Upper Churchill Power The Unexamined Alternative

Muskrat Falls Revenue Stream Fact or Fiction

A Discussion Paper on Muskrat Falls By: JM Volume VIII

January 2013

Muskrat Falls Revenue Stream - Fact or Fiction

Executive Summary
On December 17, 2012 the Government of Newfoundland and Labrador issued a press release to mark the sanctioning of the Muskrat Falls project. The release purported that the project will
also generate estimated revenues in excess of $20 billion over 50 years once it comes on stream. This is a remarkable amount of revenue, and the reference was a standard speaking note for both Nalcor

and the Government during public debate leading to the sanctioning of the project. It was further stated in the House of Assembly that Muskrat Falls would generate an average of 450 million in annual revenues, with 120 million available in 2020 [Hansard, December 10th 2012]. In this context revenue refers to the money remaining to Nalcor after the payment of all operating costs, Innu payments and direct debt obligations. It is the money which could be potentially returned to the Provincial Government. The Government would receive this dividend as a return on the original equity invested by the province. It must be clarified to the reader that for the project to meet the minimum requirements of lenders, the Government of Newfoundland must invest approximately $2 Billion in the project in the form of equity. This contribution will either be raised by the province through additional debt, or by taking money from cash reserves. The equity investment by the Government will therefore be subjected to interest charges and debt servicing. Any potential dividends from Nalcor must first be used to repay the equity borrowing, before it can be used to build Hospitals, roads or provide salaries to public servants. The actual returns to the tax payer will be substantially lower than indicated within the December 17th press release. To the knowledge of the Author this actual return to the taxpayer has never been stated by either Government or Nalcor. Furthermore, the Federal Loan Guarantee also requires that a minimum debt servicing ratio of 1.4 be maintained throughout the loan repayment period. This required Debt Servicing Ratio will result in a lower dividend to the provincial government in the early years of the project. This specific term of the Federal Loan Guarantee will ensure that there is not 120 million returned to the Government of Newfoundland in 2020. In fact in 2020 the Muskrat Falls project will have a negative cash flow, if the terms of the FLG and the equity repayment requirements are considered. The debt servicing on the Equity borrowed by the provincial government, and the terms of the Federal Loan Guarantee will result in cash flow challenges in the first 10 years of the Muskrat Falls project. This essay will present a cash flow for the project which includes both the direct debt repayment, and repayment of the equity loans. It will consider both the base case of no export sales and with excess power is being sold at market rates. Cash flow models have been

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Muskrat Falls Revenue Stream - Fact or Fiction produced, and show that the net return to the province will be less than 50 million CAD for more than 20 years after Muskrat Falls first produces energy. This is shown graphically below.

When you consider the equity repayment, the required debt service ratio, and include the potential upside from power exports, Muskrat Falls will be in operation for nearly two decades before the net returns to the Government of Newfoundland will match that presently provided by the Upper Churchill. This statement is one which is not fully understood by even the most buoyant supporters or sharpest critics of the Muskrat Falls project. It is also not well understood by the general public that between 2006 and 2016 the taxpayers of Newfoundland and Labrador will provide Nalcor with nearly $3.5 Billion dollars in the form of deferred dividends, cash payments, and equity contributions to support such projects such as Muskrat Falls and Hebron. This is a startling amount of taxpayer money given to a Crown Corporation. This type of public investment may be acceptable if it produces a measureable return to
the people of the province. But it is not acceptable when Nalcor and/or Government have not clearly identified what these true returns will be. With no normal oversight offered by both the Auditor

General and the Public Utilities Board, is Newfoundland transitioning into an authoritarianism
society centered on the provincial energy corporation? It is hope of the Author that this Volume will further facilitate public discussion on aspects of the Muskrat Falls project, which are conspicuously absent from the public domain. A Muskrat Falls Discussion Paper Volume VIII Page 2

Muskrat Falls Revenue Stream - Fact or Fiction

Part 1:

Introduction

Nalcor should be commended for the large amounts of information they have released to the public on the Muskrat Falls project. However, despite the vast amounts of technical information released, there remains considerable confusion regarding the very simple question What returns can the taxpayers of the province for the tremendous risk they are taking. What is the real revenue stream? Consider some of the information which is available within the public domain:
CEAA Joint Review Panel Final Report [Page 24] Further, Nalcor indicated at the hearing, that in its analysis, Muskrat Falls includes a high equity content (41percent) and that the shareholder might forgo dividends so that not much of a revenue stream is expected from Muskrat Falls for distribution. Hansard November 21, 2012 Minster Kennedy: As I indicated yesterday, the revenues have obviously been looked at with the bond rating agencies, as Nalcor is going to borrow money from the markets. Also, Mr. Speaker, the provincial government has engaged in the rigorous review of the economics of this project, but just to put it in perspective, the revenues that we show right now, there will be approximately $130 million available to the Province in 2020 that will be over and above the payment of all expenses. That is based on 40 per cent of the power. It does not include the export or the other 40 per cent. Hansard December 10, 2012 MR. MARSHALL: Mr. Speaker, the revenues that will go into Nalcor and Emera will pay off the cost of operating those assets, the cost of constructing the project. There is also a return that goes to the equity holder. I just indicated that we will receive, on average, dividends of about $450 million a year over the fifty years; on average. That is about $20 billion over the fifty-year life of the project. I think we are going to do very well, and I do not think we are going to have to ever worry about losing that project. That project is going to provide stable and fair electricity rates to the people of this Province for over 100 years.

The main contributor to the confusion within both the general public and the House of Assembly is that Nalcor has not provided a clear report outlying the data used to develop the project estimates, and how that translates into an incremental unit rate for Muskrat Falls energy. This report should also outline the calculations for the resulting blended rate, the cash flow curve for the project, and the calculation of the return on equity. Although there was not a single report, the general public could find most DG2 information scattered through a series of RFIs and Exhibits submitted to the PUB. The primary references are: Overall CPW Analysis for Interconnected Option: Exhibit 99 Muskrat Falls Power Purchase Details: RFI-KPL-Nalcor-27 Rev. 1
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Muskrat Falls Revenue Stream - Fact or Fiction Equity Summary for Project: RFI KPL-Nalcor-20 Muskrat Falls Cash Flow Analysis: CE-64-Rev. 1 Overall Blended Revenue Requirement: PUB-Nalcor-5

As the tax payers will bear 100% of the project risk, a succinct report outlying the project economics should have been a deliverable to the House of Assembly to support the recent debates. Furthermore, as Muskrat Falls is touted as a means of diversification of our provincial economy, it is also important that the financial returns to the people of the province also be openly communicated. What reward will the taxpayer realize by assuming this tremendous risk? The consensus within the debates was that there will be 120 million in dividend payments available to the Government of Newfoundland, increasing to an average of ~450 million each year over the 50 year economic life of the Muskrat Falls project. This would be 20 Billion to the provincial coffers over the life of the project. When including potential exports this number would increase to 24 Billion in nominal dollars. These statistics are misleading, to the point that even the opposition house leader believes that there will be 24 Billion entering the general coffers of government.

As was recently identified by former Minister of Finance Dr. J.F. Collins [Ref. 17], the dividends reported by Nalcor, and repeated in the House of Assembly, are prior to the repayment of the debt required for the equity contributions. When you consider the repayment of the loans required for the Equity contributions the net revenue to the government is much less than that implied above. Within this report the Author will attempt to re-create the actual revenue stream from Muskrat Falls. It will hopefully educate the reader as to when we may actually expect to see real returns from the project. The data presented are a collection of information which has been presented by Nalcor, and/or the Government of Newfoundland. References have been provided where appropriate.

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Muskrat Falls Revenue Stream - Fact or Fiction For consistency in this essay dividends refer to the money generated from Muskrat Falls by Nalcor (minus immediate debt repayment, operating costs, and Innu payments). This is what can potentially be transferred to the provincial government in return for their equity investment. Net Revenue (NR) is the money remaining to the government once the equity debt payments are removed from the dividend returns.

Part II

Nalcors Projected Cash Flow

During Nalcors 2011 annual general meeting [Ref. 1] Ed Martin presented the proposed financing of the Muskrat Falls project. Contained within this presentation was a slide of the revenues from the project, with the debt and OPEX costs identified. This is provided within Figure 1:

Figure 1: Muskrat Falls Cash Flow [Ref. 1]

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Muskrat Falls Revenue Stream - Fact or Fiction

Average Annual Dividend = 450 Million

Figure 2: Dividends Payable by Nalcor from Muskrat Falls Project [Ref. 1] The area shown in green is the dividends or free cash flow from the project. In 2020, Nalcor will charge Muskrat Power at 200 $/MWhr. With 2,000,000 MWhr of energy sales, this will result in approximately $400 million in gross revenue. After they pay their direct debt obligation (for 65% of the total cost of Muskrat) and other operation costs there will be approximately 120 million dollars left over as a potential dividend to government. However 35% of the Muskrat Falls generation plant is being financed by Equity contributions from the provincial government. These dividends are not Free Cash as described by Nalcor, but they must first service the debt required to provide the Equity contribution. Within the recent debates Marshall, Kennedy and Dunderdale did not clarify fully where the provinces equity was coming from. It should not be considered as Equity per the conventional definition. This equity will either have to be borrowed, or provided from cash reserves. As the Province is still carrying a $8.9 Billion dollar debt, there is also a real cost of servicing the latter form of equity, as the cash reserves currently available could be used to lower the provinces net debt, or reduce the impressive annual deficits which are currently being accrued by Government. There is nothing free about the Dividends indicated in Figure 2.

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Muskrat Falls Revenue Stream - Fact or Fiction

Part III:

Muskrat Falls Cash Flow

During the PUB process Nalcor presented a cash flow model for the Muskrat Falls Generating Facility [Ref. 5]. Based on a 75:25 debt to equity ratio the project would have to be in operation for 10 years before the Debt Servicing Ratio of 1.4 could be maintained with no additional cash infusions from Government. It concluded that the generating element of the project would require additional equity contributions to meet the minimum standard of lenders. The Federal Loan Guarantee prescribed the debt to equity ratios for each project, and the required debt servicing ratio to be respected over the life of the project. These inputs have a direct impact on the dividends which can be returned to the principal shareholder, the tax payer. Based on the debt to equity ratios, the Author has attempted to re-create the actual cash flow from the Muskrat Falls project(s). Unlike the Nalcor cash flow analysis presented in Reference 5, this model also includes the repayment of the Equity contributions with an interest rate consistent with other Government borrowing. The sources of information used to develop this model include: The Debt to Equity Ratios assumed in the Federal Loan Guarantee [Ref. 6] The project costs allowed for in the Federal Loan Guarantee, which was assumed to include AFUDC or interest during construction. Operating Costs consistent with that presented in the 2011 AGM (Blue Lines in Figure 1). Gross Revenue stream for both the LIL and MF elements of the project per a response from the Power in Your Hands Website [Ref. 3]. A linear growth has been assumed. Interest Rate for Equity borrowings of 5.5%. This is consistent with debt obligations for the provincial government. It is assumed that all equity could be used to defer other long term debt of the province. Interest Rate for Debt borrowings of 5.3%. This is based on a 2% reduction from the rates used in the DG2 calculations to reflect the impact of the Loan Guarantee [Ref. 4]. Debt Service Ratio of 1.4 to be maintained during the term of the FLG, on each individual project, and in aggregate [Ref. 6]. Labrador Island Link Total Project Cost: Debt to Equity Debt Portion Equity Portion Debt: Equity: Year 50 Revenue: 3.2 Billion (Includes IDC) 0.75 : 0.25 2.4 Billion (Consistent with FLG) 0.8 Billion Level amortization over 50 yrs per FLG Assumed to be 50 year repayment, level amortization 88.4 Million [Ref. 3]
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Muskrat Falls Revenue Stream - Fact or Fiction Year 1 Revenue: Operating Costs: 250.8 Million [Ref. 3] $10 Million in Year 1 escalating to $40 Million in Year 50 [Ref. 1]

Figure 3 summarizes the potential dividends available to the government for the Labrador Island Link portion of the project. This is similar to Slide 33 of the 2011 AGM. It should be noted that this analysis assumes that Nalcor are Flow Per Year LIL themselves, and are not in Yearly Cash developing the Labrador Island Link partnership with Emera. This is done for simplicity of the presentation.
$300,000,000

$250,000,000

Free Cash / Dividends

$200,000,000 Debt Operating Revenue $150,000,000

$100,000,000

$50,000,000

$-

11

16

21

26

31

36

41

46

Figure 3: Labrador Island Link Dividends (Shown in Red) The area shown in red is the free cash and it is consistent with an 8.4% rate of return on the equity contributions (Year 1 the ROE would be 8.4% of 800 million = 67.5 Million). However, as noted in the previous section this equity is not money on hand, per the traditional sense. It will need to be borrowed. Figure 4, includes the repayment of the equity borrowing assuming an interest rate of 5.5%, with level amortization over 50 years, similar to the debt repayment scheme. It is clear that when considering the province has to repay the equity contribution there is no real cash flow being generated from the Labrador Island Link.

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Muskrat Falls Revenue Stream - Fact or Fiction

Yearly Cash Flow Per Year Labrador Island Link
$300,000,000

$250,000,000

$200,000,000

Equity Debt Operating Revenue

$150,000,000

$100,000,000

$50,000,000

$-

11

16

21

26

31

36

41

46

Figure 4: Labrador Island Link (LIL) Cash Flow with Equity Repayment Considered

Muskrat Falls Generation Facility Total Project Cost: Debt to Equity Debt Portion Equity Portion Debt: Equity: Year 1 Revenue: Year 50 Revenue: Operating Costs: 4.0 Billion (Includes IDC) 0.65 : 0.35 2.6 Billion (Consistent with FLG) 1.4 Billion Mortgage Style Amortization over 30 yrs per FLG Mortgage Style Amortization over 30 Years 167.6 Million [Ref. 3] 988 Million [Ref. 3] $25 Million in Year 1 escalating to $190 Million in Year 50 [Ref. 1]

Figure 5 summarizes the potential dividends available to the government for the Muskrat Falls Generation Facility portion of the project. In addition the debt servicing on the Equity contributions are also included to understand fully what the cash flow will be for the province. It demonstrates that assuming the Equity is Free the Muskrat Falls project will effectively be in a cash neutral position in the early years. However, if one considers the servicing of the 1.4 Billion dollar equity contribution, it will be ~10 years before the project is cash positive. After that there is very healthy net revenues returning to the province.

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Muskrat Falls Revenue Stream - Fact or Fiction

Yearly Cash Flow Per Year Muskrat Falls Generating Facility
1,200,000,000

1,000,000,000

800,000,000

Equity Debt Operating

600,000,000

Revenue

400,000,000

200,000,000

11

16

21

26

31

36

41

46

Figure 5: Muskrat Falls Generating Facility Cash Flow Integrated View of Cash Flow With these 2 projects an integrated view of cash flow can be determined to understand when there may actually be a net revenue stream to the Provincial Government. This should not just be considered as gross revenues minus costs. It should also reflect the requirement of the Federal Loan Guarantee to maintain a debt service ratio of 1.4. This will require each subsidiary company to keep retained earnings, thus delaying their return to the provincial government. Alternatively the Provincial Government may have to make additional investments in the project in the form of liquidity. Figure 6 provides a summary of the free cash or dividends from the entire project. It does not consider the debt servicing of the equity contribution. It is very similar to that provided by Nalcor, as shown within Figure 2. Of note is that to maintain a 1.4 DSR there must be a 100 million dollar infusion into the project in year 1. This would have to be recovered from the rate payer, but it is unsure if this has been included in the rates provided by Nalcor in their rate calculator? Figure 6 may look impressive, as does the dividends declared by Nalcor as shown in Figure 2. However, to be clear this is not what will be returning to our pockets. It is what will be potentially returning to the provincial government, which must first be used to repay the principal and interest on the 2 Billion dollar equity contribution.
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Muskrat Falls Revenue Stream - Fact or Fiction Figure 7 is the same integrated cash flow, bit it considers the repayment of the equity portion by the province. This realistic scenario clearly demonstrates that the project will not have positive cash flows until 11-12 years after first electricity. This would be on or about 2030. This is in direct contradiction to what Minister Kennedy indicated in the House of Assembly. Muskrat Falls will not generate incomes of $120 million in 2020 unless we completely neglect the interest cost and equity repayment. Furthermore Minister Kennedy did not state that the Government will likely have to inject ~100 million in equity to maintain the DSCR =1.4 in the early stages of the project to meet the requirements of the Federal Loan Guarantee. If the Equity loan is to be repaid under similar terms then liquidity infusions of ~30 million a year will also be required to maintain a DSCR of 1.4 in the first 5 years of the project. The terms of the FLG will therefore likely impact the rates eventually recovered from the consumer in the early years of the project.

Dividends From Muskrat Falls

900,000,000

800,000,000

Total Dividend = 19.5 Billion (Nominal)

700,000,000

600,000,000

500,000,000

400,000,000

300,000,000

200,000,000

100,000,000

0 1 (100,000,000) 6 11 16 21 26 31 36 41 46

(200,000,000)

There is requirement for ~100 Million Cash infusion in year 1 to maintain 1.4 DSCR.

Figure 6: Free Cash / Dividend from Muskrat Falls Project (Equity Repayment Ignored)

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Muskrat Falls Revenue Stream - Fact or Fiction

Figure 7: Net Revenue from Muskrat Falls Equity Repayment Considered

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Part 4:

Export Revenue and Other Costs

It is clear that it will be many decades before the Province will benefit from real revenue from the Muskrat Falls Project. However, with the Maritime Link or Labrador mining, we should be able to supplement the negative cash flows in the early years of the project with export revenue. Table 1 provides a summary of what potential export sales may be realized, with the resulting impact on the cash flow from the entire project. It clearly indicates that it will be ~2031 before there is a cumulative positive cash flow on the project. There are several assumptions in these calculations. Unit rate of 65 $/MWhr in 2018 consistent with EIA projections [Ref. 7]. Escalated at 2% per year. 1900 MWhr of energy available for export, based on the increased island requirement from the DG3 analysis. This is reduced for 7% losses to the Maritimes, and that an additional 0.2 x 980 GWHr is provided to Emera for the first 5 years of the agreement. Tariff of 10 $MWhr for wheeling the energy into the US. It is assumed that following Bill 61 that Nalcor will still qualify for an export license [Ref. 8] It is assumed that only 85% of the available energy is sold to the external spot markets.

It is also important to note the potential deficiencies resulting from the Emera commitment of 1 TWhr of energy per year will only exasperate the cash flow concerns. As was previously identified by the Author [Ref. 8] there will be a shortfall in the 2036 time frame. This is effectively summarized within Figure 9. With the DG3 demand profile there is an additional 200 GWhr of energy required in the noted timeframe, compared to the DG2 requirement. Therefore in the period of 2033 to 2041 there will be some 200-400 GWhr of energy needed to supplement the Muskrat Falls supply. Assuming this energy comes from RECALL (cheapest source of energy) then the cash flow will have to be adjusted to reflect the loss of revenue associated with not selling the RECALL power. This cost is directly the result of providing 1 TWhr of energy annually to Emera.

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Muskrat Falls Revenue Stream - Fact or Fiction Table 1: Potential Upside from Energy Exports
Cumulative Net Revenue to Provincial Government
$ $ $ $ $ $ $ $ $ $ $ (153,884,306) (179,352,029) (198,697,999) (210,226,236) (215,250,201) (202,592,961) (185,843,723) (161,340,954) (138,433,527) (117,481,002) (91,853,917) (61,934,079) (28,114,868) 17,573,696

Year

Energy For Export

Unit Rate $/MWhr 65.0 66.3 68 69 70 72 73 75 76 78 79 81 82 84

Tariff

Export Sales

Adjusted Cashflow
$ $ $ $ $ $ $ $ $ $ $ (153,884,306) (25,467,723) (19,345,970) (11,528,237) (5,023,965) 12,657,241 16,749,238 24,502,769 22,907,427 20,952,524 25,627,085

2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031

1567 1,421 1,275 1,129 982 1,036 890 744 598 452 305 159 13 0

10 10 10 10 10 10 10 10 10 10 10 10 10 10

$ $ $ $ $ $ $ $ $ $ $ $ $ $

73,257,250 67,994,593 62,437,106 56,575,599 50,400,631 54,402,597 47,815,354 40,889,645 33,615,063 25,980,920 17,976,241

9,589,754 $ 809,887 $ - $

29,919,839 $ 33,819,211 $ 45,688,564 $

2032 2033 2034 2035 2036 2037 2038 2039 2040 2041

Figure 9: Potential Energy Deficiency with Emera Commitment

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Muskrat Falls Revenue Stream - Fact or Fiction Recall may meet the energy requirements, but the complete Muskrat Falls solution still has dependence upon thermal units to help meet the capacity and reliability requirements for the island. In the Manitoba Hydro DG3 report [Ref. 10] there were 10 new CT units and 1 new 170 MMW CCT unit which would have to be added to the interconnected option. Prior to 2041 there are 4 new 50 MW CT units which will be added, at a total cost of around $225 million. Although the cost of these CT units will be absorbed in the final rates to the island consumer, they will require equity contributions. Thus considering the loss revenue associated with using RECALL power to meet the Emera commitment, and the requirement to add 50 MW CT units to the island how much real wealth will the Government generate from Muskrat Falls prior to 2041? Figure 10 provides a summary of the potential dividends from Muskrat Falls expressed in 2012 dollars. It is based on the following assumptions: Use of RECALL to meet shortfalls starting around 2032. The same pricing has been used as the export sales rate. 25% of the CAPEX cost of new 50 MW CT units prior to 2041. This has been assumed to be $75 million in 2014 dollars escalated at 2% annually. This matches the price used in the DG2 analysis [Ref. 11]. The annual net return has been shown in 2012 dollars. A discount rate of 2% has been used, matching the CPI adjustments assumed by Nalcor in the escalated Power Purchase model developed for Muskrat.

Within Figure 10 there are 2 additional data lines provided for comparative purposes. The dashed line represents the 2011 dividend paid by CFLCo to Nalcor [13]. When you consider the equity repayment, and include the upside from power exports, Muskrat Falls will be in operation for nearly two decades before the net returns to the Government of Newfoundland will match that presently provided by the Upper Churchill. The second line is the 2004 Dividend paid by Newfoundland and Labrador Hydro to the Government of Newfoundland, escalated to 2012 dollars. This was one of the last dividends returned to the government prior to the formation of the Energy Company known as Nalcor. This chart shows that when you consider all the real costs associated with the Labrador Infeed option proposed by Nalcor it is clear that Muskrat Falls will not be a major revenue creator for the Government of Newfoundland and Labrador until after 2041, or the debt is retired. In their arguments the Government has been disingenuous to suggest otherwise.
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Muskrat Falls Revenue Stream - Fact or Fiction

Figure 10: Summary of Net Dividends from Muskrat Falls Exports Included

Part V

Stewardship of Nalcor

In 2008 the provincial government created the energy corporation known as Nalcor. However, the idea of a provincial energy corporation existed prior to the rebranding exercise. In one of the major policy initiatives of the Williams government, in 2006 dividends paid by Newfoundland and Labrador Hydro were ceased, and the earnings retained in the energy corporation for the purposes of reinvestment. In 2006 the taxpayers of the province began their investment into the Energy Corporation. For 6 years the normal earnings of Nalcor and its subsidiaries (CFLCo, Energy, Energy Marketing, Oil and Gas and Newfoundland and Labrador Hydro) have been kept in the corporation for the purposes of growth. These have allowed strategic investments in projects like the North Amethyst Project, Hebron and Hibernia South. It has also permitted Nalcor to partake in riskier ventures such as the exploration wells completed in Parsons Pond.

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Muskrat Falls Revenue Stream - Fact or Fiction But these initiatives were not completed with the re-investment of profits alone. In addition to the deferred dividends, Nalcor has also been the beneficiaries of significant equity contributions by the provincial government. Now with Muskrat Falls the Provincial Government is about to embark on an unparalleled expenditure of public funds considered as an Equity investment. Over $2 Billion will be invested within the next 4 years on the Muskrat Falls Project. This is before any cost overruns are considered. During the same period, Nalcor has large investment obligations for their ownership stakes in the Hebron (5%), Hibernia South (10%) and White Rose (5%) developments. These obligations will also require large amounts of equity investments, presumably in the form of cash infusions from the provincial government. The author estimates that this could be in excess of $1 Billion in additional equity requirements. From their 2011 annual report Nalcor presently have $1.4 Billion cash in hand, which they refer to as shareholder equity. It is unclear if they will draw down on this cash in hand to use for these equity investments. Considering Nalcors stated goal to have debt to equity ratios in the 0.5 to 0.65 range [Ref. 16], it is likely that the majority of this equity will come from the provincial government. Assuming that the 1.4 Billion shareholder equity currently on hand is used for the oil and gas portfolio, the entire Muskrat equity investment must come from the tax payers of the province. Table 2 provides a summary of the deferred dividends, and cash infusions that Nalcor have or will benefited from during the 10 year period from 2006 to 2016. If the provincial government must maintain their practice of keeping dividends in Nalcor until the completion of Muskrat Falls there will about ~3.5 Billion of taxpayer money invested during the period of 2006 to 2016.

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Muskrat Falls Revenue Stream - Fact or Fiction Table 2: Summary of Taxpayer Investment in Nalcor 2006-2016 (in Millions)

The investment in Nalcor is staggering, and I do not believe it is well understood by the people of the province. This investment has been driven by requirements arising from the federal loan guarantee to meet debt to equity ratios required by Nalcor subsidiaries about to embark on multi-billion dollar projects. This $3.5 Billion dollar equity investment is the enabler to initiate muskrat falls, and take on an additional 5 Billion dollar debt. All for a mere 500 MW of continuous power! The Government of Newfoundland has for 5 years talked about how Nalcor will be the engine for economic growth in Newfoundland. Based on this level of investment the people of the province should expect a clear presentation as to when will these returns take place. In her yearend interview, the Premier stated that we must have a discussion about income taxes and services. The Author recommends that this review be also extended to Nalcor. After 5 years since its inception, it may be wise to review the entire purpose and goals of the Provincial Energy Corporation. At least the people of the province deserve to have visibility as to when they will see real returns, for the copious amount of money which has and will be invested.

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Muskrat Falls Revenue Stream - Fact or Fiction

Part VI:

Conclusions

The goal of this essay was to provide further clarity regarding the net returns which will be coming to the people of the province from Muskrat Falls. Kennedy, Marshall and others often promoted annual dividends, which did not consider the repayment and debt servicing of the significant equity contributions from Government. Neither does it consider the time value of money. As Nalcor have not provided a definitive set of calculations to arrive at the final rates, the financial models have been developed from various information sources. They are therefore approximate. Table 3 presents a summary of the net returns from Muskrat Falls considering the repayment of Equity and other factors. It is clear that when you include the repayment of the equity, and discount the money to todays dollars the returns are much less modest than $20 Billion. Furthermore most of these returns occur well into the future, with profits taken directly from the pockets of future generations of Newfoundlanders.
Present Cumulative Value of Dividends (In Millions) Period Description 0% Equity Repayment Not Considered Equity Repayment Included Equity, Export, and CT Units Considered Equity Repayment Not Considered Equity Repayment Included Equity, Export, and CT Units Considered 19,700 14,905 Discount Rate 2% 10,239 6,792 7% 2,741 887

2018-2067

4,102 625 1,000

3,012 256 670

1,513 (179) 234

2018-2041

What Else is at Risk? During the preparation of this essay it became clear that the Energy Marketing arm of Nalcor is the one area which is contributing high levels of profitability into Nalcor. Unlike the regulated business (and Muskrat Falls) these profits are not generated from the pockets of the provinces rate payer. Unlike the oil and gas investments it does not require large amounts of equity investment. The Energy Marketing division is effectively the cash cow of Nalcor, which is
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Muskrat Falls Revenue Stream - Fact or Fiction truly bringing new wealth into the province by selling the remaining RECALL power from the Upper Churchill into the US markets. At ~50 million a year in annual profit, the sale of RECALL into the US markets will also generate more cash than Muskrat from now until 2041. Within the January 5th editorial [Ref. 14] the Telegram raised the issue of FERC reciprocity. Previously raised by the Author [Ref. 15] it is clear that Bill 61 may put in jeopardy Nalcors ability to sell Muskrat Power into the US. Minister Kennedys response concerning FERC was [Ref. 14]:
Asked directly about that problem when he was explaining the new legislation, Natural Resources Minister Jerome Kennedy said the government would wait and see whether its new rules were challenged: "Under the open access transmission tariff, there certainly would be an argument there, but we'll have to wait and see how that develops. ... But you are right. Under FERC and under the OATT, there would be or could be potential arguments, but we'll have to wait and see if they arise

Not having the ability to sell excess Muskrat energy into the US may not be an issue if Emera or Labrador mining are able to purchase it. But the potential castration of the lucrative Energy Marketing arm of Nalcor is concerning. Are we now potentially confined to selling all this energy to Emera? Will this egg be the one which overloads the basket? Is the Rate Calculator Correct? The Federal Loan Guarantee had many clauses which may ultimately affect the rates in the early years of the project. The requirement for the Debt Service Ratio of 1.4 will necessitate more liquidity in the early years, which must be recovered in the rates. Appendix A may also require that the debt servicing of the equity may have to be considered on an annual basis, as well as over the life of the project. The annual requirement may potentially lead to higher rates in the early years. The Federal Loan Guarantee also clearly states that the PPA and LIL rate structure must include allowances for taxes and other fees. This is interesting as there seems to be no inclusion of Federal or Provincial taxes in the DG2 reports. Traditionally Nalcor was exempt from paying Federal Income tax, where it was a crown corporation. It would be worthwhile for Nalcor to clarify what these taxes are and whether the exemption from corporate income tax will continue.

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Muskrat Falls Revenue Stream - Fact or Fiction What is the real long term benefit from Nalcor? The people of this province have invested tremendously into Nalcor. But how much longer will the taxpayer be considered responsible for underwriting its growth activities? When will we see real returns? Should Nalcors mandate also be reviewed by the Premier when the government begins their rounds of budget consultations? Will Muskrat Falls Promote Economic Sustainability? To conclude it is clear that in todays booming economy the driver for Muskrat Falls is not reinvestment of our current oil wealth for future generations. Rather the only justification for completing this project now, is to meet our domestic power needs. We are embarking on an $8.9 Billion dollar project to meet ~2 TWhr of energy per year. But the project is being paid for by the assumed 50% growth in our energy requirements over the next 50 years. With no projected population growth this is a risky proposition. Volume 1 of this discussion paper series explored the potential for power purchases from North American markets wheeled to the island on a submarine cable. As the debate draws to a close I cant help but think that this is by far a much better option, a one in which Nalcor did not include within their DG3 information onslaught. It is a solution with far less risk, and ultimately lower electricity costs to the people of the province. When you consider the small returns from Muskrat Falls prior to 2041, what is the driver for ignoring the most obvious solution to our power needs? We must also ask ourselves why are we commencing the largest public works project in our provinces history, when we cant find workers to build oil platforms? In her year-end interview Premier Dunderdale said it was in the name of economic sustainability. Completing Muskrat Falls now will ultimately achieve the opposite. This is the subject of a future volume in this discussion paper series.

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Muskrat Falls Revenue Stream - Fact or Fiction

References
[1] [2] [3] Nalcor AGM 2011 RFI-KPL-20 Revenue Email from Power in Our Hands Website. Shown below
1) For 2018 (the first full year of operation) the Muskrat Falls PPA payment is $167,637,000 and the Labrador-Island Link payment is $250,868,000. Muskrat Falls energy at Soldiers Pond is 2,076 GWh. The equivalent Holyrood cost for the same year is $456,836,000. 2) For DG3, the 2067 Muskrat Falls PPA payment is $987,899,000 and the Labrador-Island Link payment is $88,368,000. Muskrat Falls energy at Soldiers Pond is 4,635 GWh. The equivalent Holyrood cost for the same year is $2,552,915,000.

[4] [5]

Page 141 November 2011 submission from Nalcor http://www.pub.nl.ca/applications/MuskratFalls2011/submission.htm CE 64 http://www.pub.nl.ca/applications/MuskratFalls2011/files/exhibits/abridged/CE-64(R1)Public.pdf

[6]

FLG http://www.powerinourhands.ca/pdf/Terms%20and%20Conditions%20of%20the%20Fed eral%20Loan%20Guarantee.pdf

[7] {8] [9] [10] [11] [12]

http://www.scribd.com/doc/104937414/Upper-Churchill-The-Unexplored-Alternative-1 http://bondpapers.blogspot.ca/2012/12/jm-7-bill-61-relapse-of-free-market.html http://bondpapers.blogspot.ca/2012/10/muskrat-falls-importance-of.html Manitoba Hydro DG3 report http://www.pub.nl.ca/applications/MuskratFalls2011/submission.htm http://www.nalcorenergy.com/uploads/file/derrick%20sturge's%20presentation_nalcor %20agm%2006%2009_web%20posting.pdf

[13] [14] [15] [16]

Nalcor 2011 Annual Report http://www.thetelegram.com/Opinion/Editorial/2013-01-05/article-3151065/Wait-andsee/1 http://bondpapers.blogspot.ca/2012/12/jm-7-bill-61-relapse-of-free-market.html http://www.nalcorenergy.com/uploads/file/derrick%20sturge's%20presentation_nalcor %20agm%2006%2009_web%20posting.pdf

[17] [18]

http://www.thetelegram.com/Opinion/Letters-to-the-editor/2012-12-28/article3147792/Government-is-hiding-facts-on-Muskrat-Falls/1 Page 24 CEAA Joint Review Panel Final Report. http://www.env.gov.nl.ca/env/env_assessment/projects/Y2010/1305/lower_churchill_ panel_report.pdf
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