Wednesday, April 27, 2016

Will Muskrat Falls Concerns Spill Over To Nova Scotia?

The completion of the Muskrat Falls project in Labrador is far less certain now than it was even two weeks ago. Though it’s anything but dead. The old boss at Nalcor isgone along with the entire board. Nalcor’s new chief, Stan Marshall, has mused publicly about whether the project will even be completed. This has led Nova Scotians to rightly wonder what the impacts are in our province if the project is cancelled or significantly delayed. I wrote a short blog on this the other day which you can find here

Now we get into the details. So if you are interested, go grab a coffee, or tea, or some other drink because this will take some space to walk through.

I’ll put it right out there. If I was a betting man, I would put money on the Muskrat Falls project ultimately moving ahead. That being said, it’s highly likely the delays which have already occurred will grow and the completion date of the project will be pushed out significantly. Perhaps very significantly. Pushing the project out could save Newfoundland (Nalcor) money (at least in terms of cash flow) on the project at a time that they are cash strapped.

Both Energy Minister Michael Samson and Premier Stephen McNeil say they called their counterparts in Newfoundland and were assured nothing has changed. It was right for them to call. They had to. But it’s meaningless. Officially the project is going ahead until and unless it’s not. No one in the Newfoundland government is going to say the project is not going ahead unless they reach that kind of decision.

The same thing played out in reverse when I became Energy Minister. Premier Dunderdale and her Energy Minister Derrick Dalley (who was ultimately moved to Tourism after delays in the project under that administration) called me (and I understand the Premier’s office) regularly asking whether we needed anything else sorted out before they could finalize the federal loan guarantee.

The Maritime Link

The Maritime Link portion of the project (which is what Nova Scotia ratepayers actually pay for) is on time and budget. Regulated by the Nova Scotia Utility and Review Board (UARB), it’s difficult for Emera to push through any cost overruns to Nova Scotia ratepayers, so Emera has significant incentive to keep it on budget. That being said there are things Emera cannot control and one of their major contractors has run into its own financial issues, including difficulty meeting payroll recently. The financial predicament of that contractor is a concern, but doesn’t seem to be a significant issue at this stage.

I’m not going to rehash the pros and cons of the Maritime Link and Muskrat Falls here. Outside of concerns I expressed in opposition and as Energy Minister about some elements of the contract and the costs, putting Nova Scotia on an energy loop rather than at the end makes a lot of sense. For that to happen the loop actually has to be completed. If energy from Muskrat Falls (which is a weird hybrid of a traditional dam and a run of river project) is stable, regular, inexpensive, and reasonably predictable, then the project will be good for Nova Scotia’s energy portfolio as it moves away from fossil fuels.

There are risks, such as those indicated in a review by Manitoba Hydro, which showed an outage in certain parts of the system could result in interrupted delivery of power to anyone down line, including Nova Scotia. These risks have not been mitigated because there is no way to address some of the issues Manitoba Hydro described. At the end of the day, many of the risks and issues had been debated and decided on before the October 2013 election. 

Here's an excerpt from the draft of my forthcoming book:

Within days of the October election I was asked by McNeil’s transition team to attend a briefing on the Maritime Link project. Department staff were told not to assume it was a sign I would become energy minister in the coming weeks. I’d already been told I would be, but couldn’t tell anyone. The date of the cabinet swearing-in hadn’t even been announced. That meeting was the first moment I realized just how far along the project was in terms of approvals. Despite concerns I had, it was apparent how little we would be able to change in the contract without significant financial risk to the province, and thus taxpayers. I also learned there was no Plan B to meet federal and provincial environmental targets if the project fell apart and no time to build alternate energy infrastructure. The options would be limited, but I was still determined to get answers (good or bad) to the outstanding questions I had, and see what improvements or enhancements we could, as a new government, achieve.
Some of the concerns I had were brought up in UARB hearings. Some were the subject of legal advice from government lawyers (which I cannot disclose due to cabinet confidentiality, but I think would be worth the government releasing as some of the advice deals with the issues I am addressing here).

Gull Island Is The Prize

Before going on too far, it’s important to understand what is important to Newfoundland. 

Muskrat Falls is not. Surprised? Don’t be. 

In pretty well every meeting I had with Nalcor, the Newfoundland government, or their opponents either in opposition or as minister, it was made clear to me Muskrat Falls was just a way to get to Gull Island (a much larger potential hydro project in Labrador). Muskrat Falls is important as a staging project to Gull Island. It is important for getting the energy loop of the Maritime Link built. It is important for accessing the US market. 

Above all, Muskrat Falls, for many in Newfoundland is an issue of pride for those who want to send energy to market somewhere, anywhere, without going through Quebec, a province who many Newfoundlanders still feel wronged by over the Churchill Falls project.

Yes, some Muskrat Falls energy was intended to displace the oil fired generation at Holyrood, but there were other options, perhaps less expensive and less technologically challenging ones. Nalcor has admitted that it might not be the best option to replace that generation.

CBC recently reported Nalcor’s Stan Marshall as describing the final deal with Nova Scotia in this way:
He also criticized Nalcor's contract with Emera on the maritime transmission link, saying bluntly, "the contract looks to be very much in the benefit of Nova Scotia.”

After I was able to negotiate some improvements to protect Nova Scotia ratepayers in the Maritime Link deal, I was crucified on Newfoundland social media and on Newfoundland talk radio for being no better than the Quebec representatives in the Churchill Falls deal. I don’t think it was anywhere near that bad, but there is no question that the changes made to the deal shifted more of the risk to Nalcor and away from Nova Scotians. I was asked about it during interviews, but the rule in government is ministers should stay away from commenting on politics in other provinces. 

Privately, and perhaps influenced by numerous conversations with the well versed people in the 2041 group (lawyers, citizens, and others who were troubled by the Muskrat Falls project), I was concerned for Newfoundlanders about some elements of the deal they were signing onto. Newfoundland, however, was not going to agree to substantial changes to the arrangements already signed in 2010 and 2012, so I was left to try and address the risks to Nova Scotians. The Newfoundland government were begrudgingly ok with shifting the risk for the project as well as a few other guarantees because Gull Island was still in their sights, oil prices were high, and money was flowing on the Rock.

In retail terms Muskrat Falls was a loss leader to get at the bigger prize. Gull Island.

The Risks

Gull Island is probably now a pipe dream. Perhaps decades off if it ever happens. The recent review of costs on the Muskrat Falls project pretty well put a chill over government mega projects in the province. It has certainly changed how Newfoundland looks at the Muskrat Falls project.

As it currently stands Nova Scotia faces two primary risks with Stan Marshall’s musings in news reports that Muskrat Falls might not happen. These are the Force Majeure provisions and delays to the project. I’ve received a lot of feedback on the Force Majeure issue.

I actually feel the biggest risk to Nova Scotia is a delay, not Force Majeure, but the latter does appear in the contract, and word from numerous sources is that it is quietly being talked about, so I’ll address that first. Keep in mind however, that as long as Nalcor commits to eventually completing the project, it appears likely it wouldn’t need to claim Force Majeure to avoid penalties of any kind to Nova Scotia (unlike what media reports have suggested). Here are Emera’s own words in response to my questions before Nova Scotia’s review board (NSUARB ML-2013-01 IR-70):
If any part of the Muskrat Falls Project is delayed but ultimately completed, there is no compensation due to NSPML or the Nova Scotia ratepayer by Nalcor as Nalcor remains obliged to provide the full NS Block.
(a) If Nalcor does not complete any part of its project because of an Extended Force Majeure event described in the Maritime Link Joint Development Agreement, there is no compensation due from Nalcor to Emera. This event is unlikely to occur as Nalcor is relying upon this project to serve customers, the state of design to address project risks and procurement of long lead items to date.
It’s interesting to note that Nalcor has now said that Muskrat Falls might not be the best way to serve Newfoundland’s energy needs. The claim that the project was sufficiently planned to avoid budget and timeline problems has already proven to be false.

Force Majeure

The idea that Nalcor could claim Force Majeure to avoid any claims by Emera against them for not completing the project was first raised to me by contacts in Newfoundland who are much closer to the state of the project than I am.
There are many definitions for Force Majeure. Investopedia includes a lengthy discussion, but essentially boils it down to this:
Force majeure also encompasses human actions, however, such as armed conflict. Generally speaking, for events to constitute force majeure, they must be unforeseeable, external to the parties of the contract, and unavoidable (irresistible). These concepts are defined and applied differently by different jurisdictions.
The important thing about this is that it is broader than an Act of God. More often than not, a party can claim this and whether or not the claim is valid, it goes to mediation and/or court to decide. The issue for Nova Scotia isn’t whether a claim of Force Majeure is ultimately legitimate, but whether it is claimed at all. If Nalcor pursued this, it wouldn’t matter much whether the claim was ultimately founded or not, as it could be years of discussion and debate before it is settled.

During the UARB hearings Emera stated they would be using the definition found in the
Edison Electrical Institute Standard Form Master Power and Sale Agreement. This definition is very broad in terms of what could be considered Forece Majeure:

"Force Majeure” means an event or circumstance which prevents one Party from performing its obligations under one or more Transactions, which event or circumstance was not anticipated as of the date the Transaction was agreed to, which is not within the reasonable control of, or the result of the negligence of, the Claiming Party, and which, by the exercise of due diligence, the Claiming Party is unable to overcome or avoid or cause to be avoided.
It’s been suggested to me that there are a number of possible arguments which could be claimed (again this does not mean they would be successful). Top on the list is the collapse of the price of oil. 

This may seem to be an unrelated issue, but for Nalcor it isn’t. Nalcor has significant interests in offshore Newfoundland. They are also a crown corporation. Both the government of Newfoundland and Nalcor itself have been impacted by the unforeseen collapse in the price of oil. It was well understood that this provided much of the financial capacity for both to move the project forward. It’s hard to deny that some of Nalcor’s challenges are related to this issue, and their ability to absorb cost overruns at Muskrat Falls has become more limited.

It was also becoming evident even a year ago when I attended meetings in the United States, that Newfoundland was having difficulty selling energy from the project in the US market. The decline in natural gas prices has allowed electricity prices to stabilize in much of the Northeastern US, and in some cases even drop. So much so that even Quebec, which can offer cheaper prices than Newfoundland, isn’t having as easy a time as it once did.

This last point is particularly poignant because if you follow the link and read the full Edison definition Emera said would be used, specifically excludes loss of a buyer's market from Force Majeure, but does not exclude loss of the seller's market (Nalcor) as a reason for claim.

Feeding into the speculation that Nalcor could claim Force Majeure or something similar were the comments of Stan Marshall which made national news. Marshall is a smart businessman. His comments were almost certainly planned and calculated. They were planned for the Newfoundland audience to show he understands their pain, but possibly also as a warning to Emera on the project. 

According to testimony at the hearings, the Maritime Link agreements include standard provisions which require Emera to mitigate any losses in order to limit any compensation which could be payable to Nalcor in the event of a contractual breach. 

If Nalcor did walk away or found itself in some other breach of contract, they may be able to now point to the comments by Marshall as the date when Emera ought to have been trying to reduce its own, and thus Nalcor’s, financial exposure.

The important point isn’t whether a claim of Force Majeure would be successful. The risk to Nova Scotia is that if it is claimed, then it will be battled out in court or mediation of some kind. A process which would likely drag on. A process where Nalcor would likely win just by virtue of the fact they would almost certainly end up with either no penalty or a penalty much lower than if they walked away with no claim of a reason. 

Moreover, the risk to Nova Scotia is extended when you consider the fact Nova Scotia can’t afford delays in the Muskrat Falls project if it is to meet conditions associated with federal and provincial environmental regulations, and especially the terms of the Equivalency Agreement. That agreement is largely premised on Muskrat Falls being operational and allows Nova Scotia more time to wind down coal plants if it meets federal greenhouse gas targets. It states:

4.2 Given that Nova Scotia has amended the Greenhouse Gas Emissions Regulations, and given that the Minister of the Environment is satisfied that the effect of the Greenhouse Gas Emissions Regulations on greenhouse gas emissions levels is and will be equivalent to the effect on greenhouse gas emissions levels of the Reduction of Carbon Dioxide Emissions from Coal-Fired Generation of Electricity Regulations, the Minister of the Environment will  recommend to the Governor in Council to make an order declaring that the provisions of the Reduction of Carbon Dioxide Emissions from Coal-Fired Generation of Electricity Regulations do not apply in Nova Scotia.

The Greater Risk – Delay

The greatest risk to Nova Scotians in the Muskrat Falls situation is delay. It’s the greatest risk for a number of reasons. Among those reasons are the fact that delays have already been announced, so the risk is real, and delay is harder for Nova Scotia to deal with that cancellation.

I mentioned before there is no Plan B. Sure, tidal is on the long term horizon, wind farms are coming online, and other smaller renewable energy projects will come into play over the next few years. But nothing that could replace Muskrat Falls. 

The Muskrat Falls project is intended to provide anywhere from eight to 20 percent of the province’s electricity. As I noted above, it is also the basis of the Equivilency Agreement with the federal government. Without the level of emission free energy Muskrat Falls is intended to provide, the province will not meet its regulatory and legislative requirements, let alone any new targets which come with the federal ratification of the Paris agreement on climate change.

While some have suggested that Hydro Québec is an alternate, it is likely not. As Energy Minister I travelled to Québec to meet with my counterpart about imports. Québec was happy to sell, but they ultimately chose not to respond to a request for proposals for energy. Grid bottlenecks in New Brunswick prohibit any meaningful imports from Québec (Nova Scotia does buy some small amounts now on the spot market). The cost of upgrades in New Brunswick would have to be paid for by someone, and even if it was funded, it is almost certainly too late to get the project done by the time Muskrat Falls was supposed to come online. 

The same is true for almost any other possible replacement source of electricity. Four or five years ago a Plan B could have been pursued and the worst case scenario would have been having too much electricity, combined with the possibility of exporting energy to subsidize Nova Scotia ratepayers. That is not an option now.

While it has been reported that delays would mean that Nalcor would have to compensate Emera so other sources could be purchased, this does not appear to be the case. As you will have read earlier in this blog, Emera itself admitted the compensation provisions are really related interruption of service after the project is in service, not delays in coming online. The Nova Scotia Department of Energy received its own advice on this in 2014 basically saying the same thing. As long as the so-called Nova Scotia block is delivered at some point, there is nothing which means Nalcor is in breach.

This is where ratepayers in Nova Scotia may find themselves in a bind.

Neither Emera nor the Nova Scotia Government have any idea if the project will proceed or be delayed. Even today, the government admitted they might not know theproject status until June. The Nova Scotia Utility and Review Board has already approved costs for the Maritime Link to be charged to ratepayers in lieu of the block of energy. They were fairly firm that adding additional costs for the project would not be looked upon kindly. After all, the Maritime Link / Muskrat Falls project was only marginally better financially for ratepayers than some of the other options which were reviewed.

Nova Scotia has to meet rules on renewable energy and greenhouse gas emissions. If it can’t meet the terms of the Equivilancy Agreement then it is required to wind down the province’s coal plants much more quickly, and at much higher cost to ratepayers, than agreed to with the Muskrat Falls project in place.

Alternatively, or perhaps as well, ratepayers will have to procure renewable energy from another source. This will almost certainly have to be done on the spot or short term energy markets. This is unplanned energy and could end up being quite costly as options are limited.

The Future

The longer term future for this project is anyone’s guess. As I stated earlier, I do believe Muskrat Falls will get built. But I also believe it will be built with significant delays and more cost overruns. The cost overruns don’t impact Nova Scotia ratepayers, but the delays do.

Lots of things could happen. Emera has a huge stake in the project. They could decide to invest shareholder money to keep the project afloat. This would make their shareholders unhappy but if the risk grows, it would be a smaller financial hit to the company than the project falling apart entirely.

Emera could also choose to start an aggressive program of building renewable energy infrastructure to sell to Nova Scotia Power on the spot market. This is unlikely, but it's an option which has to be on the table somewhere.

The Nova Scotia government is almost certainly also having discussions with the federal government about greenhouse gas, coal plant, and emission rules to see what flexibility there might be. It’s not to say anyone will want to call in a favour there, but it would be irresponsible for the government to not at least be having those discussions.

The future of Muskrat Falls is Newfoundland and Labrador’s decision and theirs alone. Nova Scotians are now along for the ride and there is little that can be done until a decision is made. But even if there is only a delay, Nova Scotia will need to start thinking about contingency plans fairly soon.