16 January 2017

A muskrat by any other name... #nlpoli

Memorial University economist Jim Feehan proposed in the December issue of Canadian Public Policy that the provincial government should change the way electricity is priced in Newfoundland and Labrador once Muskrat falls comes on stream.

Now to be clear,  the way government prices electricity will already change for Muskrat Falls.  The project is so financially odious that the only way its proponents could get it off the ground in the first place is to force local taxpayers to bear the full cost of the thing, plus profits to everyone involved except themselves.  That's what will happen.

The provincial government used to have a policy to ensure we had the lowest cost electricity possible. No any more.  With Muskrat Falls, we get the most expensive electricity possible and may well wind up with the most expensive electricity in Canada.

Now Feehan is suggesting that we price electricity  based on the external markets in the fashion that the pricing will be set for the Nova Scotia block.  Unbundled transportation costs and let people see what they are paying for that.  And allow other costs of providing electricity,  like fluctuations in oil prices, show up directly on consumer electricity bills.

This so-called “efficient” pricing would have the virtues, in Feehan’s argument of transparency, efficiency, and salvation.  People will be able to see what they are paying for. They will adjust their consumption in response to price changes.  Most importantly, consumers will be saved from having to pay for the single largest public policy failure in Canadian history.

This is a very thoughtful paper, vetted by some very capable people, and offering an idea  - “efficient” pricing – that makes a lot of sense.  It makes sense because Feehan’s notion of “efficient” pricing is nothing more than the time-tested notion that we ought to let the market decide.  “Efficient” pricing is really just another way of saying that consumers ought to make their own decisions based on actual costs. Armed with the proper information, consumers can and will allocate their resources efficiently and, in the end, all will be right with the world.

Do no harm

Good public policy must solve problems without causing more.   The central problem with Feehan’s proposal, like the arguments in favour of Muskrat Falls, is that while it purports to fix one problem and deliver another benefit,  it really doesn't fix anything at all.  Feehan goes further than most, though, by proposing that not only would his scheme help solve the current problem,  it could have avoided it in the first place.

Feehan claims that the existing method of pricing electricity was a key reason we have Muskrat Falls problem.  The existing pricing suppressed prices below where they would have been.  This allowed this led to a growth in demand,  a heavier-than-needed reliance on thermal generation at Muskrat Falls, and that in turn led the provincial government to propose Muskrat Falls as the solution to finding more, cheaper electricity. "Efficient" pricing "would have substantially reduced consumption growth, resulting in either an elimination of or a substantial delay in the need to add generation capacity." (p. 487)

The problem with this claim is that rising demand and an excessive reliance on thermal energy did not bring about the Muskrat Falls project.  These were merely the ex post facto rationalisations - discredited from the outset - that proponents used to justify a project that actually had no purpose other than a political one.

What's worse,  "efficient" pricing would have produced higher consumer prices. That the means by which Feehan's idea would have produced its benefit.  As it was, proponents of Muskrat Falls used increased prices under the existing pricing scheme as a rationalisation for their project. Prices are going up, they said and they will be worse in the future. They touted Muskrat Falls as the best solution not only for higher prices but for prices that fluctuated  - as they would in Feehan's approach - due to changes in fuel costs.

Another path to the same destination   

Once Muskrat Falls arrives, the entire cost of it will be borne by the ratepayers in Newfoundland and Labrador. The government's intention from the outset was to double domestic electricity prices. The only identified source of revenue is electricity rates in Newfoundland and Labrador.  As the project grew progressively more expensive,  proponents started to talk of the potential for making export sales of some of the electricity and of using that to help pay off the costs. Politicians talked about the option of foregoing dividends.  The federal loan guarantee includes a provision that electricity rates in the province must be set to cover the cost of the loans and the profits.

That remains the essence of Feehan's new pricing scheme.  Feehan would lump all Nalcor electricity sales revenues together and see if Nalcor as a whole makes enough money to pay off the loans. That is the essence of what Feehan means when he says that the government ought to give Newfoundland and Labrador Hydro any “export earnings, net of transaction costs”.

Apparently, he specifically means Churchill Falls , since Feehan lists any earnings from the Muskrat Falls subsidiary corporation (MFCo) as a second source of cash. Feehan doesn't make plain how this might work exactly since MFCo’s domestic consist solely of what it gets from Hydro - which comes from consumer rates in the current scheme – and whatever paltry amount might be had from export sales outside of whatever is going to Nova Scotia.  Feehan talks rather freely about exports to all sorts of foreign climes but he never comes to grips with the practical reality that the revenue net of costs tend to be abysmally low even on electricity from Churchill Falls, which costs next to nothing to make. Proponents of Muskrat Falls have the same problem and, like Feehan, never deal with it.

The difference between Feehan's idea  and the current pricing scheme is that in Feehan’s scheme, the cost to consumers for electricity will probably be less than it is current or slightly more.  That's because he is pegging domestic rates to rates outside the province in a highly competitive market.   By pricing electricity using outside references, Feehan confirms what many already know:  there were and are cheaper sources of electricity than Muskrat Falls.  That is the reason, by the way, for the new government policy in 2012 that forces Newfoundland Power to buy from Nalcor.

Feehan claims this monopoly was intended to prevent Muskrat Falls power from coming back to the province more cheaply.  Where he gets that idea is a mystery.  The reason for the Nalcor monopoly is that , without the closed market, the connections to the mainland would allow Newfoundland Power to buy cheap electricity and import it in place of ludicrously expensive Muskrat Falls. We know foreign sources are cheaper since Nalcor officials have indicated that they plan to buy cheap power from outside the province and sell it to consumers at inflated rates under the closed-market scheme.  Since domestic ratepayers are the only customers for Muskrat Falls, proponents of the idiotic scheme had to create a monopoly to make it viable.

In any event, Feehan acknowledges that the rates under his way of figuring electricity rates might not be enough to cover the Muskrat Falls bill.  If they can’t scrape up enough that way,  he allows, then the government might have to raise taxes, borrow more, cut spending, and do other things to shift cash to cover off the Muskrat Falls debt.   As Feehan puts it, the “ultimate owner of NL Hydro,  the provincial government, may have to forgo dividends (from Nalcor) and even make financial contributions. The latter would involve increasing taxation, reducing program expenditures, or incurring more public debt. Each has its drawbacks and costs.”  Each has its own drawbacks and costs, indeed.

The government will forgo dividends to leave revenue with Nalcor to cover the debt repayment. “Financial contributions” is a fancy way of saying transferring even more cash to Nalcor from public bank accounts.  The only way to do that – as everyone might easily guess – would be to borrow more or cut government spending.

Feehan’s ace-in-the-hole solution to Muskrat Falls, though, is one he has floated before:  a special tax.  Feehan calls it a “fixed charge on all end users of electricity, possibly differentiated by customer classes  and payable to NL Hydro.” 

In the end, consumers in Newfoundland and Labrador under Feehan’s scheme would be in precisely the same predicament as they are under the current Nalcor scheme.  They alone will bear the full cost of Muskrat Falls. Whether it comes in the form of a doubling of their existing bills based on an increase in their electricity rate or in the form of a specific “Muskrat Falls Debt Retirement Surcharge” is irrelevant if the amount winds up being precisely the same.

Not only will the cost of Muskrat Falls to ratepayers be the same  be the same, but the implication will be the same. Feehan has nothing to offer on that front. As the cost of electricity rises, consumers will change their behaviour in either scheme.  That is, they will do everything in their power to lower their use of electricity as the cost of it rises. Businesses will convert to alternate energy sources or – more likely – close up or leave.  As they lower their consumption, the amount of their bills will either remain the same or increase.  Remember,  even in Feehan’s scheme revenue from the sale of electricity has to factor into the revenue stream and since Nova Scotia’s liabilities to pay for Muskrat Falls are limited,  the only pool of cash is the very small market in Newfoundland and Labrador.

There may be a worthwhile discussion in the future on the government's energy policy, including the way we set electricity prices.  There is a more pressing matter in front of us, namely coping with Muskrat Falls.  That is an issue with greater implications and we will turn to the matter of a bailout and provincial sovereignty in another post.