28 February 2012

Danny and Jerome! on Muskrat Falls financials #nlpoli

Former member of the House of Assembly and Newfoundland and Labrador Hydro director Danny Dumaresque made the news over the weekend with a claim that he had a document showing that the provincial energy corporation had no luck raising $4 billion in the money markets.

On Monday natural resources minister shot back with the claim that  - according to VOCM - that the document Dumaresque had was a hypothetical situation drawn up by Nalcor itself.  VOCM also reported:

Kennedy says the project has been well received and he doesn't anticipate problems with funding.

He said.

He said.

Sort of.

What Dumaresque was referring to, most likely, was information that is also contained in an answer Nalcor provided to the public utilities board last week. Unless Dumaresque’s got something else,   this is really just part of the analysis of options that Nalcor ran.

At the same time, it isn;t something that you can just blow off with the Chip Diller assurance that everything is just fine.   As you’ll see below,  there’s a lot more in this particular bit of information than might meet the eye.

Here’s the entire document filed with the PUB with some notes and comments in between to help you understand what it is all about.

Consumer Question: In the reply to PUB-Nalcor-1 46 regarding a cost of service (COS) price for Muskrat Falls power in year 1, Nalcor states that an internal rate of return (IRR) of 8.4% was used "On this basis the cost of service in year 1 would be $214/MWh".

“Cost of service” is the usual way that the utilities board prices electricity.  As the province’s natural resources department website puts it:

Legislation directs the PUB to use cost of service methodology to derive rates, allowing an appropriate rate of return on a rate base of allowed costs. The PUB determines the allowed rate of return according to financial market conditions.

$214 per megawatt hour translates to – take a breath – 21.4 cents per kilowatt hour.  Go get your ‘lecky bill if you need to see that you are paying about half that rate right now for what you get.  When you stop hyperventilating, read on.  The question continues:

(a) Is the cost of the TL [transmission line] from Labrador included in the $214 /MWH?

(b) If so, provide a breakdown of the $214 /MWh cost between the Muskrat Falls site and the TL.

(c) Provide the in service capital costs (separately for the Muskrat Falls site and for the TL) used to calculate the COS $214 MWh year 1 price.

(d) Please provide a breakdown on debt/equity ratios/interest rates/return on equity used for the $214 MWh cost (separately for Muskrat Falls site and TL).

(e) Instead of using the 8.4% IRR, can Nalcor provide the COS Muskrat Falls power price in year 1 (for the Muskrat Falls site plus TL) using the same assumptions as used for TL COS pricing regarding debt/equity ratios same interest rate for debt and the same return on equity)?

Now comes the answer:

A. (a) The cost of the Labrador Island Transmission Link is not included in $214 /MWh provided in response to PUB-Nalcor-46. The cost of service price in year 1 of
operations is based on an 8.4% return on equity coupled with the sales profile for the Island to be comparable to  Nalcor’s alternative pricing model for Muskrat Falls of $ 76 /MWh ($2010, escalating at 2% annually).

(b) Please refer to Nalcor’s response to (a) above.

So right away, Nalcor confirms that the 21.4 cents per kilowatt hour they have already given as the cost of service pricing does not include transmission.

(c) The in-service capital cost for Muskrat Falls assuming an AFUDC rate of 8.4% is $3.6 billion. 

This part is a bit technical but here’s what it says.  If you use a method called “allowance for funds used during construction” or AFUDC then the cost of the dam at Muskrat Falls is $3.6 billion.

(d) The key financial parameters used in the calculation of the alternative cost of service for Muskrat Falls were 100% and an 8.4 % return on equity in order to maintain comparability with Nalcor’s pricing approach and model.

Maybe that’s clear to super-duper insiders but when they asked for a group of ratios, Nalcor gave them two.  The 8.4% is clearly identified as the return on equity or profit. 

But what’s the 100%?  Good question.

(e) In an escalating supply price analysis framework, leverage of 75% debt is not financeable because the initial low sales volumes and associated revenues would result in inadequate debt service coverage as required in capital markets. During the first 6 years of commercial operations there was insufficient cash flow for debt servicing as the debt service coverage ratio was below 1.0. For years 7 through 12, the debt service coverage ratio was below the minimum threshold of 1.4 times recommended by Nalcor’s financial advisors.

Here’s the fun bit.

This paragraph tells you that Nalcor’s analysts ran a scenario in which they borrowed 75% of the money they would need.  They also included – apparently – an entirely new pricing scheme for Muskrat Falls that would see Nalcor pass on to consumers only one third of the actual cost of producing electricity and shipping it to them.  Those costs would have to be made up somewhere else, even if they weren’t coming directly from residents of the province as ratepayers.

That’s why they keep talking about an “alternative” pricing scheme.  Presumably they’d have to change legislation to get this in place but that’s really just the tip of the very big financial iceberg that neither Nalcor or the provincial government will discuss publicly.

In any event, when Nalcor and its advisors ran the scenario using the projected sales in Newfoundland only, Nalcor could not make enough money in the province to service the debt for the first six years after construction. 

For the second six years they made a bit more but not enough to hit the minimum recommended by Nalcor’s analysts.

Another thing to note here is that  we’ve been assured all along that this project made financial sense and that it would produce a “revenue stream” that would the project.

Yeah well, that didn’t turn out to be true.  For one thing, there are no export sales for any of this power.  The project is supposed to come entirely from provincial sources. And as this analysis shows, Nalcor couldn’t make the thing fly – even hypothetically on paper – using some favourable assumptions and a pricing scheme that was designed to make the project work.

- srbp -

2 comments:

rod said...

I listened to both sides in the media yesterday and was wondering where the truth was in all of this.

Where is the federal loan guarantee?
I'd be interested to hear their analysis of the plan. Their promise was to provide a loan guarantee, or the financial equivalent if the deal made sense.

In any event, when you borrow money for a high risk venture, the interest rates are pretty high.

Dave Adey said...

I'm a bit confused about this. Danny D said he found a document that stated MF was not financeable. Jim Morgan also talked about it on Open Line. However, Jerome Kennedy says it's not so and Ed Martin goes on open line and says it was just a question that was asked by the PUB and they gave a response. Am I right so far?

It seems a little weird that this fooled some people into believing it was real. Why ask a question like that without trying to finding a set of numbers that would work. How can Nalcor answer a question about what the banking world will do, maybe they already tried it?

I just find it strange that anyone would put up something like that for the public to see without explaining that it was not a real situation that actually happened.