Why it pays to read the fine print

Russell Wangersky
Send to a friend

Send this article to a friend.

I wanted to write about the seagulls, honest I did. Tuesday night, against the deep blue of the last moments of evening sky, five or six flights of seagulls headed for the harbour. Lit from beneath by the streetlights, and ghostly silent, they were like some sort of avian apparition.

But time is a fleeting thing, and we are charging headlong towards the next decision-point on the Muskrat Falls project, a timeline so critical that the provincial government won’t give the Public Utilities Board even 90 extra days to do a full report.

So instead of seagulls, let’s talk about the cost of service billing and then, of a different utility being skewered by its own hydro plans.

Here’s one definition of cost of service billing: “In cost of service regulation, the regulator determines the revenue requirement — i.e., the ‘cost of service’— that reflects the total amount that must be collected in rates for the utility to recover its costs and earn a reasonable return.”

Another? “A traditional electric utility regulation under which a utility is allowed to set rates based on the cost of providing service to customers and the right to earn a limited profit.”

It works by referring to a relatively simple formula: rate base times allowed rate of return equals required return, plus operating expenses equals revenue requirement.

Right now, the provincial government and Nalcor argue that Muskrat Falls power will cost 7.5 cents per kilowatt hour (kW/h) to produce, plus seven cents or so to transport to the Avalon, and then — with markups for Newfoundland Power’s rate of return for distributing the power — will reach something like 16.4 cents per kW/h.

That, the government says, will actually mean cheaper electricity, compared to burning oil to make power and refurbishing the Holyrood plant.

But not without a little hocus-pocus — because that’s not really what the service will cost.

Recently, Nalcor was asked by the PUB to calculate the cost of Muskrat Falls power using the traditional cost of service method.

The answer? At Muskrat Falls, it will cost 21.4 cents per kWh, then add seven cents or so cents for transmission, for 28.4 cents per kWh. Then there’s Newfoundland Power’s markup, but we’ll leave that aside for now.

The 7.5-cent figure came about because Nalcor chose a different way to calculate the cost of the power.

From a PUB application, exhibit 46, here’s Nalcor’s rationale:

“In the context of the Muskrat Falls development, the island ratepayer energy requirements at the time of plant commissioning is projected to use only about 40 per cent, or 2 (terawatt hours) TWh, of the plant’s average annual production of 4.9 TWh.

“While the island’s energy requirements increase over time in line with economic growth, the early‐year (cost of service) COS rate for Muskrat Falls power would be a significant burden for ratepayers in those years, as the required COS revenue for Muskrat Falls would be at its maximum and the power required by ratepayers would be at a minimum.

“To address this issue, an alternative approach to Muskrat Falls power pricing was developed which affords a number of advantages for ratepayers. … This escalating supply price is lower than would be indicated initially by the COS framework. It escalates evenly over time, and is applied only to power actually used by ratepayers — the early‐year burden placed on ratepayers at that time is minimized.

“This is accomplished essentially by requiring that the equity investor ‘wait’ for its return over the project life. It should be noted that the equity investor is not forgoing any return for waiting; it still earns its rate of return on the entire investment over the course of the term …”

That’s reasonable enough — it backloads a block of the large initial costs onto users years later. It’s essentially “buy now, pay later” — but for it to work, other things have to happen.

Power rates have to continue to increase by two per cent per year, and the amount of power being used by island residents also has to increase to match the utility’s projections. If either of those forecasts don’t come true, big financial chickens will come home to roost on our kids.

Why this is important will come later — just remember that 28.4 cents per kilowatt hour. Because that lets you look at apples and apples.

For interesting reading about how projects can go sideways, you might look at the Manitoba PUB’s examination — and rejection — of Manitoba Hydro’s latest rate application.

(Interestingly, a division of Manitoba Hydro is acting as an independent consultant for this province’s PUB in its review of the Muskrat Falls project.)

You can find the Manitoba PUB decision online at http://www.pub.gov.mb.ca/pdf/12hydro/5-12.pdf.

Now, the whole thing is 232 pages, filed 11 days ago, but boy, does it flag some critical points about how electricity sales are changing.

“Since Manitoba Hydro developed its plans, there have been major changes in the economic landscape,” the document says.

“The projected capital costs associated with Manitoba Hydro’s development plans have increased substantially; opportunity export prices have fallen; there has been market recognition and development of massive shale natural gas deposits — affecting supply plans in the United States and wholesale market electricity prices; the likelihood of premium prices for clean hydro-generated electricity has receded with the attention now being paid to the economy; industry demand for electricity and the expected growth in industrial demand has fallen; and the Canadian dollar is now near par with the (U.S. dollar),” the board’s decision says, essentially rejecting the utility’s current development plans.

“The board recommends that government subject Manitoba Hydro’s major capital development plans to a review by an independent panel with the required level of expertise.”

Sound familiar? It should. That’s what many people want to see here.

But there are other surprises: “Circumstances have changed since Manitoba Hydro, in its 2008/09 (plan), projected that new hydraulic generation would be required in 2018/19. Domestic consumption has declined by more than 1,500 GWh/year at a time the export market has ‘shrunk.’”

Scary words for people looking at expanding in the electricity market. Another concern raised by those watching Muskrat Falls? The potential for cost overruns. Nalcor has budgeted a 15 per cent cushion; Manitoba Hydro has seen a jump in costs at some generating projects — even before the projects begin — of 50 per cent.

“On an overall basis, the capital costs for Manitoba Hydro’s major generation and transmission projects have increased in excess of $2.6 billion,” the board pointed out.

“Against the backdrop of different types of business plans, together with the apparently skyrocketing capital costs … together with a depressed export market and Manitoba consumers being held financially responsible for any losses, the board is of the view that Manitoba Hydro’s capital projects require careful and detailed scrutiny.”

There’s plenty more: forecast overruns in the billions and long-term debt forecasts that have gone from $7.8 billion in 2010 to a forecasted $23 billion in 2029.

What does it mean?

And what does it all mean if you look at the Manitoba projects through the cost-of-service telescope?

“Manitoba Hydro’s new generation … will carry fully-costed initial in-service costs in excess of 10 cents/kWh. That indicated cost is almost double the current net cost of not only wind resources but also the cost of shale gas-driven CCGT (combined cycle gas turbine) generation.”

(And, for comparison purposes, around one-third of the fully costed in-service price of Muskrat Falls energy, at around 28.4 cents per kW/h. I told you to remember that number. Scared yet?)

What does the export picture look like? Well, Manitoba’s been able to get between three cents to five cents per kWh in recent sales — meaning there’s a very real case to be made that export customers are paying less than it costs to generate the electricity — and things are getting worse.

Again, the board decision: “In the board’s view, Manitoba Hydro may be facing close to its worst-case export market scenario, particularly relative to the situation anticipated in IFF09-1, because of such factors as:

‰ projected major generation and transmission project costs 50 per cent higher than initially forecast;

‰ natural gas generation costs having decreased by 30 per cent to 40 per cent or more;

‰  the U.S./Canada exchange rate decreasing revenues by 20 per cent  (offset in part by the depreciated value of Manitoba Hydro’s debt held in U.S. dollars);

‰  a complete lack of carbon pricing as opposed to the $20-30/tonne of CO2 apparently once forecast by Manitoba Hydro; and

‰ continued U.S. wind subsidies along with decreasing wind generation costs due to technical improvements and efficiencies.

“Furthermore, the board does not see how all of these negative market scenarios will be reversed for many years to come. The obvious risk faced by Manitoba Hydro is that the current status quo prevails for the foreseeable future.”

The board even took a shot at an “independent” company asked to do a review of Manitoba Hydro’s plans, saying the review wasn’t valid because it didn’t challenge any of the utility’s assumptions.

“The end product of the information from all these planning documents is Manitoba Hydro’s ‘road map’ as to future major capital projects (generating stations and transmission lines) that will be required to meet Manitoba Hydro’s future domestic loads and firm export commitments. There is subjective decision making involved — together with numerous assumptions — that underpins any current version of Manitoba Hydro’s Preferred Development Plan,” the board said. “The significance/importance of examining and testing those assumptions and decisions cannot be overemphasized. With capital costs and financing costs in the tens of billions of dollars, the stakes are high for the domestic ratepayer who is at risk to bear the costs.”

That, also, should sound familiar. Where does the buck stop? Easy.

Here’s what Manitoba’s PUB is concerned about:

“(The) burden will fall to the domestic ratepayer. It is vitally important that the economics of the proposed generation and transmission investments be subject to a thorough review to ensure that the developments, if they proceed, will benefit and not overly burden domestic ratepayers.”

Muskrat Falls is based on a series of informed assumptions — but those assumptions could be wrong.

They have to be tested independently, right down to their underpinnings — and frankly, that has not been done yet. Perhaps the PUB’s review here will do it. We’ll see.

Russell Wangersky is editorial page editor of the St. John’s Telegram. He can be reached by email at rwanger@thetelegram.com

Organizations: Public Utilities Board, Division of Manitoba Hydro, Newfoundland Power Manitoba PUB

Geographic location: Muskrat Falls, United States, Manitoba Canada

  • 1
  • 2
  • 3
  • 4
  • 5

Thanks for voting!

Top of page