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March 9, 1998
(Executive Council)

FRAMEWORK FOR
CHURCHILL RIVER HYDRO DEVELOPMENTS


BACKGROUND:

In early 1997, the Premier of Newfoundland and Labrador and the Premier of Quebec directed officials to examine the viability of hydro developments in Labrador and related projects in Quebec.

In the course of these discussions, three projects have been selected for potential development. The preliminary viability of the projects has been examined within the context of forecasted markets, estimated capital costs and financing conditions.

On the basis of these exploratory discussions and conclusions, the Government of Newfoundland and Labrador and the Government of Quebec have asked Newfoundland and Labrador Hydro and Hydro Quebec to pursue the opportunities identified, and to undertake formal negotiations with a view to concluding by the end of 1998 a Memorandum of Understanding establishing the parameters of agreements necessary for these projects to proceed. Newfoundland and Labrador Hydro and Hydro Quebec have also been asked to undertake the appropriate consultations with Aboriginal groups concerning their participation in the projects.

In conjunction with these negotiations, governments have authorized the corporations to conduct further engineering and feasibility studies and estimates, as required. It is estimated that between $15 million and $20 million will be spent in 1998. Preliminary work and arrangements with respect to the required environmental and regulatory review processes will also be initiated.

In the context of the recent Kyoto decisions, the reduction of greenhouse gases has become an important global issue. In agreeing with the Kyoto protocol, Canada accepted the target of reducing its emission to an average of 6% below 1990 levels by the 2008-2012 time frame. The contemplated projects will significantly reduce greenhouse gas emissions and will make a substantial contribution towards meeting this target.

The negotiation of a Memorandum of Understanding (MOU) will be conducted on the basis that the contemplated projects constitute an integrated package, and will proceed along the following lines:

 

GENERATION:

1. Gull Island

The Gull Island project will be developed by a Limited Partnership created under the laws of Newfoundland and Labrador. It will be owned 65.8% by Newfoundland and Labrador Hydro, and 34.2% by Hydro Quebec.

Power produced at Gull Island will be sold to two entities as follows:

(i) Newfoundland and Labrador Hydro will purchase under a long-term contract 1000 Megawatts (MW) and 7.5 Terawatt Hours (Twh) for consumption in Newfoundland and Labrador. Newfoundland and Labrador Hydro will purchase its electricity from the Partnership at a price which reflects cost and includes a fair and reasonable return on equity to the partners over a 30-year period; and,

(ii) Hydro Quebec will purchase the balance of the electricity produced at Gull Island on a market netback basis which will reflect market prices at the time of the sale. The power purchased by Hydro Quebec will be subject to a floor price guarantee. This floor price guarantee will facilitate financing of the project without recourse to the partners. Hydro Quebec will, through consultation and agreement with the Gull Island Limited Partnership, determine markets and related parameters. Hydro Quebec will receive a marketing fee of 2.8% of the wholesale market price.

Previous development expenses of $60 million on Gull Island will be reimbursed to Newfoundland and Labrador Hydro by Gull Island Limited Partnership at the closing of the long-term debt financing.

A progressive royalty regime will be applied by Newfoundland and Labrador to the Gull Island project. The details of the royalty regime will be negotiated as part of the MOU on the following basis:

(i) Royalty payments will increase as project profitability increases above a specified level. That level will provide the partners with a fair and reasonable return on equity; and,

(ii) The highest marginal royalty rate will not exceed 50%, such that incentives will exist to maximize returns from the project.

The revenues received by the Government of Newfoundland and Labrador from the royalty will be in addition to the distributions received by Newfoundland and Labrador Hydro from the project.

The value of greenhouse gas emission credits associated with the Gull Island project will accrue 100% to Newfoundland and Labrador Hydro.

2. Churchill Falls Phase II - New Capacity (estimated to be 1000 MW) and Partial River Diversions in Quebec

Hydro Quebec and Newfoundland and Labrador Hydro have also agreed to undertake the following developments:

The St. Jean and Romaine partial river diversions in Quebec will be developed by Hydro Quebec in a partnership with Quebec based local communities.

In conjunction with these diversions, CF(L)Co. will add an estimated 1000 MW of generating capacity at a new powerhouse at Churchill Falls. Hydro Quebec will pay CF(L)Co. a capacity utilization charge which will provide CF(L)Co. shareholders with a fair and reasonable return on equity.

The electricity produced at this development will be sold by Hydro Quebec, at a fixed regulated price, to the Churchill Falls Phase II Marketing Limited Partnership, created under the laws of Newfoundland and Labrador. It will be owned 65.8% by Newfoundland and Labrador Hydro and 34.2% by Hydro Quebec.

The Churchill Falls Phase II Marketing Limited Partnership will, in turn, resell the electricity to Hydro Quebec on a market netback basis which will reflect market prices at the time of sale. This sale produces the value which is to be shared by the partners - 65.8% to Newfoundland and Labrador Hydro and 34.2% to Hydro Quebec.

Hydro Quebec, through consultation and agreement with the Churchill Falls Phase II Marketing Limited Partnership, will determine markets and related parameters. Hydro Quebec will receive a marketing fee of 2.8% of wholesale market prices. As well, Hydro Quebec will provide a floor price guarantee under its long-term electricity purchase agreement.

The arrangements regarding water flows from Quebec will be renewable at Hydro Quebec=s option at the end of the debt amortization period of CF(L)Co.=s newly installed capacity.

In recognition that water flows are from Quebec, the greenhouse gas emission credits from this project will be shared 50/50 by Newfoundland and Labrador Hydro and Hydro Quebec, and no royalties will apply to this project.

3. Muskrat Falls

The feasibility of development at Muskrat Falls has not been established to the same extent as Gull Island or the partial river diversions. Accordingly, more work needs to be done.

To this end, Newfoundland and Labrador Hydro and Hydro Quebec will form a Limited Partnership with ownership of 65.8% for Newfoundland and Labrador Hydro and 34.2% for Hydro Quebec. This Limited Partnership will be created under the laws of Newfoundland and Labrador.

The partners will invest up to a maximum of $20 million for required feasibility studies to assess potential for commercial development of the Muskrat Falls site in conjunction with the development of Gull Island and Churchill Falls Phase II including the partial river diversions.

The development of Muskrat Falls, if undertaken, would proceed along the same lines as Gull Island for issues such as royalties and emission credits.

 

TRANSMISSION:

New transmission facilities will be required in Labrador and in Quebec. Hydro Quebec TransEnergie will include, in its overall cost of service, the cost of service of those new transmission facilities in Labrador and in Quebec, under a rolled-in tolling methodology, subject to applicable filings and decisions.

1. Transmission in Labrador

In Labrador, the transmission facilities will be built and owned by Labrador Transmission Limited Partnership which in turn will be owned 50% by Newfoundland and Labrador Hydro and 50% by Hydro Quebec. The Labrador Transmission Limited Partnership will be created under the laws of Newfoundland and Labrador.

Labrador Transmission Limited Partnership will build and own the following transmission facilities:

- A 735 kV line from Gull Island to the Quebec/Labrador Border.

- A 735 kV line from Gull Island to Churchill Falls.

- Any required transmission upgrade in Labrador to accommodate the Churchill Falls Phase II project.

- High voltage AC line(s) from Muskrat Falls to Gull Island to coincide with Muskrat development, if applicable.

The Labrador Transmission Limited Partnership will contract its total capacity to Hydro Quebec TransEnergie. The contracted price will cover the cost of service including the amortization of the capital costs of the lines, plus operating and maintenance, and provide a fair and reasonable return on equity to the partners of Labrador Transmission Limited Partnership.

The MOU will contain a "Shotgun" provision at the end of Labrador Transmission Limited Partnership's asset amortization period. Such provision, as may be modified by the parties, will provide an option to acquire, through the acquisition of partnership interests, the assets of Labrador Transmission Limited Partnership at net book value, thus allowing Newfoundland and Labrador Hydro to purchase the assets at such value.

2. Transmission in Quebec

Hydro Quebec TransEnergie will build and own the required transmission facilities in Quebec to interconnect with Labrador Transmission Limited Partnership's grid, providing the requested service based on a long-term service request from Hydro Quebec's commercial arm - Services Energetiques. Hydro Quebec - Services Energetiques will enter into long term agreements for the transmission capacity required for Churchill Falls Phase II, Gull Island Generation Limited Partnership and Muskrat Falls (if applicable).

 

ABORIGINAL INTERESTS:

The Provinces and the partners in these projects, Newfoundland and Labrador Hydro and Hydro Quebec, are committed to working cooperatively with Aboriginal groups to ensure that legitimate Aboriginal interests are addressed in a fair and equitable manner.

The determination of specific processes and mechanisms for addressing Aboriginal interests is a matter for discussion between the Aboriginal parties and the partners in these projects. These discussions will commence immediately and proceed concurrently with the negotiation of the Memorandum of Understanding.

 

OTHER:

The framework allows Newfoundland and Labrador Hydro, through CF(L)Co., to immediately recall 130 MW from Churchill Falls production for the benefit of Newfoundland and Labrador as provided for in the existing contract.

Hydro Quebec will enter into a Guaranteed Winter Availability Contract with CF(L)Co. for extra peak season generating capacity estimated to be 680 MW for each period from November 1 through March 31 starting November 1, 1998. The termination of the Guaranteed Winter Availability Contract will coincide with the termination of the Upper Churchill Power Contract. By way of example, in the first season (1998/99), the additional revenues to CF(L)Co. will be $3.4 million. This will escalate to $34 million in 2008/09 and thereafter escalating annually by 1%.

The parties will also negotiate a Shareholders Agreement for CF(L) Co.

None of these arrangements will alter the Upper Churchill Power Contract or affect the positions of the parties with respect to the Upper Churchill Power Contract.

Subject to considerations of economic efficiency for the projects, the parties will work together to maximize the economic benefits of these projects for Newfoundland and Labrador and Quebec and to achieve a proportional and equitable sharing of such benefits.

The partners are committed to undertaking these projects in a manner that is sensitive to the environment and are committed that all projects will be subject to a thorough environmental assessment in compliance with all applicable environmental laws. Additionally, all projects will be subject to all applicable regulatory obligations.

 

NEXT STEPS:

Within the context of this Framework, Newfoundland and Labrador Hydro and Hydro Quebec intend to conduct further engineering and feasibility studies and estimates, as required; initiate preliminary work and arrangements with respect to the required environmental and regulatory review processes; consult aboriginal groups concerning their participation in the projects; and conclude a Memorandum of Understanding by December 15, 1998.

1998 03 09               3:15 p.m.


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