Manitoba Hydro developed its plans, there have been major changes in the economic landscape," the document says.

"The projected capital costs associated with Manitoba Hydro's development plans have increased substantially; opportunity export prices have fallen; there has been market recognition and development of massive shale natural gas deposits - affecting supply plans in the United States and wholesale market electricity prices; the likelihood of premium prices for clean hydro-generated electricity has receded with the attention now being paid to the economy; industry demand for electricity and the expected growth in industrial demand has fallen; and the Canadian dollar is now near par with the (U.S. dollar)," the board's decision says, essentially rejecting the utility's current development plans.

"The board recommends that government subject Manitoba Hydro's major capital development plans to a review by an independent panel with the required level of expertise."

Similar issues here

Sound familiar?

It should.

That's what many people want to see here.

But there are other surprises: "Circumstances have changed since Manitoba Hydro, in its 2008/09 (plan), projected that new hydraulic generation would be required in 2018/19. Domestic consumption has declined by more than 1,500 GWh/year at a time the export market has 'shrunk.'"

Scary words for people looking at expanding in the electricity market.

Another concern raised by those watching Muskrat Falls? The potential for cost overruns.

When costs leap

Nalcor has budgeted a 15 per cent cushion; Manitoba Hydro has seen a jump in costs at some generating projects - even before the projects begin - of 50 per cent.

"On an overall basis, the capital costs for Manitoba Hydro's major generation and transmission projects have increased in excess of \$2.6 billion," the board pointed out.

"Against the backdrop of different types of business plans, together with the apparently skyrocketing capital costs ... together with a depressed export market and Manitoba consumers being held financially responsible for any losses, the board is of the view that Manitoba Hydro's capital projects require careful and detailed scrutiny."

There's plenty more: forecast overruns in the billions and long-term debt forecasts that have gone from \$7.8 billion in 2010 to a forecasted \$23 billion in 2029.

By way of comparison

And what does it all mean if you look at the Manitoba projects through the cost-of-service telescope?

"Manitoba Hydro's new generation ... will carry fully-costed initial in-service costs in excess of 10 cents/kWh. That indicated cost is almost double the current net cost of not only wind resources but also the cost of shale gas-driven CCGT (combined cycle gas turbine) generation."

(And, for comparison purposes, around one-third of the fully costed in-service price of Muskrat Falls energy, at around 28.4 cents per kW/h. I told you to remember that number. Scared yet?)

What does the export picture look like?

Well, Manitoba's been able to get between three cents to five cents per kWh in recent sales - meaning there's a very real case to be made that export customers are paying less than it costs to generate the electricity - and things are getting worse.

Again, the board decision: "In the board's view, Manitoba Hydro may be facing close to its worst-case export market scenario, particularly relative to the situation anticipated in IFF09-1, because of such factors as:

- projected major generation and transmission project costs 50 per cent higher than initially forecast;

- natural gas generation costs having decreased by 30 per cent to 40 per cent or more;

- the U.S./Canada exchange rate decreasing revenues by 20 per cent (offset in part by the depreciated value of Manitoba Hydro's debt held in U.S. dollars);

- a complete lack of carbon pricing as opposed to the \$20-\$30/tonne of CO2 apparently once forecast by Manitoba Hydro; and

- continued U.S. wind subsidies along with decreasing wind generation costs due to technical improvements and efficiencies.

"Furthermore, the board does not see how all of these negative market scenarios will be reversed for many years to come. The obvious risk faced by Manitoba Hydro is that the current status quo prevails for the foreseeable future."

And, on independent reviews

The board even took a shot at an "independent" company asked to do a review of Manitoba Hydro's plans, saying the review wasn't valid because it didn't challenge or test any of the utility's baseline assumptions.

"The end product of the information from all these planning documents is Manitoba Hydro's 'road map' as to future major capital projects (generating stations and transmission lines) that will be required to meet Manitoba Hydro's future domestic loads and firm export commitments.

"There is subjective decision making involved - together with numerous assumptions - that underpins any current version of Manitoba Hydro's Preferred Development Plan," the board said. "The significance/importance of examining and testing those assumptions and decisions cannot be overemphasized. With capital costs and financing costs in the tens of billions of dollars, the stakes are high for the domestic ratepayer who is at risk to bear the costs."

That, also, should sound familiar.

Where does the buck stop?

Easy. Here's what Manitoba's PUB is concerned about:

"(The) burden will fall to the domestic ratepayer. It is vitally important that the economics of the proposed generation and transmission investments be subject to a thorough review to ensure that the developments, if they proceed, will benefit and not overly burden domestic ratepayers."

Muskrat Falls is based on a series of informed assumptions - but those assumptions could be wrong.

They have to be tested independently, right down to their underpinnings - and frankly, that has not been done yet. Perhaps the PUB's review here will do it. We'll see.

Russell Wangersky is The Telegram's editorial page editor. He can be reached by email at rwanger@thetelegram.com.

Geographic location: Muskrat Falls, Manitoba, United States Holyrood Canada

• 1
• 2
• 3
• 4
• 5

Thanks for voting!

Top of page

• Marie
January 30, 2012 - 16:34

Without a full external financial audit, no one even knows if they are meeting 100% of their legal compliance requirements. Does it matter? It should. For some strange reason Danny's Team doesn’t want people talking or asking about Danny's Dream except to agree with them on everything. Why are they in such a mad rush to push it through without due diligence. We will be the ones paying for it and much as we love Danny like our ancestors loved Joey, he did sign this deal on his way out the door. Maybe he was tired and confused - thinking business instead of government at the time and there are some huge differences in principles there.

• IF NALCOR GOES AHEAD WITH THE MUSKRAT FALLS PROJECT IT WILL LOSE ALL CREDIBILITY
January 29, 2012 - 21:54

If NALCOR goes ahead with this Muskrat Falls Hydroelectric Project with all the inherent risks involved, it will lose all crediblity.

• DD
January 30, 2012 - 12:40

Where did you get the idea they ever had any credibility in the first place.

• Cyril Rogers
January 29, 2012 - 16:07

Ms Dunderdale's spurious attack on The Telegram has hopefully woken them up but, unfortunately, the government does a lot of business with newspapers and we don't have too many options in St. John's. I found Mr. Wangersky's article to be most refreshing and I hope the bullying tactics of the government will not get in the way of the truth. The Telegram owes the people of this province the unvarnished truth and I trust journalists will start to become ever more diligent in their search for the truth and full disclosure on these kinds of mega-projects.

• Denise Hennebury
January 30, 2012 - 08:56

Well said Russell ... and Cyril. We need this kind of research and reporting to keep the public informed on all sides of the issue. We all have our everyday work to do (and don't all have the time available to dig as deep as we might like), thank goodness that some people's everyday work helps to keep us asking questions!

• gerry martin
January 28, 2012 - 22:07

Here is a far out connection as the business case for MF looks weaker by the day. The \$5B Dannylands subdivision complete with new hospital, is locked at the hip with the Muskrat Falls project. Without a government fueled mega-make-work project pumping dumb money into a bad project for several years after peak oil, there won't be anyone to buy homes in Dannyland. All the lieutenants who were appointed by DW, are sworn to make this happen. All the rest of us are doomed to pay for it.

• ed power
January 28, 2012 - 18:57

• stan
January 28, 2012 - 18:23

So many irrelevant "points" in this article and obviously trying to confuse people. Completely obvious the writer has a beef with the government and is trying to confuse the issue because he knows he can't show Muskrat Falls isn't the best option. It's a shameful tactic to purposefully try to confuse the public. He talks about "export" markets drying up, yet Muskrat Falls and the numbers are based on the island's needs, anything else is gravy. He talks about potential cost overruns, but forgets to say all projects have the same potential for overruns, and that MF is the cheapest. Hard to ever take this writer seriously. Really looking forward to another article on how the auditor general's report could potentially mean there are "slush funds" that we don't know about. Shame. Shame. Shame. Shame. Please just write about seagulls.

January 28, 2012 - 16:48

FACT: In 2010 Holyrood provided 803 GWh of energy to island customers (about 10% of our total demand).++++ FACT: That equates to only about 26% of Holyroods 'firm' capacity. ++++++ FACT: Even during the worst winter months (Jan, Feb, March) over the last 8 years Holyrood needed to operate at an average of only 50% of its capacity --- even during the winter. +++++ FACT: Over the last 6 years, that winter average usage for Holyrood went down to 44%. ++++ FACT: Over the last 10 years the average oil cost per KWh of energy produced by Holyrood was 7.5 cents/KWh. +++++ FACT: Nalcor just reported that the actual cost per KWh of energy generated at Muskrat Falls will be 21.4 cents/KWh (and that seems to exclude transmission costs --- add another 7 cents/KWh). FACT: This summer/fall alone Nalcor spilled 694 GWh of energy from its existing island hydro sites --- enough to satisfy Vale's demand for a year and Nalcor says they expect to keep spilling until Vale comes on stream to use up our EXISTING 'EXCESS' CAPACITY. +++++ FACT: That 694 GWh alone is enough to meet our ACTUAL 20 average increase in demand for ----- and wait for this ---- 91 years. AND ON AND ON AND ON IT GOES. But that should do for now.

• HarbourMaster
January 28, 2012 - 16:24

Excellent article Russell obviously you have done a great deal of research and have pointed out significant pitfalls in the Muskrat Falls proposal. My only fear is that we currently have a very weak governing party who seem to be followers and not leaders. In this case they are the followers of NALCOR who have their own bigger is better agenda. It is obvious that NALCOR has told Ms. Dunderdale that they do not want the PUB to complete a detailed review for fear that they will uncover cheaper alternatives and discrepancies in NALCORs economics.

• Steve
January 28, 2012 - 15:17

The whole problem with Muskrat Falls is the cost of the transmission system. Pursuing this ridiculous idea of sending energy to the US for profit will bankrupt this province. The costs of the transmission system are simply too high for it to ever be profitable. If it goes ahead, this project should be about guaranteeing the future energy supply for Labrador, and a separate project should be completed to provide power for the island. Speaking of which.... http://nalcor.ca/assets/infocentre_infosheets_meetingloadonanisolatedislandsystemapril18final.pdf Has anyone else read this 'misinformation sheet'? I wonder why nuclear was never considered as an alternate supply. One Candu ACR-1000 would cost less than their alternative expansion projects and provide even more electricity for domestic consumption. Actually, why not just let the water keep on running instead of backflooding several thousand square kms of forest for this dam, and build two reactors instead? Makes too much sense I suppose. Hydro, this so called 'green' renewable source of power, is far from green!!! BTW, one of the largest proven reserves of uranium in the world is in Labrador. In terms of electrical energy, our province would be self sufficient for centuries, and the mines would provide a similar amount of employment. These idiots running our government are selling us down the river, both literally and figuratively. May God help us if Muskrat goes ahead in its current form.

• William Daniels
January 28, 2012 - 14:34

I finally agree with John Smith. We need to shelve this project. Now.

• Concerned Citizen and Consumer
January 28, 2012 - 12:45

An exceptionally clear and informative Editorial. Many thanks for contributing so usefully to the public dialogue on the Muskrat Falls project.

• Sheldon
January 28, 2012 - 11:17

Andddd.... cue somebody using the name "John Smith" to appear and rebuke Russell, and the column, and the paper. And don't forget to tell him he has an agenda, or he's a liberal, or he's stupid, or both. This project is a great project, Dr. Locke, Nalcor, Navigant, provincial government, blahh blahh blahh.

• Cyril Rogers
January 28, 2012 - 10:40

Mr. Wangersky, you have finally done what most of the media has been avoiding....some investigative journalism. These are the kinds of concerns and questions that NALCOR and the government have avoided like the proverbial plague. Your comparison to the Manitoba Hydro scenario sends us ominous warnings about the pitfalls of going ahead with this project but it is obvious that the government and NALCOR will never accept the truth, unless external forces defeat them. They are determined to go ahead with their propaganda game and use arrogance and misleading data to try and convince people that those who object to the project are wrong. We are not wrong but they persist!! Why? Why? There is no imminent crisis and likely will not be one, if they develop smaller projects in a timely manner and encourage a smarter use of electricity. Keep up the good work and keep generating facts in the face of government propaganda!

• John Smith
January 28, 2012 - 09:30

Well, Russell thanks for that scary story. I guess we should shelve the project right now. However, I think you forgot a couple of things in your attempt at spin. Out of the 506,000 or so of us that live in this province, about 480,000 of us live on an island. An island with an isolated grid. An island that gets power from a oil burning, polluting antiquated plant, an island that will be at a power deficit by 2020. So inorder to make the deal work, we have to spread some initial cost out? That is quite nomal in this type of deal, so I've read. The thing is, what is the lowest cost option for us? Not Manitoba. You see Russell, Manitoba is on the mainland, they are not on an isolated island grid. They can buy and sell power on the spot market with ease. We cannot. We have to worry that our oil fired Jenny in holyrood keep huffin and puffin..as we crank up the electric heat. So Russell I say to yopu and the naysayers...what's the alternative? Let's hear the dream about cheap wind, and importing LNG again. LOL Give me a break.

• Eli
January 28, 2012 - 15:26

John, I'd like to have your medication although I'd be disturbed if I neglected to take it as often as you seem to do. But do your best and keep Russell's figure of 28.4 cents a kilowatt hour in mind. It will put me and a lot of seniors on the friggin' street if it becomes reality.

• Willi Makit
January 28, 2012 - 22:59

The alternative? Ummm, if you're really keen on an interlinked solution, link the systems, and find another source for the power. The bulk would be supplied through recall or (gasp!) purchased power from Quebec, and save the difference. Using 21.4 cents COS for Muskrat Falls Power, it makes economic sense, and all 100% as green as Muskrat Falls. When the Churchill Falls contract expires in '41, 100% of our needs could be met through sources that we would then own. Worst case we pay HQ spot price in the interim, and if you want to motivate people in NL to conserve, that’s a sure fire way of doing it. Any necessary purchases could be further reduced by augmenting the Island grid with alternative sources which would provide the additional benefit of a more fault tolerant grid. Following that approach, there’s a much lower cost risk and no selling an ownership stake in the Belle Isle link to Emera. We lose the dam part of the make work project but at a time when there's a skilled trade shortage and huge cost overruns on mega-projects are the norm, well worth it. Look no further than the \$100 million worth of Hebron work we just lost or Vale's experience for the real world (aka the private sector) as proof of that.