How 2024 is 1969
Guest analysis and commentary by Antonym Serezhny
The 1969 Power Contract between Hydro-Quebec and Churchill Falls (Labrador) Corporation was and is “take or pay.” For the first 45 years, Hydro-Quebec took a fixed amount of energy (electricity) at a fixed price. That has continued under the renewal clause except that from 2016 until 2041 the price dropped by 20% to 0.2 cents per kilowatt hour. Had Hydro-Quebec not taken the electricity, they’d still have had to pay for it, hence the name take or pay.
From 1969 to 2016, HQ had the right to all the energy Churchill Falls (Labrador) Corporation could produce, except for the TwinCo Block (225 megawatts) and the Recapture Block for Newfoundland and Labrador Hydro (300 MW). Until the end of 2014, CF(L)Co delivered the TwinCo Block free of charge. This block replaced electricity produced by the Twin Falls Power Company, which was owned in part by the mining companies in western Labrador to supply their mines and the neighbouring towns with electricity. TwinCo shut down its plant near Churchill Falls in 1975 in exchange for free electricity until 2014. Since then - in 2023, for example - NL Hydro paid CF(L)Co just over two cents per KWh for the TwinCo Block and under the current arrangement, which expires in 2041, NL Hydro cannot sell the TwinCo Block outside Labrador West.
Under the 1969 Power Contract, CF(L)Co sells NL Hydro the 300 MW Recapture Block for the same unit price of 0.2 cents a KWh that Hydro-Quebec pays CF(L)Co.
Bond Papers. Explaining the world so more people can understand it.
The MOU’s power purchase agreement for Churchill Falls is also a “take or pay” contract that would run from 2025 to 2075. According to the official announcement, HQ and NL Hydro will during those 51 years pay CF(L)Co the equivalent of a present value of 5.9 cents per KWh, with the price escalating at two percent a year. HQ must take or pay for stipulated blocks of generating capacity and energy from the existing CFLCo plant. NL Hydro must do the same thing, with HQ having the right to buy any recapture that NL Hydro does not use.
Therefore, the new Churchill Falls power contract is basically the same as the 1969 Power Contract, with the sole substantive difference being that the 2025 version contains a 2% annual price escalator. If the wholesale price HQ gets for exports during the next 50 years increases on average by more than 2% per year, then Newfoundlanders and Labradorians will come to resent the 2025 - 2075 arrangement because HQ will reap more and more profits by reselling the relatively cheaper CF(L)Co energy into HQ's export markets.
If HQ does choose to build Gull Island, then the “take or pay” Gull Island power purchase agreements (Gull Island PPAs) for both HQ and NL Hydro would run for 50 years following commissioning of the Gull Island plant. The price paid by both companies will cover Gull Island’s cost plus a predetermined profit and a return for each partner of eight to nine percent on the equity each must put into the project. The debt-to-equity ratio for Gull Island is to be 75:25. (CF(L)Co's original debt-to-equity ratio was also roughly 75:25.) NL Hydro will own 60% of the Gull Island operating company’s shares, with HQ paying NL Hydro $3.5 billion for its 40% of the Gull Island shares. Gull Island will also have a 2% annual price escalator.
As with the renewed Churchill Falls agreement, the Gull Island PPAs are basically the same arrangement as the 1969 Power Contract, with the sole difference being that the Gull Island agreements would contain a 2% annual price escalator. As with the new Churchill Falls agreement, if the wholesale price HQ gets for reselling Gull Island electricity increases by more than 2% per year, then Newfoundlanders and Labradorians will come to resent the Gull Island arrangement because HQ will reap more and more profits by reselling the relatively cheaper Gull Island energy into HQ's export markets.
The two percent escalator isn't enough to avoid the pitfall of the 1969 original deal. The 1969 Power Contract had HQ and NL Hydro from 1976 to 2016 paying CF(L)Co roughly 0.25 cents per KWh. If that initial 0.25 cents per KWh price had been subject to a 2% annual escalator, then as of 2012 CFLCo would've been charging HQ and NL Hydro about 0.5 cents per KWh [note: doubling due to 2% annual compounding occurs at the rate of 72 / 2 = 36 years].
As wholesale prices in HQ's export markets have since the late 1970s been much higher than a half cent per kilowatt hour, the five decades of anger in Newfoundland and Labrador would have occurred even if the 1969 Power Contract included a two percent price escalator. Had CF(L)Co in 2012 sold 30 terawatt hours of electricity to HQ for a half cent per kilowatt-hour, CF(L)Co's total revenue from HQ would've been about $150 million. HQ's American securities filing for 2012 reported that electricity "sales outside Québec amounted to $1,431 million for 35.2 TWh," or just over 4 cents per kilowatt-hour. In 2012, HQ would still have pocketed $1.220 billion from reselling 30.0 TWh of CFLCo electricity, or just over 800% more than HQ paid CFLCo.
It’s useful to consider what NL Hydro chief executive officer Jennifer Williams told the House of Assembly in early January:
“The 5.9 cents...is a number that represents in today's dollars a starting point for what this power will now be paid for by Hydro-Québec...we've done a lot of analysis to determine what is a fair price to be paid for this energy, understanding all of its characteristics, as well as its location, the existing partner that we have, [renewing] the [agreement] 17 years early, all of those aspects. When we take all of those aspects, and through the negotiating period with Quebec, we believe that on a forecast basis, $33.8 billion for the hydroelectricity that Hydro-Québec will take from the existing plant is a fair price that splits the value between us and Hydro-Québec in a manner that we think is fair.”
“But then we represent that in today's dollars with the number 5.9 cents. Basically, as you take the 5.9 cents, and to get essentially the same number, $33.8 billion, starting this year at 5.9 cents, you escalate it at 2 per cent a year. All of the revenue over the next 51 years will be a net present value of $33.8 billion, or $195 billion [in nominal dollars].”
“So that's essentially what that 5.9 cents is. However...it's not set. So I will talk a little bit about potential futures and what are the various scenarios that might occur...There are three ways that the pricing will be connected to each kilowatt or various kilowatt hours that will come out of the plant in Churchill Falls...What's going to change in the next 20, 30, 40, 50 years?”
“What we've done here is we've said, let's not pick any one of those, let's pick all of them. How we talk about it is basically a mutual fund of options for pricing...So what this will help us do is to de-risk if one of those indices doesn't do well then we're not going to regret it...”
“This is a really fundamental aspect of engineering out that risk of the past.… We're not picking one single rate. We’re picking a mutual fund of options here. The other really important point that we have...Quebec to commit to …fairness.” Fair is noted...in the second last line of the first paragraph [of Schedule F].… Fairness is indicated earlier somewhere else.… It is really, really important that Quebec have [sic] intended and have [sic] entered into this MOU with us to ensure that the pricing remains fair over the term of the PPA. This...is one of the most important things that we've gotten in writing and upon which we're going to now...continue negotiations to definitive agreements.”
The problem for Ms. Williams’ lengthy explanation is that in an eight-to-one decision in 2018, the Supreme Court of Canada concluded that the 1969 Power Contract is fair. No sane person - and Hydro-Quebec is run by sane people - is going to leave it to the courts some 20 or 30 or 40 years from now to determine what is fair based simply on the proclivities of judges who may not yet have even entered law school.
That is why Hydro-Quebec insisted that the Memorandum of Understanding (MOU) Ms. Williams signed include the following:
2.2(b) NLH and HQ agree to negotiate the Definitive Agreements on the basis of the following key commercial principles in respect of the New CF PPAs:
(ii) new pricing terms applicable to the amount of volumes attributed to CF as it currently exists (i.e., the volumes that do not reflect the CF Units Upgrade), which terms will be retroactive to January 1, 2025...which will have a forecasted net present value of $33.8 billion as it relates to payments to be made to CF(L)Co by HQ throughout the term of the New CF PPAs, as further specified in Schedule E, Schedule F and Schedule G and based on the assumptions set forth therein;
Schedule F: ...The block pricing structure, to be agreed upon in the coming months following the date of this Agreement, shall be established to target the agreed upon annual schedule of forecasted payments [in Schedule G]. The total of the forecasted payments [in Schedule G] to be made to CF(L)Co by HQ is $33.8 billion (on a net present value basis) in respect of the volumes of electricity from the existing CF plant and assuming that NLH will be exercising all of its volume recapture rights...
The Government of Newfoundland and Labrador and NL Hydro officials have already very publicly staked their reputations and in some cases political futures on selling the MOU as a great, transformational deal. HQ is therefore in the driver's seat: it will turn the MOU's "$33.8 billion (on a net present value basis)" from a forecast or suggestion into iron-clad legal reality. After all, are Jennifer Williams and Andrew Furey ever going to admit that they can't agree with Hydro-Quebec’s CEO Michael Sabia and Quebec's Premier Francois Legault as to what "fairness" means? Does anyone really believe that NL Hydro could now ever contemplate going looking for other customers for CF(L)Co's post-2041 electricity?
The similarity between the mid 2020s and the 1960s goes deeper.
Compare the role being played by today's MOU with that of HQ's 1966 letter of intent. HQ has used the MOU to manoeuver Newfoundland and Labrador into de facto committing to accept a new Churchill Falls power contract, the details of which HQ now intends to dictate to the provincial government and its energy company. That's essentially what happened in 1966: HQ used a letter of intent to entice Brinco to begin full-scale construction of Churchill Falls without having the necessary financing in place. In the subsequent negotiations over what became the 1969 Power Contract, Brinco ended up being forced to accept HQ's demand for an automatic 2016-2041 contract extension at an even lower fixed price.
The only real difference between today's situation and that of the 1960s is that in 2025 we should collectively know better.
