NLIS 8
May 16, 2000
(Executive Council)

Labrador Hydro Backgrounder
Deregulation in Electricity Markets

Since the Federal Energy and Regulatory Commission (FERC) ordered Role No. 888 in 1996, US electricity markets have moved from a highly regulated to a deregulated market environment. This deregulation has not happened over night; what has transpired is a set of incremental moves towards a full open market. This transition has been difficult given that electricity is a commodity which much be used when generated and needs to be delivered on a very reliable basis. The situation is further complicated by issues related to transmission access into a market place.

The deregulation has not been implemented consistently across all states or jurisdictions in the United States. For example, the North Eastern United States, particularly New York and California, have been on the cutting edge in regard to implementing market-driven parameters into electricity markets.

In these markets, electricity is traded on a power exchange similar to a stock market. Recent experience has shown that, in these markets, prices vary greatly from season to season, day to day, even from hour to hour.

As recently as last week it was reported that prices have gone from $25/Mwh to over $6,000/Mwh in New England. This represents a 24,000 per cent increase. Such extremes in daily volatility underscore the need for commercial agreements which ensure windfalls accrue to all market participants and not power brokers who take advantage of analogous situations to create large profits.

Over the last few months, both New York and Calfornia markets have moved towards Location Based Market Pricing (LBMP). In LBMP markets, the price paid for electricity varies from zone to zone within the state. This new zonal pricing was partially implemented in November 1999 and new changes are going to be brought into effect over the next year to move these markets to a full LBMP system. The LBMP system adds a new level of uncertainty to the market place. Like any new market, in the early stages of development, there is significant room for market manipulation and uncertainty. Examples of market manipulation have already been documented by regulatory agencies in these jurisdictions.

Given this market uncertainty, the trend in new generation is low capital cost combined cycle gas fired generation. Since the upfront cost is low, the level of investor risk is minimized. This new competition and the rapidly changing market place adds a new challenge to a large capital intensive hydro development like the Lower Churchill. To be able to finance these projects, lenders/financiers require certainty regarding future prices. The Lower Churchill can compete because of its low cost structure but the market place must first settle into a period of increased certainty once the initial growing pains of deregulation are past. It is not prudent to commit hundreds of millions of tax payers� dollars in an environment with increased uncertainty.

 Labrador Hydro Backgrounder
Progress to date on Labrador Hydro Project negotiations with HQ

Since March 9^th, 1999 Newfoundland and Labrador Hydro (NLH) has executed:

 1. A three-year agreement with Hydro-Quebec to recall 130 mw of power for a total  of $78.9 million. The province has already received about $70 million in revenue from that total. When the contract expires in 2001, NLH will be in a position to renew the agreement with Hydro-Quebec or find the best alternative use for this power. NLH expects to receive a similar level of annual revenues beyond 2001.

2. A Guaranteed Winter Availability Contract under which CF(L)Co provides excess additional winter capacity to Hydro-Quebec. For providing this capacity CF(L)Co will receive $1.5 billion over the next 41 years. Of this Newfoundland and Labrador will receive more than $1 billion (on average $29 million per year). Furthermore, CF(L)Co�s financial integrity will be maintained and the possibility of cash deficiencies at CF(L)Co will be no more.

NLH also negotiated the terms of the CF(L)Co Shareholders� Agreement as part of the negotiations for the development of the Lower Churchill. The Shareholders� Agreement does not affect the original 1969 Power Contract, but it does provide two significant benefits for Newfoundland and Labrador:

The 1969 Power Contract granted Hydro Quebec the right to make good any cash deficiencies incurred by CF(L)Co by purchasing more shares in CF(L)Co. Hydro Quebec could have gained voting control of CF(L)Co through this process. The Shareholders' Agreement gives NLH a similar right. Hydro Quebec can never gain control of CF(L)Co as long as NLH is prepared to make additional investments in the company, in accordance with its 66 per cent share holding.

The CF(L)Co Shareholders' Agreement also ensures a power supply at reasonable rates for Western Labrador. Under the 1969 Power Contract, Hydro Quebec had the right to acquire, at 1969 Power Contract prices, the 225 MW block of power dedicated to Labrador West when the current arrangement expires in 2014. With this new agreement, Hydro Quebec no longer has that right. Instead, this power will be available for Labrador at reasonable commercial rates. This means a secure power source for Labrador West and the profits will stay within Newfoundland.

In summary, NLH has made $70 million from the 130 MW recall and has the potential to garner in the range of $15 to $17 million per year over the next 41 years (total - $650 million) from this block of power. In addition over that same period of time, NLH expects to average about $29 million per year from GWAC (total - $1 billion). This total of about $45 million in extra revenues per year from the Upper Churchill more than doubles Newfoundland and Labrador�s previous take from the 1969 contract. These extra revenues when considered in the context of gains in the CF(L)Co Shareholders� Agreement clearly show that our investment of time, money and resources over the past 24 months has been well worth it.

 Labrador Hydro Backgrounder
2000 Environment & Engineering Field Programs

The proposed 2000 environment and engineering program will provide continuity in environmental information and in ongoing discussions/negotiations with the key regulatory agency, DFO, and Innu Nation. The information will assist in assessing alternate projects and will provide information necessary for environmental assessment.

The proposed 2000 engineering and environmental field program will focus on the area and information necessary to assess development at either Gull Island and/or Muskrat Falls. The cost estimate for the Labrador Hydro Project is $2 million.

Continue the historic resources assessment work from 1998 and 1999 with surveys in the potential reservoir area. This work has successfully trained and employed Innu field personnel.

Continue the collection of hydrometric data from stations in place since 1998 on the Churchill River, main tributaries and Naskaupi River.

Progress the transmission line corridor and route selection through constraint mapping and consultation (a joint study with engineering).

Collect information on fish productivity in the Churchill River to develop the models to validate the alternate fish habitat compensation approach.

Probable Maximum Flood study for the entire Churchill River basin.

Transmission line corridor and route mapping.

Preliminary engineering design of alternative plant and switchyard configurations.

Comprehensive engineering feasibility studies for potential developments at both Gull Island and Muskrat Falls were done in 1998 and 1999. Technical feasibility studies for transmission routes between Gull Island and Montagnais, Gull Island to Churchill Falls, Muskrat Falls to Gull Island, and the HVDC link to the Island were also done in 1998-1999. Costs to date are approximately $7 million, with Hydro-Quebec paying $3 million, Labrador Hydro Project $4 million.

A comprehensive program of biophysical environmental studies was completed in 1998 for the potential project area in Labrador. A reduced program of studies (archaeology, fish population characteristics, hydrology and water quality) was done in 1999. The costs to date are approximately $10.5 million, with $4.5 million billed to Hydro-Qu�bec.

The remaining field studies necessary for preparation of an Environmental Impact Statement (EIS) have been identified by the Acres-Jacques/Genivar (JAG) engineering and environment services contract. The remaining studies relate to engineering, biophysical and socio-economic aspects.

Work is ongoing with Innu Nation to develop an approach to providing traditional Innu knowledge in the project assessment.

Work is ongoing with DFO regarding the acceptance of an alternate approach to evaluation of fish habitat compensation for the project.

2000 05 16                                             9:40 a.m.