Muskrat Falls: Why We Need a Regulatory Review – Part Two

Ron Penney and David Vardy examine the risks associated with the planned Muskrat Falls hydroelectric mega-project in Atlantic Canada.
Published on January 17, 2013

Part Two

Viability of the project

Taxpayers need to know if the Muskrat Falls project is viable and whether it would be financeable without a federal loan guarantee. The term sheet for the loan guarantee (section 3.5 A (i) calls for “indicative credit ratings” confirmed by credit rating agencies on a “non-guaranteed basis”. We also need to know whether our rates will continue to be competitive with the rest of North America. Evidence (e. g., see CE 64 R1Public) filed with the PUB showed that the project could not cover the interest on debt in the early years without a large up-front infusion of taxpayers’ money. The project cannot stand up to normal “cost of service rate setting” evaluation but instead rests upon a new rate setting paradigm which is untested in this jurisdiction and which has not been readily adopted in other jurisdictions. Nalcor has admitted that the rates would be very high if standard cost of service rules were followed and would cause “rate shock”. The term of the guarantee, for Muskrat Falls and Labrador Transmission Assets (the lines between Muskrat Falls and Churchill Falls) will be 35 years (section 3.2 (i)), and not the 50 years used in the DG2 estimates. Will this mean higher rates than originally planned?

Under normal cost of service accounting the generation component of the wholesale electricity rate in the first year would more than double, from 9.2 (using Power Purchase Rate methodology) cents to 21.4 cents per kilowatt hour (see PUB-Nalcor-46 and CA-KPL-Nalcor 27, rev. 1). Adding the 21.4 cents to the transmission cost of 14.7 cents brings the 2017 wholesale rate to 36.1 cents per kilowatt hour. Nalcor therefore made the decision to transfer more of the costs to future generations than it would under traditional cost of service accounting. The questions remain: is this project financially viable? Is it really the lowest cost alternative? Is the enormous risk worth it? Will we our rates be excessive compared with those paid by other North American ratepayers?

The claim is made that this project is unlike the building of a hospital or road and that it will stand on its own merit, generating its own revenues and creating an extremely valuable asset and that it will not detract from the capacity of the province to make other financial commitments. Such a claim ignores the likelihood that demand for power may not increase as projected and the valuable asset may end up as a white elephant, producing power that will have to be sold below cost, due to changes in energy markets. We are a small province, without a diversified economy. We are dependent on commodity prices and highly vulnerable to global fluctuations, as we have recently learned with the decline of oil and mineral royalties and their adverse effect on our financial position. The fact of the matter is that the disposable income of our citizens is finite and so is the potential to raise taxes, or to finance a large energy megaproject on the backs of ratepayers, who are one and the same as taxpayers. The uncomfortable truth is that, if Muskrat Falls is sanctioned, its financial burden will impose real limits on funds available for health care (e.g., the long delayed Corner Brook hospital), education, transportation and other public services.

This project will make ratepayers reliant on power from a remote location and on 1100 km of new high voltage direct current (HVDC) transmission lines, including a subsea crossing, through inaccessible terrain and subject to extreme weather conditions. Holyrood, on the other hand, is located close to the major population centre. The first MHI report noted the need for a higher transmission line construction standard than Nalcor had proposed, a standard where the likelihood of power disruption was once in 150 years, rather than once in 50 years, as had been proposed by Nalcor. In higher elevations MHI proposed a standard of once in 500 years. The MHI report of October 2012 says “Outage periods up to one month or greater in remote locations are possible.” We need to know how reliable our power will be after Holyrood is decommissioned. We still don’t know if the reliability standards recommended in the first MHI report have been accepted by Nalcor.

Nalcor has touted the advantage of access to emergency power from Nova Scotia. Emera has almost two years to decide whether to participate in the Muskrat Falls project. What will happen if they decide not to participate?

Is there any compelling need for this project, in light of the fact that overall electricity demand has remained level over the past 20 years? The new load growth projections call for the total island peak to increase by 21 MW per year over the next 20 years. While there has been an increase in household electricity use, industrial demand has declined significantly, largely because of the loss of two pulp and paper mills and the availability to the Island grid of electrical energy previously used in the paper industry.

The evidence is that household electricity use is likely to decline in the long run, due to reduced substitution of electricity for other energy sources and to the long term demographic trends of fewer people in the age groups related to household formation with more people in the older age groups who are interested in downsizing and moving to more compact spaces. It is also the case that electricity use per household in Canada and in the United States has been declining (Natural Resources Canada, Office of Energy Efficiency, Residential Sector, Energy Use Analysis 1990 to 2009, 2011, and US Energy Information Administration: Annual Energy Outlook, with projections to 2035, June 2012). It is not clear to us why this trend should be different in NL. There is no energy crisis and no galloping energy demand. Nor is Muskrat Falls appropriately sized to meet the modest increase in energy demand projected. Why would we not build capacity on an incremental basis to match demand rather than overbuilding with this high risk megaproject?

Why has Nalcor not taken conservation and energy efficiency more seriously? Other jurisdictions are aggressively moving to restrain domestic demand, including Nova Scotia. Why are we not promoting more efficient forms of space heating such as geothermal and ambient air heat pumps, rather than subsidizing the use of electric heat by pricing it below the cost of production? Why are we not responding with new energy policy initiatives to the fact that 85% of new homes are installing inefficient electric space heating?

Why has Churchill Falls not been part of the analysis? The 2007 Energy Plan correctly pivots around 2041 when the infamous power contract comes to an end and Upper Churchill Power becomes available. The Government has recently raised Quebec’s minority interest in CFLCO as inhibiting our ability to access Upper Churchill power in 2041. That argument is wrong. One thing we know for certain is that we will have the right, once the contract comes to an end, to take full control of the water rights, the power plant, the reservoirs and the transmission lines within our Province, ensuring that the Quebec minority interest is extinguished. That is why our energy policy should be based on taking the steps necessary to allow us to take advantage of that fact rather than undertaking a massive and extremely risky mega-project which has the potential to bankrupt the Province.

Why is government perpetuating the fallacy that Muskrat Falls, with its two costly sub-marine crossings, and its Maritime Link with the Nova Scotia, represents a solution to the impasse with Quebec? The transmission lines, towers and sub-sea cables have limited redundancy. They are not large enough for Gull Island power or recaptured energy from Churchill Falls in 2041. Nalcor itself admits that the export of Gull Island power requires access to transmission lines through Quebec to achieve minimum transmission cost to markets in the US and the rest of Canada. By building Muskrat Falls we are substituting high cost energy for the lower cost energy that will be available to us from Churchill Falls and burdening future generations with this high cost.

Why is government ignoring the fundamental changes that have taken place in the North American electrical energy market? Questions dealing with energy markets have been answered by Nalcor with information dealing with short term markets and spot prices. Spot prices will not recover the full cost of Muskrat Falls power. We need medium to long term markets and these are not available because of the shale gas revolution and the conversion of coal and oil fired thermal electric plants to the use of natural gas feedstock, at a cost below that of Muskrat Falls power. Why are we unwilling to recognize this and to consider seriously the potential of natural gas for the conversion of the Holyrood plant?

The spectre of rising oil prices is one of the major drivers for Muskrat Falls. There have been a series of recent studies and articles which argue that the global oil market is not as supply constrained as had been assumed. A recent study from the Harvard Kennedy School by Leonardo Maugeri (Oil: The Next Revolution, Discussion Paper 2012-10, Belfer Center for Science and International Affairs, Harvard Kennedy School, June 2012, page 6) concludes that:

Oil is not in short supply. From a purely physical point of view, there are huge volumes of conventional and unconventional oils still to be developed, with no “peak-oil” in sight. The real problems concerning future oil production are above the surface, not beneath it, and relate to political decisions and geopolitical instability. …

The shale/tight oil boom in the United States is not a temporary bubble, but the most important revolution in the oil sector in decades. It will probably trigger worldwide emulation over the next decades that might bear surprising results – given the fact that most shale/tight oil resources in the world are still unknown and untapped. What’s more, the application of shale extraction key-technologies (horizontal drilling and hydraulic fracturing) to conventional oilfield could dramatically increase world’s oil production.

These emerging developments in the world energy market suggest the wisdom of an incremental approach to meeting our energy needs until 2041, as compared with the commitment to a major megaproject whose viability is dependent on escalating world oil prices. Muskrat Falls is a large megaproject in relationship to the small population and fragile, resource-based economy of Newfoundland and Labrador, one which imposes significant risk. An energy strategy which emphasizes conservation and energy efficiency, combined with smaller projects built on an incremental basis, as needed, will reduce financial risk to the province. Just as the Federal Government has pushed the reset button on the F-35 purchase our Government needs to do the same on Muskrat Falls. Let’s take advantage of time provided by the Nova Scotia regulatory review and bring Muskrat Falls back to our own Public Utilities Board. It’s not too late to do the right thing.


Ron Penney, former Deputy Minister of Justice, Government of Newfoundland and Labrador, and former City Manager, City of St. John’s; and


David Vardy, former Clerk of the Executive Council and Chair of the Public Utilities Board, Government of Newfoundland and Labrador.

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