17 June 2008

Privatizing Hydro: a glance back

Introductory Note:

One of the more controversial proposals over the past 20 years was the privatization of Newfoundland and Labrador Hydro.

Much of the Hydro privatization story has passed into myth, much like the Churchill Falls story. Unfortunately for anyone interested in looking more closely at the idea of Hydro privatization today, some of the documents publicly available 15 years ago are no longer readily accessible.

Following is a text of an address delivered by Premier Clyde Wells to the St. John's Board of Trade in November 1993. It is the prepared text, not a transcript of the actual speech. It doesn't need much comment; the thing speaks for itself.

In order to produce this post, the original hard copy of this speech was scanned electronically. Please note that errors in spelling and so forth may remain, despite careful editing.

Next in this series will be the 1969 Churchill Falls contract. Given the documents length, it will take some time to scan and edit and the subsequent online versions will be broken down into smaller segments.

Government of Newfoundland and Labrador

Restructuring and Privatizing the Electrical Industry
of Newfoundland and Labrador

An Address by
The Honourable Clyde K. Wells
Premier of Newfoundland and Labrador
to the
St. John's Board of Trade
November 17, 1993
Check Against Delivery

I want at the outset to express my appreciation to the Board of Trade for giving me this opportunity to advise you and through you the people of the province of the government's position with respect to privatization of Newfoundland and Labrador Hydro.

Contrary to some suggestions you have been hearing this is not a proposal intended to benefit a particular company or group of people. This proposal is intended to benefit the province and its people both in their capacity as electrical ratepayers and in their capacity as taxpayers. It is also completely consistent with the overall economic vision and goals that the government is pursuing for Newfoundland and Labrador.

In June of 1992, after nearly two years of research and extensive consultation throughout every region of this province, government released its strategic plan entitled, Change and Challenge. At that time we stated that Change and Challenge is a living document for the Newfoundland and Labrador economy in the latter years of the 20th century and beyond the year 2000. To quote:
Our economic vision for Newfoundland and Labrador is that of an enterprising, educated, distinctive and prosperous people working together to create a competitive economy based on innovation, creativity, productivity and quality.
Two of our set of eight guiding principles for economic development are worthy of repeating today:

  1. The private sector must be the engine of growth. While it is a role of government to create an economic and social environment that promotes competitiveness, it is the enterprising spirit of the private sector that will stimulate lasting economic growth, and
  2. Government policies and actions must have a developmental focus where the client comes first. The structure of government must be streamlined, efficient and responsive to public need and to changes in the economy.
As well Action Item 31 of the Strategic Economic Plan specifically commits the government to "avoid providing services where they can be provided by the private sector".

The ultimate goal of privatization and restructuring is to improve the economy as a whole. There is hardly a country in the world today that does not have a major privatization plan in hand. These plans constitute a main pillar for the future economic strategy of most governments.

December 1992 Economic Statement by the Finance Minister

As part of his address to the House of Assembly on December 4, 1992, the Honourable Winston Baker, Minister of Finance, reviewed the state of the provincial economy and outlined a number of important decisions that the government was taking to deal with our financial and economic position.

One of the fundamental policy statements articulated by Mr. Baker at that time was government's decision to review the various operations, crown corporations and agencies of government and to pursue a privatization and restructuring program for those areas presently in the public sector that could be owned and operated by the private sector. That was also consistent with the government's often stated position that scarce and difficult to raise public funds should not be tied up providing commercial type services that the private sector is prepared to provide unless there is an overwhelming public policy reason for so doing.

Since the presentation of that economic statement, we have been pursuing the privatization of several government activities including the provincially owned Computer Services Corporation, certain assets of Newfoundland and Labrador Housing Corporation, Newfoundland Hardwoods and Newfoundland and Labrador Hydro. We are currently considering other possible restructuring and privatization opportunities.

One of these has attracted a significant amount of attention in the past few weeks. That one is Newfoundland and Labrador Hydro.

A little background might be helpful to a full understanding of the issues.

In 1989, Fortis, the parent company of Newfoundland Power, approached government with a view to purchasing certain select rural assets of Newfoundland and Labrador Hydro, mainly all the lower voltage transmission and distribution assets. Government, on the advice of Hydro and others, rejected the offer. Fortis, offering slightly different terms, pursued the matter again in 1992.

Government again asked Hydro for advice. The Board of Directors of Hydro initiated an assessment of the Fortis offer. The Board also decided to review at the same time various other alternative structures for the province's electrical industry.

Hydro retained ScotiaMacLeod and RBC Dominion Securities, two of Canada's largest and most respected investment dealers. These two companies have participated in billions of dollars of successful privatization and restructuring transactions in Canada and throughout the world. It is noteworthy that they were the lead advisors in the recent successful privatization of Nova Scotia Power. They have also been the senior fiscal advisors to Hydro and the province for over ten years.

The financial advisors recommended that Hydro and the government reject the Fortis offer because it did not represent fair price and payment terms for the assets in question and was not the best strategic alternative for the future structure of the electrical industry of Newfoundland and Labrador.

Hydro's Board of Directors and its advisors pursued the assessment further and ultimately advised the government that the status quo was obviously a viable option but if the government wished to privatize it could do so successfully either by privatizing Hydro on a stand-alone basis or by first merging with Fortis and/or Newfoundland Power and then selling its shares in the merged company. They did however advise that the combination with Fortis/Newfoundland Power was preferable to a stand-alone privatization, from the point of view of government, taxpayers and ratepayers, if the combination could be effected on acceptable terms.

Government reviewed the results of this process, but before proceeding decided to further consult with experienced electrical industry experts both within and outside the province. All affirmed that in the event of privatization, merger was the preferred course and nearly all recommended privatization as the best course for government to follow. Accordingly the government decided:
  1. To reject the offer from Fortis; and
  2. That it was in the best interest of the people of the province to pursue the restructuring and privatization of the industry by either merging Hydro and Fortis/Newfoundland Power, or by privatizing Hydro on a stand-alone basis.
Shortly after making this decision, the President of Hydro, the Minister of Mines & Energy, and I met with the Chairman of Fortis and the President of Newfoundland Power. At this meeting on August 30th, we asked them if they were interested in participating in an investigative process to determine whether the merger of the two Newfoundland electrical companies into a single integrated investor owned utility might be achievable and in the interest of all concerned.

I also advised the Fortis/Newfoundland Power representatives that if satisfactory progress towards a merger that would achieve government's stated objectives could not be accomplished in a reasonable period of time, then we would proceed to privatize Hydro on a stand-alone basis.

Overview of the Negotiation Principles and Current Status

It might be helpful to review some of the major principles and objectives that we established for these discussions, and to provide an overview of the major components that will be part of any merger with Fortis/Newfoundland Power, or the privatization of Hydro on its own.

Objectives Established

Before any discussions began with Fortis/Newfoundland Power, government established its set of overall objectives for any merger between Hydro and Fortis. In summary, these objectives are:
  1. To get the highest reasonable price possible for its hydro assets;
  2. The elimination of the guaranteed debt of Hydro from the Province's financial statements is to take place as soon as possible, and the government is to have no future financial responsibilities.
  3. To achieve the most efficient and effective provincial electrical industry.
  4. Either by restructuring the industry or privatizing on its own, government would intend to divest itself fully of its shareholdings in the electrical industry (except for its investments in Churchill Falls (Labrador) Corporation, the Lower Churchill Development Corporation and the Gull Island Power Corporation) as soon as practical, by way of a broad public offering of common shares in Newfoundland, the rest of Canada and possibly elsewhere.
  5. Discussions are to proceed in an appropriate and orderly manner and both parties are to observe confidentiality until an understanding in principle can be disclosed, or negotiations are discontinued. This is normal and necessary in a negotiation of this nature.
  6. The initial executive management team and the initial board of directors of the merged company would require input and approval of government.
  7. Ownership, voting and possibly other restrictions would apply to the shares of the new merged entity to ensure the electrical industry is widely held and not controlled by a small number of individuals or corporations, nor controlled by foreign investors.
  8. To ensure the restructured and privatized industry is well capitalized and credit worthy so that it will be able to finance the Province's future electrical requirements, and
  9. To achieve stable or improved revenues for the provincial treasury from the electrical industry.
  10. Within the context of these objectives to minimize the rate increases charged industrial, commercial and domestic customers in the immediate and longer terms.
A few days after the initial meeting with Fortis representatives, the Chairman of Fortis informed me that they were interested in participating in such discussions. Accordingly it was agreed to establish negotiating teams to start the discussions. It was also agreed that the public and Fortis shareholders should be made aware of what was occurring. This was done by a joint news release on October 1st. These discussions are now proceeding but they are still at a very preliminary stage.

Fortis has not yet agreed to fully meet the requirements of government, that I have just outlined, to ensure that what occurs is not a take over by Fortis but is genuinely a merger of the two corporations with the final structure reflecting the level of assets and strengths each of the two parties will bring to the merged company. Unless such requirements are met there will be no merger.

Major issues to be addressed

Recent public commentary has raised a variety of questions. Valid or not these questions should be addressed. I will do so by posing the questions that have been raised and providing government's answer.

Why is the proposed transaction a merger?
1. The only way to effectively eliminate the duplication that presently exists and would continue to exist if Hydro were simply privatized on a stand-alone basis would be a merger. All of the expert advice available to government recommends such a merger.

2. The newly merged company would be neither Fortis, nor Hydro, but a true combination of the people, assets and shareholdings of Hydro and Fortis.

3. The percentage of the new entity that is coming from the government's ownership of Hydro is the majority interest in the new company, and will then be sold to investors in Newfoundland and Labrador, throughout Canada and the world by a public share offering.
Why is Hydro and Government negotiating only with Fortis?
1. Newfoundland Power, a company wholly owned by Fortis, is the only other electrical utility in the province and it distributes electricity to 85 % of all electrical customers in the province. Any effort to restructure the industry in the province must include Fortis, and only Fortis.

2. The advisors and government are of the opinion that the most efficient operating structure for the electrical industry is to have a fully integrated operation for the generation, transmission and distribution of the product to the customer, and that can only be achieved by negotiating with Fortis.

3. We do not want control to be with another corporation outside the province and we do not want private interests, either within or outside the province, to buy Hydro. Therefore, it is not appropriate to seek bids for Hydro. The interests of the province will be best served if its electrical industry is a widely held public company that cannot be controlled by any group either within or outside the province and can raise the capital required for future growth of the industry.
Will the Government get fair value for its investment?
1. Most definitely, Hydro and government's financial advisors are among the best in the world. Their projections indicate a very attractive value can be achieved and that there will be a profit to the people of the province from the privatization of their investment in Hydro.

2. The government will not privatize Hydro, either in a merged entity or on a stand-alone basis, unless the value received is fair and is consistent with values other governments have received in similar privatizations.

3. The government will only agree to proceeding with a transaction with Fortis if the proceeds are at least equal to or greater than would be received by privatizing Hydro on a stand-alone basis.

4. Government will obtain an opinion from recognized investment bankers that the proposed transaction is fair to the taxpayers of the province. Without such an opinion there will be no merger.
How will the province's financial position be improved?
1. The guaranteed debt of Hydro represents approximately 18% of the total direct and indirect debt of the province. This will be significantly reduced immediately, and completely eliminated over the longer term. Hydro's current debt and equity today is approximately $1,250,000,000.

2. The province will receive a substantial amount of cash from the profitable sale of the securities that it will receive in the privatized company. This cash will be used to reduce the province's debt by lowering our future borrowing requirements, thus saving current account interest expense, which means avoiding tax increases and/or government program cuts that would otherwise occur.
Will this mean that there will be an increased outflow of capital from the province through payment of dividends?
I believe the answer is NO. More than 90% of Hydro's current interest payments are to institutions outside the province. While part of the debt will be converted to equity, dividend payments won't make us worse off. Thousands of Newfoundlanders and Labradorians will be encouraged to invest in the shares of the new entity, thus keeping more dividends in the province. In addition the retained profits in the new utility will be reinvested in new fixed assets within the province, no different than what occurs now. In total, more money will remain within the province.
Will this assist the province's credit rating?
1. The major U.S. credit rating agencies, Standard & Poors and Moody's visited with me and senior ministers and officials earlier this year. They were strongly supportive of government's plans to restructure and privatize various crown agencies including Newfoundland and Labrador Hydro, as well as our other financial management initiatives.

2. The province's total direct and indirect debt as a percent of gross provincial product is 61.5%, the highest in Canada. Financial institutions frequently emphasize this when commenting on the province's financial state or its credit rating. The elimination of the Hydro debt and the reduction of future debt and borrowing requirements from privatization can only be positive, and will result in improved creditworthiness.
What will be the government's on-going role in the electrical industry?
1. The new company will be totally subject to regulation by the Public Utilities Board in respect of all of its electrical utility activities.

2. Government will still be responsible for the regulatory policy regime of the electrical industry. We will be introducing a new Electrical Power Control Act that will ensure the people of Newfoundland and Labrador, and specifically the consumers, will continue to have an efficient, fair and reliable electrical industry.
3. The restructuring and privatizing of the industry will be governed by a Privatization Act which will outline the policies under which the new company will operate. This Act will cover major policy issues such as ownership rules, to ensure regulation and management of the industry remains within the province and not with other organizations in Canada or foreign countries.

4. The government will continue to control and be responsible for the development of future electrical development because it will retain ownership of Churchill Falls Labrador Corporation, The Lower Churchill Development Corporation, all other Labrador water rights, all undeveloped island water rights, and the policy direction for non-utility independent generators and alternate power sources.
Will electrical rates increase?
1. Rates in the future, as now, will only be set after hearings by the Public Utilities Board. Under any of the alternatives of the industry, including leaving things as they are today, rates will increase as costs increase.

2. Privatization, whether by merger or on a stand alone basis, will cause some additional rate increase beyond that which would otherwise occur in the first five years. That additional increase due solely to privatization should average about 1 % per year or less. Merger and privatization should result in lower rate increases beyond that five years.

3. Any rate increases must be considered in light of the benefits to the provincial treasury of privatization. Generally speaking the more the people as taxpayers get from the sale the more the same people as ratepayers will have to pay in the future. Government's objective will be to achieve the greatest fair return we can get while at the same striving to keep any increase at a minimum.
What will be the impact on the employees and the unions?
1. One of the objectives of the industry restructuring is to improve operating efficiencies. Merging two large utilities such as Hydro and Fortis/Newfoundland Power will result in the elimination of certain areas of duplication in management, administration, and maintenance. These will be identified and a fair and equitable program will be developed to accommodate early retirement, voluntary severance and position redundancies.

2. The Unions will be involved in the merger process if a transaction is agreed upon. So will the non union employees.

3. It is premature to speculate on numbers or specific areas of operating efficiencies that will result.
Concluding comments

On October 1st when we announced that we were beginning discussions with Fortis/Newfoundland Power, we stated that any transaction would have to meet three objectives:
1. To create a more efficient electrical industry.

2. To be fair to the current public shareholders of Fortis and Newfoundland Power and to the electrical utility ratepayers of the province, and

3. To maximize the proceeds of privatization of Newfoundland Hydro for the people of this province.
I hope my comments today have helped explain how we arrived at the strategic decision to begin a restructuring process for the electrical industry; that we are going about it in a careful and responsible way; and that the achievement of our objectives will be in the best interests of all the people of Newfoundland and Labrador.

The restructuring and privatizing of the electrical utility industry is not being done behind closed doors. I advised the people of the province as soon as the basis for negotiations was decided upon by both parties. We have considered many different alternatives; sought advice from the industry experts; and engaged highly respected and experienced financial advisors, before deciding to restructure and privatize the industry. We will keep the public and House of Assembly fully informed as discussion progress. In any event no such privatization can be completed without full debate and passage of the necessary legislation by the House of Assembly.

The government's stated policy is that we will privatize and restructure government operations, crown corporations and agencies where there is no overriding public policy purpose for government to remain as an owner. The electrical industry meets this policy criteria.

The province is being affected by the profound economic and financial forces which are impacting the economies of all countries of the world. These forces make it imperative that we make wise use of investment capital and that the electrical industry, and for that matter, all sectors of our economy, be operated in the most productive fashion possible. That is what we are seeking to achieve.

Thank you very much.