BOTTERELL LAW CORPORATION BARRISTERS & SOLICITORS 2324 Brethour Avenue SIDNEY, BC V8L 2A3
250.655.7410 E-MAIL: RBOTTERELL@TELUS.NET
Delivered via E-mail: pvla@xplornet.com May 25th, 2015 Peace Valley Landowner Association SS#2, Site 12, Comp 19 Fort St. John, BC V1J 4M7 Attention:
Ken Boon, President
Dear Ken Boon,
Re: Savings to BC Ratepayers from Delay to Site C Dam Project Your Request The BC Hydro and Power Authority (BC Hydro) has filed an affidavit related to four cases currently before the Federal Court claiming that the Site C Clean Energy Dam Project (Site C project) would cost $175 million more if the start of project construction were delayed for one year.1 You have asked my opinion on whether this statement is true or whether in fact there will be savings to BC ratepayers from a delay to Site C. I understand that PVLA is interested in the answer to this question because the $175 million cost of delay is advanced as a reason for not referring key economic issues to the BC Utilities Commission for further review, as recommended by the Joint Review Panel. This letter: • • • •
provides background about the Site C project, integrated resource planning, present value financial analysis, and key findings of the federal/provincial Joint Review Panel, outlines the most appropriate approach for measuring the impact of delay on Site C project costs, presents and discusses BC Hydro’s estimates of the impact of delay on Site C project costs, and makes concluding observations.
1
Affidavit of Michael Savidant, Commercial Manager of the Site C Clean Energy Project, affirmed January 15, 2015, paragraph 14.
May 25, 2015
Savings to BC Ratepayers from Delay to Site C
Page 2
Summary Answer BC Hydro’s analysis shows that delaying the Site C project for 2 years will result in gross savings estimated at $317 million.2 After adjusting for the present value of other costs of delay, the net savings to BC ratepayers of a 2-year delay will be approximately $200 million. A longer delay will very likely generate higher net savings to BC ratepayers. The $175 million cost of delay estimate contained in the Savidant Affidavit is incomplete and misleading. It is incomplete because it does not take into account the sale of surplus Site C power at a loss until Site C’s full 5,100 GWh are needed. If the construction of Site C is delayed 2 years, significant export losses will be avoided. The Savidant estimate is misleading because it is a cash cost estimate rather than a present value estimate. Other BC Hydro cost estimates are routinely presented in present value terms to ensure comparability. As you have noted, a delay in the start of construction of 2 years would provide time for further consideration of crucial economic questions raised by the Joint Review Panel. Importantly, BC ratepayers will achieve the net savings of approximately $200 million whether or not construction of Site C proceeds after a 2 year delay.
Facts My opinion is based on a review of publicly available BC Hydro information regarding the costs and savings from a delay in the Site C project. Unfortunately, BC Hydro has not, to date, provided public access to its detailed internal information, calculations and System Optimizer computer modeling of the impact of a delay to the construction start on Site C project costs. It has also not published an estimate of the impact of delay on the incremental present value cost of the project. You may wish to request that BC Hydro provide full access to such information. Please note that while I have a financial background3, I do not consider myself an expert in the area of energy economics and accordingly have relied on BC Hydro information, calculations and computer modeling in reaching my primary conclusions . As you will see from the analysis set out below, my conclusions are based upon applying BC Hydro’s own analysis to the information BC Hydro has made publicly available. In general practice BC Hydro has been consistent in its methods of financial analysis, except for in the case of its estimate on the cost of delay of construction of Site C. Moreover, BC Hydro has provided no rationale or explanation for why it has applied a different methodology to arrive at its conclusions on costs of delay. Accordingly, I have applied BC Hydro’s own methodology to BC Hydro’s own information to arrive at the conclusions set out below. And for the reasons set out below, it is reasonable to expect that any additional more detailed information will refine, not reverse, my main conclusion. Even if additional information has the
2
BC Hydro November 2013 Integrated Resource Plan, Appendix 6A, Table 3, Page 6A-42. Prior to practicing law, I held a variety of management positions with the TD Bank in Vancouver and Toronto, including the position of financial comptroller for British Columbia. I also worked for the BC Government Ministry of Finance. I hold a Masters in Business Administration from UBC and I am a Fellow of the Institute of Canadian Bankers. 3
May 25, 2015
Savings to BC Ratepayers from Delay to Site C
Page 3
effect of somewhat reducing the expected net savings from delay, the savings will still likely be in the hundreds of millions of dollars.
Site C Dam Project, Integrated Resource Planning, and Present Value Analysis The Site C project is a large hydro-electric dam project on the Peace River that has been under consideration by BC Hydro since 1957 and under active development since 2001. Prior to proceeding, the Site C project required federal and provincial government approval following environmental assessment processes under the respective federal and provincial legislation. In accordance with an agreement between the two governments the Site C project was subjected to a joint review. A federal/provincial Joint Review Panel was appointed and began its review in August, 2013, publicly releasing its report May 8, 2014. Federal and provincial environmental approvals were issued on October 14, 2014 and the provincial government gave its approval for BC Hydro to proceed on December 16, 2014. The Joint Review Panel was “mandated to inquire into the environmental, economic, social, health, and heritage effects of the Project and their significance, to examine proposals for the mitigation of adverse effects, and to record assertions of project effects on the Aboriginal rights and treaty rights of the affected First Nations and Métis peoples.”4 The review was undertaken based on an Environmental Impact Statement submitted by BC Hydro, evidentiary updates provided by BC Hydro, written submissions from interested parties and public hearings. The BC Hydro Environmental Impact Statement used, among many other sources, the BC Hydro 2012 Integrated Resource Plan for the purposes of describing the need for the Site C project and the cost of the Site C project compared to alternative resources that could be used to supply needed energy and capacity5 to the BC Hydro system. When the 2013 Integrated Resource Plan was completed and approved by government in November 2013, BC Hydro updated the evidence provided to the Joint Review Panel to reflect the new information. The Integrated Resource Plan takes a whole system view to its analysis. The BC Hydro system is complex. It consists of hundreds of resources generating electricity connected by a complex transmission grid to a myriad of residential, commercial and industrial customers and interconnected to the rest of the North American electrical grid. Changes to that system, including changes in the demands placed on the system by customers and on the resources used to supply power have impacts on the system over time. BC Hydro uses a sophisticated model of the system known as System Optimizer as a planning tool to analyze the best configuration of the system over time based on a database of potential resources, future demand scenarios and various assumptions. This approach allows for different scenarios, including different portfolios of resources, to be compared. For each scenario in the Integrated Resource Plan (IRP), the present value of incremental system costs for the period up to 20406 in constant 2013 dollars was calculated7. By comparing these amounts one can see whether BC ratepayers will pay more or less under alternative scenarios.
4
Report of the Joint Review Panel, Site C Clean Energy Project, May 1, 2014, page iv. Energy refers to the average amount of electricity generated during a period, usually a year. Capacity means the highest rate at which electricity can be provided to meet high levels of demand. Energy and capacity are two key characteristics of an electrical generation system. 6 Values beyond 2040 are not included because BC Hydro’s 2013 Integrated Resource Plan used present value analysis for the period 2015 to 2040 only. 7 Values are calculated in constant 2013 dollars to ensure the results of each scenario are comparable. 5
May 25, 2015
Savings to BC Ratepayers from Delay to Site C
Page 4
Why is it important to use present value analysis? Present value analysis takes the “time value of money” into account. A dollar that you have now is more valuable to you than a dollar that you expect to get at some future time, for two reasons. •
•
First, you can invest money you have in hand and earn interest on it. Compare an offer of $100 now with an offer of $100 in a year. With interest, $100 now would be worth, say $102. Thus, the timing of future payments affects their value at the present time; and Second, there is always some degree of uncertainty about the future. That risk also acts to reduce the value of promises of future payments at the present time.
Present value analysis takes the time value of money into account by discounting future amounts using a “discount rate” to bring these future amounts to their present value. That way payments made at different times in the future can be compared on an apples-to-apples basis, including scenarios that involve different portfolios of investments. This approach is routinely applied by BC Hydro to compare the rate impact of different alternative portfolios of electricity generation resources8.
Joint Review Panel Conclusions The Joint Review Panel, based on the information provided by BC Hydro and other information received through the process, reached some conclusions and made some observations directly relevant to the question of project delay in their report:9 •
•
•
• •
• •
8 9
“The Panel cannot conclude on the likely accuracy of Project cost estimates because it does not have the information, time, or resources. This affects all further calculations of unit costs, revenue requirements, and rates.” (page 280) “The Panel concludes that, basing a $7.9 billion Project on a 20-year demand forecast without an explicit 20-year scenario of prices is not good practice. Electricity prices will strongly affect demand, including Liquefied Natural Gas facility demand.” (page 287) “BC Hydro’s outlook is that the market prices it would achieve through the forecast period would average only $35/MWh, radically less than the marginal cost of production and delivery (about $94/MWh). Site C would be a large, sudden addition to supply. BC Hydro projects losing $800 million in the first 4 years of operation. These losses would come home to B.C. BC ratepayers in one way or another.” (page 298) “The Panel concludes that relying on exports to absorb surplus production would likely be very expensive.“ (page 299) “The Panel concludes that a failure to pursue research over the last 30 years into B.C.’s geothermal resources has left BC Hydro without information about a resource that BC Hydro thinks may offer up to 700 megawatts of firm, economic power with low environmental costs.” (page 299) “… the Panel cannot be confident that the IPP alternatives vs. BC Hydro Alternatives, or supply vs. demand management alternatives, are accurately valued.” (page 297) “Someday, a growing B.C. economy will need another 5 TWh of energy. The question is when. For a number of reasons set out in the text, the Panel cannot conclude that the power of Site C is needed on the schedule presented.” (page 308)
This approach is taken as a result of a 2006 decision of the BC Utilities Commission decision. Report of the Joint Review Panel, Site C Clean Energy Project, May 1, 2014, at pages indicated.
May 25, 2015
Savings to BC Ratepayers from Delay to Site C
Page 5
Analyzing the Impact of Delay on Site C Costs In the BC Hydro affidavit referred to above, BC Hydro has taken a very narrow approach to estimating the impact of delaying Site C10, as follows: 14. BC Hydro currently estimates that a one year delay to the completion of the Project would increase the costs of construction of the project by approximately $175 million. The costs would consist of: a) $65 million in increased construction costs; b) $60 million in increased financing costs; and, c) $50 million allowance for inflation and escalation. However, this approach has a serious flaw. It looks at the impact of delay only in terms of the cash costs of construction over the full ten-year construction period. It does not consider the other impacts of the delay on the overall BC Hydro financial position and it is not a present value estimate. In particular, BC Hydro’s statement does not take into account the loss from selling surplus electricity for several years after Site C comes into service, quoted by the Joint Review Panel at $800 million over the first four years based on BC Hydro data11. Delaying Site C would avoid some of those losses, depending on the length of the delay. BC Hydro should have estimated the cost of delaying the Site C Dam Project by using the same present value methodology used in its 2013 Integrated Resource Plan. That would have taken into account all of the impacts of a delay and used present value analysis to account for the fact that those impacts happen over time. For example, the $175 million estimate does not take into account the present value savings from not having to export surplus Site C energy at a loss. Present value methodology is the only way to make an apples-to-apples comparison of the financial impacts of delay and capture all of the impacts, both savings and costs, resulting from project delay. There are two elements to such analysis are: 1. The present value of avoiding the losses due to exporting electricity at below cost; and 2. The present value of the impacts of the three types of construction cost increases outlined by BC Hydro and quoted above.
Estimating the Impact of Delay BC Hydro has provided a considerable amount of data and analysis in support of its 2013 Integrated Resource Plan, which was used to support the BC Hydro Environmental Impact Statement through the September 2013 Evidentiary Update. That information is not sufficient for me to make a comprehensive estimate of the present value financial impact of delay, but it does provide a strong indication of the order-of-magnitude of the impact and whether there is a net cost or net savings from project delay. The following looks at the savings from avoiding selling surplus electricity at a loss and the cost of construction increase due to delay. 10
Affidavit of Michael Savidant, Commercial Manager of the Site C Clean Energy Project, affirmed January 15, 2015, paragraph 14 11 Report of the Joint Review Panel, Site C Clean Energy Project, May 1, 2014, page 298.
May 25, 2015
Savings to BC Ratepayers from Delay to Site C (a)
Page 6
Avoiding the Export Losses
The loss due to exporting surplus electricity depends on the date Site C comes into service and the gap between the demand for electricity (load) and the capacity and energy provided by sources of power other than Site C.12 The 2013 IRP indicates that, using BC Hydro’s base case assumptions, additional peak capacity will be required in 202213 and additional base energy will be required in 2025, as shown in Chart 114. However, the Joint Review Panel Report went further, concluding that additional peak capacity and base energy will not be needed until 2028: “The Panel concludes that, under the Low Liquefied Natural Gas case, available resources could provide adequate energy and capacity until at least 2028.”
Subsequent to the issuance of the Report, BC Hydro pointed out an error in the Report tables describing the load-resource balance. The Panel corrected the error by issuing an Errata15, however the Panel expressly stated that its conclusions on need remained unchanged. The Chair of the Joint Review Panel, Harry Swain subsequently said “There’s a whole bunch of unanswered questions, some of which would be markedly advanced by waiting three or four years … And you’d still be within the period of time, even by Hydro’s bullish forecasts, when you’re going to need the juice.”16 While the Joint Review Panel 2028 finding is the result of a thorough independent assessment process, I have taken a conservative approach and accept BC Hydro’s estimates in the 2013 IRP for the purposes of my opinion. Chart 117
12
Referred to as the “Load-Resource Balance.” BC Hydro plans to purchase bridging capacity on the market to cover any shortage of capacity before the Site C in-service date. BC Hydro also has capacity projects that it could choose to build prior to the Site C in-service date if required, such as GMS Units 1-5 Cap Increase and Revelstoke Unit 6. 14 Under that scenario, Site C’s 5 TWh of energy would not be fully utilized in BC until 2034. 15 Report of the Joint Review Panel, Site C Clean Energy Project, Errata, June 10, 2014. 16 Gilchrist, Emma, BC Government Should have Deferred Site C Dam Decision, Says Chair of Joint Review Panel, DeSmog Canada, March 10. 2015. 17 BC Hydro 2013 Integrated Resource Plan, Appendix 6A, page 6A-26. 13
May 25, 2015
Savings to BC Ratepayers from Delay to Site C
Page 7
The Integrated Resource Plan includes the results of approximately 50 scenarios that have been run using the above-mentioned System Optimizer Model. These scenarios involve different generation resources and assumptions about the various parameters, such as demand, used in the model. Each scenario provides a present value of the incremental system cost to meet demand during the period from 2016 to 2040. Several pairs of scenarios compare the results of a Site C in-service date of 2024 with an inservice date of 2026, all other things being equal. The following table18 presents the results of the preferred resource portfolio to meet the load-resource balance need described in the Environmental Impact Statement.19 Table 1 shows that by delaying the Site C project two years, the present value of generation and transmission resources (G & T Resource Cost) is reduced and so is the revenue received from exporting electricity (Trade Revenue, shown as a negative cost in the table). In other words, by not generating a surplus for two years when there is high cost and low revenue associated with the surplus energy, the present value of incremental cost is reduced by $275 million. Table 1 – Comparison of Present Value Incremental Cost 2026 In
2024 In
Difference
Service
Service
Date
Date
Reduction (Increase)
Present Value G & T Resource Cost20
(2013 $ millions) 4,415
4,885
470
(1,784)
(1,979)
(195)
2,977
2,977
–
5,608
5,883
275
(Combined System Capital & Operating Costs) Reduction in Trade Revenue from Sale of Site C Surplus Energy21 Demand Side Management Option Cost (Impact of Conservation) Total
18
BC Hydro 2013 Integrated Resource Plan, Appendix 6A, pages 25 and 58 Site C Clean Energy Project Environmental Impact Statement Volume 1: Introduction, Project Planning, and Description Section 5: Need for, Purpose of, and Alternatives to the Project, November, 2013 20 Generation and Transmission Resource Cost 21 Export revenue at market price, which reduces the incremental cost. The loss arises because the market price is lower than the Site C capital plus operating cost. As the result of delay, less energy is exported so revenue is reduced. 19
May 25, 2015
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May 25, 2015
Savings to BC Ratepayers from Delay to Site C
Page 9
Another pair of scenario results presented by BC Hydro uses a capital cost increased by 10% to $8.7 billion, close to the current capital cost estimate of $8.8 billion announced in December, 2014 when the Site C Project was given government approval. It shows that the present value of savings from delay in that case is $317 million – as the cost of construction increases so do the savings from delay24. How would the LNG industry impact the savings? The 2013 Integrated Resource Plan also tested the impact of adding electricity needs created by the LNG industry, but did not estimate the impact of delay under those scenarios. Any LNG compression loads are expected to be powered by on-site natural gas-fired generating resources and have been exempted from the Clean Energy Act.25 However, upstream electricity demand will arise related to the production and transportation of natural gas by pipeline to supply any LNG facilities. It is likely that any significant electricity demand from this source will require additional energy by 2021 which could likely be satisfied by reducing expected exports and if needed one of the following: • •
importing energy prior to Site C generating energy; using onsite natural gas generation within the 7% gas headroom allowed by the BC Clean Energy Act.26
BC Hydro used a “No LNG” scenario as the base case in its analysis of the need for Site C, indicating that LNG sector requirements would likely be met through other means as shown in the plan’s sensitivity analysis.27 In the event that LNG load increases dramatically in the 2 year period during which Site C is delayed, the Joint Review Panel identified a variety of energy supply options that could be considered by BC Hydro, including bridging the gap with relatively inexpensive imported energy.28 Importantly, as long as BC Hydro does not sell this power at a loss to LNG sector companies, there will still be savings from avoiding having to sell surplus Site C energy at a loss for 2 years. It is therefore unlikely that the savings from delay will be reduced or eliminated by LNG. Another important question that has not been answered by BC Hydro is, “What is the optimal timing of Site C?” There is no readily apparent reason why a delay of four years instead of two years would not further increase the savings since additional export sales losses would be avoided. The Joint Review Panel report states clearly that Site C is not needed before 2028, a four year delay of the in-service date. (b) Increased Construction Cost As noted above, in addition to the avoided export losses, the present value of incremental costs will also be impacted by any increase to construction costs due to the delay. The Integrated Resource Plan notes that such other costs of delay (also referred to as deferral costs) have not been included in the 2026 in-service date scenarios. The BC Hydro affidavit referred to above provides an estimate of the other costs of a one-year delay at $175 million. However, that estimate is not comparable to the savings of $275 to $317 24
Other scenarios reported in the 2013 Integrated Resource Plan shows that savings increase as the capital cost increases, reaching $389 million at a capital cost of $10.3 billion. 25 British Columbia’s Energy Objectives Regulation, B.C. Reg. 234/2012. 26 The low cost portfolio is described as “Local gas-fired capacity with the units being relied upon for firm energy but mostly dispatched off in favour of lower cost surplus or non-firm energy from the integrated system or market imports” 27 BC Hydro, Integrated Resource Plan, Table 16, page 193, November 2013. 28 Report of the Joint Review Panel, Site C Clean Energy Project, Chapter 15, Need for and Alternatives to the Project, May 1, 2014
May 25, 2015
Savings to BC Ratepayers from Delay to Site C
Page 10
million referenced above because it is the sum of cash costs, including inflation - rather than the present value of such costs. While BC Hydro has not provided enough information to calculate the present value of these other costs of delay, looking at each individual element, it is possible to get a sense of the present value of the other costs of delay: 1. $65 million in increased construction costs - According to a BC Hydro Briefing Note29 obtained under a Freedom of Information request, the costs would arise from potentially having to redo environmental and socio/economic studies, a changed procurement process for major contracts and potential loss of key staff, creating recruitment costs. Assuming these costs are incurred in 2017 as the result of a two year delay, the present value in 2013 dollars at 5% would be $54 million.30 2. $60 million for increased financing costs – This refers to the cost of interest during construction. Part of that is interest on inflation but the present value is in constant 2013 dollars and inflation is not included. The rest is due to interest on the increased cost of construction and interest for a longer period on pre-construction debt, already incurred. That will be offset by a reduction in the present value of interest paid on construction costs because of the delay in incurring those costs (i.e. because those costs are further in the future, they are lower in present value terms). The net impact of this element on the present value is unlikely to be a large cost and might even be a savings. 3. $50 million for inflation, - Present value calculations already adjust for this factor by using constant dollar amounts and therefore this amount does not need to be included. Taking a very conservative approach and using an estimate of $54 + $65 = $119 million as the present value of the deferral cost, the net savings in cost from a 2 year delay would be $317 $119 = $198 million. And as noted above, the net savings could be much higher once the reduced present value of interest paid on future construction costs is factored in or if the delay were extended from 2 to 4 years.
Conclusion BC Hydro has stated that there will be a high cost to BC ratepayers if Site C is delayed. The $175 million cost of delay estimate contained in the Savidant Affidavit is incomplete and misleading. It is incomplete because it does not take into account the sale of surplus Site C power at a loss until Site C’s full 5,100 GWh are needed. If the construction of Site C is delayed 2 years, significant export losses will be avoided. The estimate is misleading because it is a cash cost estimate rather than a present value estimate. Other BC Hydro cost estimates are routinely presented in present value terms to ensure comparability. BC Hydro’s analysis shows that delaying the Site C project for 2 years will result in gross savings estimated at $317 million. After adjusting for the present value of other costs of delay, the net savings to BC ratepayers of a 2-year delay will be approximately $200 million. A longer delay will very likely generate higher net savings to BC ratepayers.
29 30
BC Hydro Briefing Note: Project Timing, June 17, 2014. Calculation – $ 65 million/1.05 = 61.9/1.05 = 58.9/1.05 = 56.1/1.05 = 53.5 million or approx. $54 million
May 25, 2015