Canadian Prime Minister Justin Trudeau is considering a request to guarantee new debt offerings to finish an over-budget and delayed hydroelectric project, a test of his support for low-emission energy development.
The estimated cost of the Muskrat Falls project in Newfoundland and Labrador has ballooned to $11.4-billion from $7.4-billion – meaning, on a per-capita basis, Canada's lightly populated easternmost province is spending more on a single electricity project than the U.S. government is projected to spend in its entire 2017 budget. That's on top of a large deficit and heavy debt load that prompted Moody's Investors Service to downgrade the province Thursday.
Canada's federal government already guaranteed $6.3-billion in initial bonds for Muskrat Falls. The project, which includes construction of an 824-megawatt hydroelectric dam on the lower Churchill River in Labrador, as well as two transmission lines – one to Newfoundland and the other to Nova Scotia – will produce about three times the power used by the province.
Now Trudeau, whose predecessor made the decision to back the debt, is being asked to extend the guarantees for all or part of $4-billion needed to finish it. Yet Muskrat Falls has become, by the admission of the man now tasked with finishing it, a boondoggle. The power plant still has no firm export contracts for the surplus power, said Stan Marshall, CEO of Nalcor Energy, the provincial Crown corporation behind the project.
"The simple answer is Muskrat Falls was way too big for the energy requirements of Newfoundland alone. So they got involved in a project that was too big," Marshall said in a recent interview at his office in St. John's. "You end up placing some heavy bets, and the bets have gone against you."
The Muskrat Falls development is hitting setbacks at a bad time for the province. Premier Dwight Ball introduced an austerity budget in April, and brought in Marshall to turn the project around.
Moody's downgrade to Aa3 from Aa2 was driven by an extended run of projected deficits, mounting debt and a rise in interest expenses, said Michael Yake, Toronto-based vice president and senior analyst. The downgrade also accounted for an expected equity injection into Nalcor because of Muskrat Falls, he said, and Newfoundland now has the lowest Moody's rating of any province.
"Muskrat Falls is a component but it's not the driving component," Yake said.
Newfoundland bonds have returned 3.6 per cent this year through Wednesday, below the average of 4.8 per cent for Canada's top 50 provincial and municipal issuers on a Bank of America Merrill Lynch index.
Made a difference
In December 2013, the federal government guaranteed $5-billion in bonds for Muskrat Falls and the Labrador Island Link transmission project. In April 2014, it guaranteed another $1.3-billion for the Maritime Link. That backing has made a difference – the bonds are above-average performers in 2016, returning between 6.3 per cent and 6.8 per cent.
"We certainly are looking for the federal government now to see if they would be willing to revisit the loan guarantee" and add to it, Newfoundland Finance Minister Cathy Bennett said in an interview. "Hopefully we'll hear something later on this year as to the federal government's position. I'd certainly be very optimistic." A spokeswoman declined to say whether the province wants the full C$4-billion guaranteed.
Awkward Spot The request puts Trudeau in an awkward spot – saying yes may provoke a backlash among voters already concerned about the federal government's debt, or from other regions looking for guarantees; saying no could lead to the collapse of the project and leave the feds on the hook to bondholders.
"It's difficult for Newfoundland to do it on its own," said Hosen Marjaee, senior managing director of Manulife Asset Management Limited, which manages about $35-billion in fixed income. They hold bonds related to one of the project's transmission lines. "But at the same time there has been a lot of money invested in the project, and I don't think it can be abandoned."
The Newfoundland government and Nalcor have spoken with the departments of Finance Minister Bill Morneau and Natural Resources Minister Jim Carr about the need for more guarantees, according to Bennett and Marshall.
"The Government of Canada is reviewing the request made by the Government of Newfoundland and Labrador and Nalcor Energy," said Tania Carreira Pereira, a spokeswoman for Carr's department.
The initial cost was badly underestimated, but the company has no choice now but to proceed, Marshall said, since canceling the project would cost nearly as much and still leave the province needing a new power plant, and with an agreement to provide some power to nearby Nova Scotia.
Trudeau's debut budget earlier this year pledged nearly $120-billion in deficit spending over six years in a bid to spur growth. He has also made green power a priority, announcing alongside U.S. President Barack Obama and Mexican President Enrique Pena Nieto last month in Ottawa that the three nations hope to generate half the continent's electricity from emissions-free sources – including hydro – by 2025.
That pledge will put pressure on Trudeau to support Muskrat Falls, even as Newfoundland's economy slumps amid low oil prices and a substantial forecast debt load – the highest in Canada, according to Moody's.
The project, upon its launch in December 2012, was forecast to cost $7.4-billion, rising to C$8.9-billion in 2015 before Marshall revealed the new $11.4-billion figure in June. Whether federally guaranteed or not, Muskrat Falls needs new capital to proceed, including $1.4-billion in the 2016-2017 fiscal year.
"I don't think there's interest in anything other than an additional round of guarantees," Marshall says, adding the cost overruns surprise him less than the contracts signed that bind the province to press ahead at a higher cost. "The real problem is this construct you get into when you're building a project that shouldn't have been built."