Why the feds should stay out of Muskrat Falls

What is the government of Canada doing subsidizing hydroelectric megaprojects in Atlantic Canada?

Do not be misled: That is what the federal government’s guarantee of up to $6.3 billion in debt for the Muskrat Falls hydroelectric project in Labrador amounts to. To be sure, Ottawa is not directly assuming responsibility for the debt: so long as the borrowers — Newfoundland’s Crown-owned power utility Nalcor and Nova Scotia’s Emera — are good for the money, the federal government won’t have to pay out a nickel. And yes, the 19-page agreement between the parties is bristling with caveats and riders designed to ensure the guarantee is never called upon.

But let’s not kid ourselves. By guaranteeing the debt, the federal government is assuming a liability. Suppose instead of standing behind Nalcor and Emera, it had borrowed the money itself, then sought repayment from them. Wouldn’t we agree there was a risk associated with that? The guarantee, though it does not involve a transfer of cash, has a cash value just as if it had. It’s pretty easy to calculate. It’s the difference between the project’s actual cost of borrowing and the costs it would have assumed without the federal guarantee. The figure commonly put about is $1 billion.

It would have been simpler, and more transparent, if the feds had just written the project’s public and private backers a cheque for $1 billion. It didn’t, for the same reason governments always prefer these sorts of complicated, roundabout ways of delivering the lolly: Because if it were simple and transparent, everyone could see what was going on. But a loan guarantee — why, it’s nothing at all, really.

As its proponents will patiently explain, it means the project can borrow at the same interest rate as the federal government, rather than at the higher rate creditors would demand of Nalcor or Emera. Great. Why doesn’t the federal government guarantee everyone’s loans, then? Some risks are better than others. If capital is to be allocated efficiently, they should be charged rates to match. Letting poorer risks borrow as if they were better risks steers capital into areas that are not justified by the returns, and encourages too much risktaking generally.

So I come back to my original question: Why is the government of Canada subsidizing hydroelectric projects in Atlantic Canada? To be specific: Why is it involving itself in this one? Presumably the project’s backers would agree that it would not go ahead without the federal guarantee (they can hardly admit to asking the feds to put $6.3 billion at risk for no reason at all). That is, absent this disguised subsidy, the benefits would not exceed the costs, including a return on capital sufficient to justify the in- vestment. So how is it in the national interest to underwrite a project whose costs, we have just agreed, exceed its benefits?

Provinces do this all the time, of course, and it’s always a bad idea. It biases investment toward megaprojects and away from smaller scale ventures, toward hydro-electricity and away from other power sources, toward energy-intensive industries and away from others — in each case, towards projects that would not have been the best choice on their merits, but only because of the subsidy.

Moreover, it is not only the economy of a province that is thus distorted, but the national economy — which is why Europe, for example, prohibits subsidies and other anti-competitive practices as violations of the single market.

If it is too much to ask that the government of Canada would exercise the same vigilance over our own common market, they might at least refrain from introducing distortions themselves. Granted, federal equalization payments have the same effect indirectly: Rather than charge the true economic price of the electricity they generate, and have their equalization cheques reduced accordingly, Manitoba and Quebec practically give the stuff away.

But Newfoundland, swollen with oil wealth, is no longer an equalization recipient. So why does it still need aid from the federal government? Yes, appearances can be deceiving: It still carries a heavy debt load. In which case, why is Ottawa inducing it to take on even more debt? The feds’ liability, remember, is capped at $6.3 billion. Responsibility for any cost overruns rests with the borrowers. And the cost of the project is already more than $1 billion over initial estimates.

Two arguments have been advanced for why the feds should participate, notwithstanding the project’s dodgy economics. One, it is sold as a means of reducing greenhouse gas emissions. But subsidizing less carbonemitting forms of energy is always costlier than simply taxing emissions directly. Add Muskrat Falls to the list of costs the Harper government has piled on the taxpayer in the service of its obdurate refusal to consider a carbon tax.

And two, there’s the whole Quebec thing. Muskrat Falls is part of a larger scheme to develop power along the Lower Churchill River for export via Nova Scotia to the northeastern U.S. Power from the upper Churchill, readers will recall, is sold to Quebec for a song, thanks to a terrible deal Newfoundland was suckered into signing decades ago. To protect its position, moreover, Quebec refuses to wheel Newfoundland power through its territory on its way to neighbouring markets.

In any self-respecting federation, it would be the job of the federal government to prevent such blatant provincial obstructionism. But this is Canada, so instead the feds provide the financing for Newfoundland to do an end run around Quebec. Two wrongs make a right, I suppose, as long as the taxpayer pays both ways.