Conversation with David Vardy

Canada, Crown Corporations, David Vardy, Energy, Interview, Uncategorized

David Vardy holds degrees in Economics from Memorial University, the University of Toronto and Princeton University. He was a member of the economics faculty at Queen’s University before returning to Newfoundland and Labrador to serve as a senior public servant for close to 30 years. He held numerous senior executive positions including President of the Institute of Fisheries and Marine Technology, Chair of the Public Utilities Board and Secretary to Cabinet.  He has received a number of awards in recognition of his public service leadership, including an Honorary Doctorate from Memorial University.  He was interviewed after his Frontier luncheon speech in Winnipeg on April 30, 2014.

Frontier Centre: Can you briefly describe the Muskrat Falls project?

David Vardy: The Muskrat Falls project is a relatively large hydro-electric project. It is enough to keep the province in electricity for the next 35 years but in the initial period its capacity is in excess what we need so we must find markets for some of the surplus power. It’s a project located in Labrador. It’s 1400 km from the population center. So when we talking about the Muskrat Falls project what we are really talking about is the generation project on the Lower Churchill River, which is the 824 megawatt plant projected to cost 3.6 billion dollars and we are also talking about the DC transmission line to the Avalon Peninsula which is estimated to cost 2.6 billion dollars. So that’s the Muskrat Falls project. It’s a combination of generation and transmission. When we speak about the Muskrat Falls project we’re also talking about a third component. The third component is the Maritime link. The Maritime link is the link between the island and Cape Breton Island estimated to cost 1.8 Billion dollars and it will carry 500 megawatts of power from the island, originating in Muskrat Falls, to markets in Nova Scotia.

FC: Do you see a broad similarity between the hydro expansion projects being undertaken or planned in Manitoba and those in Newfoundland?

DV: Yes I do because they are both in the north. They both require additional transmission capacity from north to south. They are both predicated to a large extent on the ability to export the power outside the province. They are both large projects and they are both projects where there is significant risk involved. Some of those risks are financial and other risks are related to energy economics. They both involve a large commitment of resources that will require future generations to repay large debt.

FC: You touched on the rationale behind some of these hydro projects which seems to be that hydro exports can subsidize local rate payers.

DV: That’s right.

FC: Has that happened historically and can we expect future expansions to subsidize Manitoba electricity?

DV: I think historically export revenue has helped to keep rates low in Manitoba. My sense is it has worked here for your benefit, for those in Manitoba. The export of power has been extremely beneficial in subsidizing and reducing local rates. I think it has worked like a charm in Quebec and in British Columbia. It has never worked to our advantage in Newfoundland because most of our exports have been from Churchill Falls and the revenues we get from those exports are very small but I think they have the potential to reduce power rates in Newfoundland and Labrador., Now whether  export prices will be as great in the future as in the past I think is very questionable because the whole market is clouded by what’s happening with the shale oil and gas which has changed the whole market place for electrical power quite fundamentally and likely has shifted the prices for electrical energy on the North American energy down to a level which makes these large hydro-electric projects of questionable  economic merit.

FC: How is the cost of future expansions compared to earlier projects because presumably the provinces undertook the easier paths to generate electricity first?

DV: That’s a good observation. Obviously you take the low hanging fruit first and those were the cheapest ones. Now we are into more expensive ones whose economics are more questionable. Now we have built some infrastructure in the north which is a big advantage to us. The thing about it is we have to be cautious. In the past when we built those big projects it was during a time when you had quite significant growth. The world economy was growing and population was growing. Now we have a big demographic shift. You have a lot more older people and you have less family formation. So I think we have to be much more cautious about these projects. The big temptation that’s lurking behind the bushes is that we’re living in an era of unprecedented low interest rates. So I think that’s tempting governments to commit to large energy projects. It’s tempting people to say we’ve got to go and do these projects while the going is good, while we can get access to this money. Because historically of course, most of those big projects were financed with 6, 7, 8 percent debt. Now we’re looking at 3, 4, 5 percent and that’s pretty tempting. With the federal loan guarantee Nalcor Energy has borrowed $5 B at a blended interest rate of 3.8%.

FC: Do you expect the two governments to face potential financial challenges from these two projects?

DV: Unfortunately I do because I think they are in a very vulnerable position, their debts are very high. I think that any overruns, any major changes, and you can’t predict the overruns they could be catastrophic. So I think that governments are putting themselves in a very vulnerable position. You know it might well be that you do the analysis and you come up with a least cost option taking a 70-80 year time span which is the span they took here. Or in Newfoundland they took 50 years but the thing about it is, the longer time span you take, the more chance there is that the projections on which these decisions are based will be completely preposterous. There is a certain merit in making decisions that give you the maximum flexibility so that you can respond to changes in the external environment. I think by committing ourselves to these projects you put yourself in a box, you reduce your flexibility, your policy flexibility because you’re stuck with these projects. You cannot retreat.  You cannot make adjustments. I’d rather make a number of small mistakes than one big one that will place an albatross around the necks of future generations.

FC: Related to that, during your talk you mentioned the fact that the elasticity of demand for electricity is greater in the long run so could you just unpack that a little bit?

DV: Yes, I looked at some of the literature on this and elasticity of demand is higher in the long run than over the short term. The cutoff point for elasticity is 1. If something is highly elastic it is more than 1 which means that if you have a 1 percent increase in price that leads to a more than one percent reduction in demand. In this particular case the elasticity measures I’ve seen, are around 0.5 which tells us that if you get a 4 percent increase in price, which is what we are going to be seeing in both Manitoba and in NL, then that going to lead to a 2 percent reduction in demand. Now the Manitoba Hydro load forecast was 1.6 percent for the next 30 years. They revised their estimates for _future load growth_____. They revised it down from 1.6 to 1.5. So if they’re 1.5 and you are going to have an increase in the price of 4 percent then if demand elasticity is 0.5 than that means you are going to get a 2 percent reduction in demand. A 4 percent increase in price, 2 percent reduction in demand. You follow me?

FC: And they are saying they are going to have an increase in demand.

DV: Right. So if they were working on more than 2 percent increase in demand then assuming that elasticity number is correct than there would be some marginal growth in demand. Now if these numbers are correct, namely 1.5 and the elasticity of 0.5, than instead of getting a positive increase, it will be a negative one.

FC: So in that respect, it almost seems like we don’t need the electricity.

DV: Exactly.

FC: What are the biggest challenges presented by hydro expansions from a regulatory perspective?

DV: From a regulatory perspective one of the biggest challenges are to figure out what are the least cost alternatives and to really focus on those least cost alternatives so that you are not wasting your time on things that are not of material interest. You must ensure you have good information and share that information with the public. The PUB must have access to studies conducted into alternatives and load-growth. I guess the biggest challenge is to ensure that the PUB have access to the relevant information and are influenced only by the information that appears before them. There should be deference to the PUB as a quasi-judicial board. Deference to the rule of law basically means that the commissioners are fully independent and are only going to consider what is presented before them. They are not going to be influenced by extraneous political influences. They have to be able to separate themselves from the politics so that they are not giving their seal of approval because the premier wants it or the government wants it. That’s a big challenge for a regulatory board, to be purely, absolutely driven by the evidence and fully independent.

FC: How would you say Manitoba does on that front? Is our oversight adequate? Do we have adequate independence from the regulatory perspective?

DV: You know something; I have not done a comprehensive review of all of the regulatory boards in Canada. I used to meet with those guys every year because we had a fraternity called the Canadian Association of Members of public Utility Tribunals (CAMPUT) and we would meet once or twice a year and talk about legislative and regulatory  changes. The problems we’re having in Newfoundland and Manitoba dealing with crown corporations are similar to those in other provinces where these crown corporations are more powerful than the boards that regulate them. . Based on  the evidence I’ve seen, Nova Scotia seems to be a good model. One of the reasons why the Nova Scotia regulatory model is working so well is because they are dealing with an investor utility, Emera Energy and its subsidiary, Nova Scotia Power. Not a Crown Corporation. So they are closer to the American model. I’m not out there extolling the American Model but I think Nova Scotia are closer to the American Model in the sense that in the States, generally speaking, the utilities are investor owned, as they are in Nova Scotia. Nova Scotia has set up the Utilities and Review Board to deal with investor owned utilities and they do it well.
I know when I was chairman of the PUB we had a consumer advocate who was appointed by government, not by the PUB as is the case in Nova Scotia. Most of my hearings dealt with the investor owned company Newfoundland Power, a wholly owned subsidiary of a publicly traded company, Fortis Inc. The consumer advocate was appointed by government and he was energetic. He would cross examine the utility and ask the tough questions. When the Consumer Advocate is engaged in a rate application from the crown corporation he has to ask himself how tough he can be without placing his future appointments to this role in jeopardy. He might say to himself, my  appointment as consumer advocate expires next year and if I’m too rough on the government’s crown corporation I may not be reappointed, so I’m going to  pull my punches.

FC: You mentioned the difference between the private companies in the United States and the Public Utilities in Canada and you kind of suggested it could be the case that the Public Utilities board is a little bit harder on the privately owned corporations because there is not that conflict of interest?

DV: I think that is true. That is very important. They tend to be harder on the investor owned than the crown corporations because they know that the government has a strong interest in those crown corporations. So I think governments have to put this conflict out on the table to avoid compromising the process to favor their Crown Corporation. The ideal regulatory process really is one where the government doesn’t make up its mind until it has heard from the PUB. If the impetus for a project comes from the government, then the government goes to the Crown Corporation, and the Crown Corporation validates the project and then it goes to the PUB knowing it has full support of government, in which case the decks are stacked against the PUB. If on the other hand the project emanates from the Crown Corporation presents it to the Public Utilities Board on its merits then the government has the evidence from the Public Utilities Board and the government has kept itself at arm’s length from the Crown Corporation. That’s the model we want to achieve. We want to have a model where the Crown Corporation is kept at arm’s length instead of having this symbiotic relationship with government, which tends to undermine the PUB review process. You know, for most Crown Corporations that’s the way it works; they operate at arm’s length from government.

FC: Basically what you are saying is that if the PUB is driving rather than the government of the day it’s going to be more neutral between the options?

DV: Yes.

FC: Do you get the sense that the respective hydro companies adequately consider the impact of these types of projects on low-income households?

DV: I don’t think they do. I really don’t think that is a part of their equation. It’s not really their mandate because they say that’s the mandate of the Department of Social Services.

FC: What is your advice to Manitobans going forward with these projects?

DV: My advice to Manitobans would be to be extremely vigilant and look for more information, always look for more information. Look for information to be placed in the public domain. The other side of this thing is Public Utilities boards have to be better at doing their jobs. PUB’s are secretive organizations. I’ll give you an example: I sent an email to the secretary of the board of our PUB and I had a list of questions. I said I was going to present in Winnipeg and I want to figure out what changes have happened in legislation with our PUB since I was there. I’m not asking to sit down with the commissioner, I’m asking to sit down with the staff and they basically came back and said no we don’t want to do that. That’s an old style mentality, we’re hands off, and we don’t talk to anybody. What they don’t do is they don’t try to improve access to information. You go into a PUB website and this is true for most of them and you say I want to find out stuff about demand side management. Well, yeah you’ll find a report on demand side management but part of the evidence that’s tabled is called requests for information or interrogatories. So every intervener, every registered person in the hearing has questions. So it will be “David Vardy, Intervener” with 100 questions and the public utility will come back with 100 answers and they won’t take the trouble to say well out of those 100 questions that David Vardy asked there was 20 under demand side management so why don’t we out those under a heading called demand side management so that Joe Blow who is trying to find out more about demand side management, he doesn’t; know what evidence is there because nobody organizes it. Now they have to do that for internal purposes but they don’t share it with the public. They are operating with the old mindset that everything is confidential, we don’t talk to anybody. We turn off the lights, nobody can see us.

FC: I suppose that that gets back to the old principle that if there’s too much information there’s no information, if it’s not well organized then people can’t comprehend it because there’s too much stuff out there.

DV: That’s one of the big problems that happened with us. We probably didn’t have the kind of informed media that you have here. So our main newspaper was doing a pretty good job. A few of us actually took time to attend a hearing and a few of us took time to read the hundreds and thousands of pieces of evidence that were filed and what we need to do is make it easier for the intelligent layman to get in there and read that stuff. Because if that person goes in there and sees this mountain of stuff and it’s not organized and they say “I can’t deal with that”. In terms of Manitoba, I think everybody has got to improve their performance, including the Public Utilities board. But I think that having people talk about the issues is really powerful because having people like Graham Lane and people like me, we are treated with a certain amount of deference. I’m not out running for political office, I’m not out supporting a candidate. I don’t go out badmouthing anybody. I try to keep it at a highly professional level. So when I say something that reacts with them, they’ll respond. They’ll respond in the sense that they won’t ignore me. If I’m out there saying this one particular document should be made public, then quite often something will happen and it will be released. This happened recently. We’re hammering away seeking access to the report of the “independent engineer” which was appointed by the federal government to do due diligence on the project and we argue that this report should be made public. I never thought it ever would because Nalcor’s position was this contains commercially sensitive information, it’s not going to be made public, go away. A couple of weeks ago, I was shocked, they released this thing. They redacted some stuff but I never expected this report to see the light of day. That’s the thing about this forum. Mobilize three or four Graham Lane’s and they won’t be ignored.

FC: Thank you for your time.