03 January 2011

Undisclosed risk: financing the Lower Churchill

“We had discussions about loan guarantee, and if they’ll do that, we think we could drive hydro rates down even lower and save millions.”
Finance minister Tom Marshall, December 2010
Ah yes, it is all so simple.

One little loan guarantee and everything is solved. 

Borrow billions and save millions.

The provincial government could issue bonds to cover the billions it will take to build Muskrat Falls.  No sweat.  Apparently, someone told Marshall the bonds would sell out in 15 minutes.  Well, at least that’s what Tom said in December.

Of course government-backed bonds would sell out in 15 minutes. Investors can’t lose.  Governments don’t evaporate in a cloud of financial pixie dust like companies do. Governments  - especially provincial governments inside big G-8 countries - always pay off. 

And that’s where Tom’s assessment starts to go off the rails:  disclosure.

What Tom Marshall didn’t say is what rate of interest he’d have to put on the bonds in order to attract investors.  That can be really important if the project runs into a major snag and costs start to skyrocket or if the provincial government winds up in a really tight financial spot in about 10 years or so from now. 
Those bond holders still have to be paid, no matter what.  And just as surely as governments don’t go bankrupt – well not very often anyways – bond holders can be a litigious bunch.  People like to ignore pesky details but if anyone wants to check, they’ll find that the people who sued over the Water Rights Reversion Act were not the Quebec government and Hydro-Quebec.

Sure that crowd joined in, but they weren’t the gang who brought suit in the first place. 


The bond-holders, people like Royal Trust Co.,  didn’t take too kindly to the little legislative scheme Brian Peckford’s administration cooked up to get rid of the 1969 Churchill Falls contract. 

They sued.

Guess what?

They won.

And they got all their money back from the original investment plus interest.

The same basic issue – the interest rate on loans  – is what Tom was talking about in that year-end interview with the Western Star.  The provincial government needs a loan guarantee from Ottawa in order to hold down the interest rate on the other money the provincial government (that’s you and me, by the by) will have to borrow in the form of bank loans.

By now you should be getting a pretty clear picture that the Lower Churchill is all about money. 

Always has been.

Even this scheme to build one small pair of dams and a crap-load of expensive transmission lines  will cost at least $6.5 billion by current estimates. Emera will pony up about $1.2 billion but that only covers a line from Newfoundland to Cape Breton.  The rest of it – about $5.0 billion worth, at least – is coming from taxpayers in Newfoundland and Labrador in one way or another.  They’ll be the ones carrying the debt around.

And just to put it in perspective, bear in mind that $5.0 billion is about half the provincial government’s current gross debt.

It is a lot of money.

And even if Tom can save a few millions through a  loan guarantee, he is still talking about increasing the public debt in this province by half again as much as it currently is.

Two things to bear in mind, at this point, as if the thought of that whopping increase in public debt isn’t enough to scare you senseless:

First, people who build these sorts of megaprojects have a nasty habit of underestimating costs and overestimating benefits. Regular readers of these e-scribbles will remember the book Megaprojects and risk.  That’s a study by three European academics into the chronic problems in public sector megaprojects.  They propose a solution, based on disclosure of risks, and we’ll get back to that in another post.  For now, just note that pesky problem of cost over-runs.

The current administration has a track record of managing public works projects that take years longer to build than originally estimated and that cost 50% to 70% and more beyond the original estimates.  If they cannot bring in a couple of health centres and an aquaculture building on time and on budget, there’s precious little chance they could sling up a bunch of lines and a couple of monstrous slabs of concrete for the price they say right now.

And lest you think your humble e-scribbler is still dipping into the eggnog, recall that when the current administration started talking about this project five or six years ago, one big dam at Gull Island and a smaller dam at Muskrat Falls plus a power line to St. John’s were supposed to cost about $3.5 billion.  No one really believed that because in 1998 the same project was supposed to cost about $10 billion.

In other words, the current version of this project is the only one they could build for almost twice the original estimate for the whole thing.  Even after hacking and chopping mercilessly they are still looking at less of a project for twice as much money.  Imagine what this teensy bit of work will cost if they actually go ahead with it!

Second, we already have a pretty good sense of the size of the financing problem.  In a 2006 article in the now-defunct Independent, Craig Westcott had a front page story based on a public lecture by Gil Bennett.  Some of you may know him as a vice-president at the provincial government’s energy company.  The title of the story tells it all:  “Growing Interest:  solving interest rate riddle critical to Lower Churchill project.”
Then came one of the toughest questions to answer, but one that is critical to the viability of the $6-billion to $9-billion project that Hydro is hoping to have on stream by 2015.
“The surprise for me tonight,” said one man, “was that this project, to get off the ground, is going to take as much as 10 years. Interest rates are starting to rise. Isn’t there a risk in taking this project so far out?” 
Bennett allowed there is. “I’m with you in that interest rates are going to be essential,” he admitted.
Westcott also quoted the late Cy Abery.  Between 1985 and 1991, Abery was the president and chief executive officer of Newfoundland and Labrador Hydro.
“If you had the right contract, it doesn’t matter,” says Cyril Abery. “You’d have to build into the contract that the price you’re agreeing to (sell the power for) is based on certain interest rates and you’d have to have a clause that if interest rates went up, the price gets adjusted. Otherwise you could get screwed. There has to be re-openers in there. If they do that, there‘s no problem. But if they don‘t do that, yes, it is a problem, especially since today interest rates are low and they‘re probably going to go up.”
Nalcor doesn’t have any such contract at this point. It just has the ratepayers in Newfoundland and Labrador.  it also doesn’t stand much chance of getting such a contract in the near future.

Westcott also spoke with Bill Wells who headed Hydro for about a decade beginning in the mid-1990s.
The problem is that while interest rates may be low now, nobody knows what they will be in 15 years time, if the project is even completed by then. Nobody even knows what they will be next year. And once the project is sanctioned, the developer will be borrowing money every year until it gets built. 

“You’re borrowing, borrowing, borrowing, spending, spending, spending (until 2015),” explains Wells. “Somebody’s got to lend you that and that interest cost during the period of construction, that just adds on to the principle because you’re not paying anything back. So at the end of the day you’ve got this lump sum of money that you owe and when you close out your financial agreement going forward for 30 years or 40 years financing, what you’re going to pay in interest is determined at that time, it’s not determined now. So interest rates in 2016, who knows? They may be up, they may be down. And one of the things is, who takes the risk on interest? That used to come up in previous negotiations. It‘s a critical factor.”
Who takes the risk? 

Good question and like a lot of other things about this latest Lower Churchill proposal it is one the provincial government doesn’t want to talk about.

Under the current plan the entire risk is borne by the ordinary people of Newfoundland and Labrador. They alone will be responsible for building the power plant. They assume all the risk. They must borrow the money and pay the interest rates – whatever they may be. 

They are also the only guaranteed customers for the power.  The gang in Nova Scotia get their chunk of power for free.  There might be some customers but thus far, the only ones guaranteed to pay are in Newfoundland and Labrador.

A federal loan guarantee doesn’t come for free either. It may lower the interest rates Nalcor or the provincial government will pay to the banks but the federal government will inevitably claim a fee for its own risk in providing the guarantee.  A loan guarantee is basically another form of investment and, like bonds and loans, it comes at a price.

As the old saying goes:  nothing comes for free.

And right next to that is another one:  it is never as easy as it looks.

- srbp -