20 July 2012

The Stuff We Don’t Know #nlpoli

Reports that say that something hasn't happened are always interesting to me, because as we know, there are known knowns: there are things we know we know.

We also know there are known unknowns; that is to say, we know there are some things we do not know. But there are also unknown unknowns: the ones we don't know we don't know.

And if one looks throughout the history of our country and other free countries, it is the latter category that tend to be the difficult ones.

Former defence secretary Donald Rumsfeld will likely be best remembered for the 30 seconds or so that it took those words to come out of his mouth during a media briefing on the lack of evidence linking Iraq to weapons of mass destruction.

As tortured as the words seem to be, Rumsfeld actually describes the fundamental problem that bedevils all of us who are trying to do anything. 

It is called uncertainty.

Uncertainty is also the last of the four factors Will Jennings discussed in his chapter on politics, risk and megaprojects that has been the jumping off point for the series

“These uncertainties are manifested,” Jennings wrote, “both internal to the project, such as in ‘scope creep’ in unplanned changes in technical specifications (which in turn can lead to costs higher than the original estimates), and in unanticipated exogenous shocks such as affecting domestic labour markets or global commodity prices. It is, therefore, also possible to link the under-estimation of project risks and the over-estimation of project benefits in the worlds of high politics and executive politics with biases that affect decision-making under conditions of complexity and uncertainty.”

At Ground Level

The stage-gate process Nalcor is using for Muskrat Falls is intended to take care of those uncertainties Jennings describes as “internal”. 

Design and engineering work at the front end of a project can figure out, for example, whether or not the original design of the dam will need to change because of the geology of the location.  Maybe the base will need to be wider and the sides longer. That would mean more materials which changes the cost but once the designers change the unknowns to knowns, they can plan to deal with them.  Potential problems for the project disappear.

Project creep has already added $1.6 billion to the 2010 project estimates.  Nalcor’s first costing was only for the dam and the two lines.  In another corner, Nalcor decision-makers came up with an extraordinary 50 year financing arrangement driven by the need to lower the apparent cost to consumers.  As Manitoba Hydro International subsequently noted for the public utilities board, that 50 year span meant Nalcor should have included the other generating capacity they’d need to meet forecast demand. That also added, incidentally, more thermal generation from oil than Nalcor current has at Holyrood!

Meanwhile, Up on the Lofty Heights

Those are all low-level tactical planning issues that are not necessarily going to stop the project.  As you climb higher up, the nature of the uncertainties changes.  By the time you get to the top of Mount Olympus, the gods at Nalcor and their political bosses can be dealing with some nasty uncertainties.  These are the kind of uncertainties that can either stop a project cold or drive the costs and timelines way off track.

Take those global commodity prices, for example. Nalcor and its political allies justify Muskrat Falls on the basis of oil prices. Muskrat Falls is the lowest cost way to meet future electricity needs, goes the argument, because the cost of oil will go up.  Oil is the only way producing electricity that they talk about other than using water running down a river.

Oil prices do go up.  They also go down. Over the course of the 50 year span Nalcor is using for Muskrat Falls, prices could go up and down all sorts of ways. But Nalcor’s planning for Muskrat Falls not only assumes oil prices will only go up, it assumes they will go up to record levels and stay there.

Sure enough, if oil goes to US$200, then Muskrat Falls is the cheaper way to go.  Consumer electricity rates won’t have to go up to pay for expensive oil.

But if oil prices don’t double from current levels within five years, as Nalcor predicts, then Muskrat Falls isn’t the way to go.  In fact, if Nalcor builds Muskrat Falls and oil prices don’t double, consumers will be forced to pay way more for electricity than they would need to.

Nalcor doesn’t have a contingency, incidentally, for low oil prices.  They don’t need to have one:  their whole scheme works solely because they have a monopoly and can force consumers to pay whatever it takes to cover the project.  That’s part of the interaction between high politics and executive politics with uncertainty that Jennings mentioned, by the way.  Nice for Nalcor.  Not so nice for consumers.

Uncertainty about commodity prices have hit Nalcor in another way already.  Around the same time that Nalcor and its political allies decided to build Muskrat Falls, shale gas started to change the American marketplace.  In their original plan, consumers in newfoundland and Labrador would be forced to pay for the entire project.  They’d also get some of the electricity during the winter months.  Another chunk of electricity would go to Nova Scotia.  The rest would go off to the United States or to other provinces in order to bring in some extra cash.

As it happened, shale gas turned out to be so plentiful and so cheap that electricity prices dropped through the floor. For the past year or so, electricity is wholesaling in the United States for 2.5 cents per kilowatt hour. That’s roughly one tenth the cost of Muskrat Falls power and its a price Muskrat Falls can’t match.  Not surprisingly, since January, Nalcor’s political allies have started talking about Labrador mines as a potential customer for Muskrat Falls.

They didn’t do that before, incidentally.  Back in November 2010, when Nalcor and its political allies gave the project their de facto sanction*, they talked about maybe using some electricity for “industrial development.”  In the coded political language of Newfoundland and Labrador, industrial development is not digging ore out of the ground.  It’s about making stuff. Like say, making aluminum.

One of the consequences of that shift in focus for Muskrat Falls is that the project cannot supply the miners’ needs.  Based on current estimates, Muskrat Falls can only produce about 570 megawatts on average.  It produces its greatest amount of electricity in May and June – when Newfoundland and Nova Scotia customers won’t need it – and produces its least amount of electricity in the middle of the winter when the island needs electricity the most. In order to meet the commitments from Muskrat Falls, as announced in 2010, Nalcor is going to have to find more electricity than the project makes.  And to meet the mining needs in Labrador, Nalcor will have to do something else on top of all that, again.

Whom the Gods Destroy

Had Nalcor conducted a systematic analysis of energy demands and possible sources of generation, they would likely have figured out early on that Muskrat Falls was not the sole answer to their needs and may not have been an answer at all.  Nalcor and its political allies apparently decided they would build Muskrat Falls and figure out what to do with its electricity later on.

A lack of critical, independent oversight and regulatory control, a lack of competition, and a symbiotic relationship between the company and its political masters have all helped to create an environment in which costs for taxpayers can only climb. Uncertainties at the low level and at the high end have already increased the costs of the project directly and indirectly.  The interaction of the four factors – uncertainty, decision bias, high politics and executive politics –  may well have already created pressures that politicians could not withstand even if they recognize the dangerous place they have placed taxpayers in.   There is no sign that any of them realise their predicament, by the way.   No sign that is, unless we read Kathy Dunderdale’s plea  - “what alternative is there? – in the most generous light imaginable.

At the base of the mountain, Nalcor can likely figure out the unknowns and control costs.  The problem for taxpayers in Newfoundland and Labrador is farther up Olympus.  Up there, things are much foggier.  What goes on at those lofty heights – what we mortals do not know and, as it seems, what the gods themselves do not know – will determine our fate.

Whom the gods destroy, they first make proud.


*  From the SNC Lavalin website:

In November, 2010, Nalcor Energy concluded arrangements, including the execution of a Term Sheet with Emera Inc, to develop Phase One of the Lower Churchill Project. …

Phase One of the Lower Churchill Project, often referred to as the Muskrat Falls development, will begin construction by early 2012 pending environmental assessment approvals and is expected to take approximately six years.