Churchill Falls at 5,428 MW is one of the Premiere Hydro Developments in the world.
The development has a drop of 1,000 feet in the space of 40 miles, in a high rain and snowfall area. This permits about 1.2 trillion cubic feet of water in storage, powering one of the top ten hydro developments in the world.
The original contract to develop Churchill Falls was signed in 1966, by Joey Smallwood.
Smallwood did not realize that the contact that he signed was only a letter of intent, and not the final contract. When he heard that Hydro Quebec had also signed, he exclaimed ‘Hallelujah’, and thought everything was resolved in NL’s favour.
Smallwood’s belief that he had signed the final contract was one major reason that Churchill Falls almost went bankrupt. In reality he had only signed a letter of intent.
Development started virtually immediately, before any proper costing, and long before any long-term financing had been secured, because the feeling was that this letter of intent was the real contract.
Construction continued through 1967, financed only with bank debt from the Bank of Montreal, with no long-term financing in place, and no long-term commitments from customers for the power – all with no final contract in place, but only a letter of intent.
The project was controlled by a company called CFLCo, of which Hydro Quebec was a minority shareholder, with the rest held by Brinco, a private company.
CFLCo used bank lines to fund construction.
As HQ was an insider to the contract and knew what was going to happen when CFLCo kept borrowing short-term debt, with little equity, and slowly moving into an illiquid position of no return.
With only a letter of intent for legal documentation, and no proper financing in place, the project ran out of money in just over a year. It was virtually in bankruptcy very quickly, with poor financial planning.
Bill Mulholland, later the CEO of the Bank of Montreal, was the investment banker on the project. He knew the risk that the lack of financing entailed, and even warned the company, but did nothing to stop the company proceeding with construction, and accumulating massive amounts of long-term debt.
Mulholand could and should have done something but chose not to. Instead, HQ was able to rescue the project and impose ruinous conditions on CFLCo.
The Project was finally completed 5 months early, and under budget, and was a remarkable success, but still went into near bankruptcy. How could this happen?
One wonders where the investment bankers were, to guide NL through the process, because the risks for the financial difficulties which came at Churchill Falls were predictable and well known, even to a person with limited financial experience. This should never have happened.
Churchill Falls today ranks as arguably one of the best hydro-electric projects in the world, yet NL ended up losing it.
The problem was not just Joey Smallwood, who is falsely blamed for the Churchill Falls fiasco. Ultimately the important decisions were made by Brinco, a company over which he had no control and little influence.
In the early 1960s, Smallwood assigned the rights to develop the Churchill River to Brinco, a company financed by the famous Rothschild family, who started a subsidiary called Churchill Falls Corporation Company (CFLCo).
The critical obstacle for NL’s attempts to develop Churchill Falls was power transmission. Churchill Falls was and is isolated in the centre of Labrador, and the only realistic way to get power to market in Ontario and the U.S. northeast is via Quebec.
The Quebec Government refused to even consider allowing Brinco and NL to build its own transmission line across Quebec.
Quebec insisted that any Churchill Falls power would have to be sold to Hydro Quebec at the Labrador border.
Demanding a transmission corridor was the only way that NL could negotiate a decent price for the immense power possible at Churchill Falls. It was well known in the early 1960s that the reservoir could generate some 34 billion KWH a year, which for example is greater than all of Manitoba Hydro’s capacity.
But with Quebec blocking NL from building power lines across their province, Hydro Quebec held all the cards.
It shouldn’t have - under the British North American Act, which was the Canadian constitution, of the day, the new province of NL had a right to demand a power corridor through Quebec.
NL was able to demand this right from Quebec, and Joey Smallwood went to Ottawa seeking support from Lester Pearson.
We have discovered a copy of this letter, in the archives at St. John’s. The letter was written by Joey Smallwood, asking the federal government to invoke the BNA Act and grant NL access to Quebec territory, but the letter was never signed and never sent.
The reason was that Lester Pearson, the Prime Minister of Canada, begged Joey Smallwood not to send that letter.
Pearson pointed out that with rising Quebec Nationalism, giving NL a power corridor would be the very incentive the separatists needed to have Quebec leave Canada.
Joey took one for the team and chose not to endanger confederation. NL never pressed for a power corridor, and as a result had to cast its lot in with Brinco, CFLCo and HQ and voted for Canada.
And that is a major reason that the Churchill Falls contract against NL was so one-sided.
Hydro Quebec knew that NL did not have another way to get the power out of Labrador.
And that they had full power to set the terms of the contract.
NL should have demanded the corridor, and been able to build the transmission line across Quebec.
Brinco and CFLCo had the backing of the powerful Rothschild Family, who were partners. And mining powerhouse RioTinto was also part of the Group.
They had full capability of building and running the whole venture without Hydro Quebec and could have financed it as well.
The second thing that CFLCo, the operator of Churchill Falls did wrong was they went ‘damn the torpedoes’ ahead with construction.
They borrowed short-term to finance a torrid construction schedule, starting in October 1966.
They borrowed short-term, mainly from the Bank of Montreal, who accommodated them to the point where the amount of funds involved grew too large and had to stop.
It was in board meetings in early 1968 that the attitude of Hydro Quebec changed. They saw the opportunity to take over Churchill Falls, and they gradually forced NL out of the picture.
By not getting that corridor for transmission, Smallwood put NL in a lose-lose situation - but Joey did it for Canada, his little bit to stop the rise of Quebec nationalism.
That, and the failure of the investment banks to properly advise CFLCo to get power contacts in place, and the reliance on bank debt to finance a major hydro project caused the short-term liquidity crisis, and near bankruptcy of CFLCo.
With Hydro Quebec seeing no obstacles, they lowered the boom on NL. The price for the power was set at $2.90 per MWH for the first years, then falling to $2.50 per MWH for the next 25 years, and then on Sept 1, 2016, the price fell to just $2.00 per MWH.
Hydro Quebec meanwhile sold the power for $60 to $90 a MWH and made massive profits from the sales.
Hydro Quebec valued the Churchill Falls contract in a filing in 1989, at $250 billion or close to $400 billion in 2021 dollars, and incredible loss for NL.
The big question is where were the investment banks were advising Brinco?
Allowing CFLCo and Brinco to continue aggressive short-term borrowings without a power contract, with no long-term financing in place, and a damn the torpedoes approach in place, without stopping them.
Also, proceeding on only a letter of intent, and borrowing short-term for almost 18 months makes no sense.
And why did the Bank of Montreal not stop them from borrowing so aggressively in short-term debt?
Ironically, Bill Mulholland, after Brinco collapsed, was chosen as CEO of the Bank of Montreal, and lasted until the 1990s. He changed Canadian banking from the benevolent state that it was in, to the rough rock and roll style of the U.S.
The bank recovered under Mulholland, although he was effectively terminated in the 1990s. This led to his replacement by the charismatic CEO Matt Barrett, who laid the base for where BMO is today.
The Rothschild family who was dissatisfied with the way permanent financing was going, and worried about their investments asked Wood Gundy to advise and give their opinion.
It was there that the truth came out. Wood Gundy at the time was not only the leading investment bank in Canada, but also played a strong role in Europe and the U.S.
With Ian Steers in London, along with Bill Wilder and Ross LeMessier in Toronto, these were among the global leaders in investment banking at the time. They discovered the problems with CFLCo immediately - no power contracts in place, no long-term financing plan yet put together.
Had they overseen this account, they would have stopped construction right away.
And had Joey Smallwood not been so pro-Canada, and ignored the threat of Quebec nationalism, with proper financial consultation, NL could have completed the whole Churchill Falls project itself, including building the transmission line.
After all, CFLCo built Churchill Falls under budget for under $1 billion, and finished 5 months early. A transmission line would have been relatively simple.
As far as Churchill Falls is concerned today, you would be lucky to finish it below $10 million per MWH of capacity, and for 5.428 Megawatts, it ranks among the top 10 hydro projects in the world. That represents a replacement price of $54 billion, versus a cost of under $1 billion to construct.
The full benefits of this accrued to Hydro Quebec for over 70 years for two reasons:
1. Joey chose Canada over NL. This stopped Quebec nationalism from benefitting from this issue. On October 30, 1995, Quebec came within 54,228 votes of negotiating separation from Canada. Did Joey’s sacrifice make a difference here? Some people think so. Did he influence 27,115 people? If so, Joey saved Canada as it exists today.
2. The investment bankers did not stop CFLCo from borrowing short-term and failed to put permanent sufficient financing in place. Brinco and CFLCo never had a contract in place, they only had a letter of intent, which has little legal clout. Joey Smallwood relied on outside experts and got bad advice. Don’t blame Joey Smallwood for Churchill Falls. He really had very little to do with it.
The covenant terms of the Churchill Falls contract were negotiated between Quebec and Brinco on terms that characterized a company in bankruptcy seeking relief from a wealthier competitor.
1. Power rates were initially set at only $2.50 to $2.90 per MWH. Quebec sold this power for $60 per MWH, showing the incredible returns HQ made.
2. A 25-year extension was forced on CFLCo, effective on September 1, 2016. The lowest prices in the whole contract will thus extend for another 20 years to September 1, 2041, when the contract ends.
3. Control of over 50% ownership would accrue to Quebec if at least two turbines were not in operation within five years. (In fact, first power was produced on December 9 and December 16, 1971, and this covenant was overcome). It was a testimony to the incredible cooperation between Bechtel Corp for construction, Acres for engineering and the Group at CFLCo, and the good coordination between the three groups.
Unlike Muskrat Falls, this Group excelled. Under budget and 5 months early for the Project, while the Olympic Stadium in Montreal went through multiple cost overruns in the early 1970s.
1. In case of default, Hydro Quebec could squeeze out NL and get 100% ownership.
2. Hydro Quebec could get control of CFLCo if $515 million in long-term debt was not in place by December 15, 1968. This was tight, and this was accomplished in September of 1968.
3. In case of dispute, Quebec law would prevail, not the laws that governed NL.
4. CFLCo had no right to sell additional shares to anyone else but Hydro Quebec, should any more shares be sold. This cut off an avenue of attack that is used in circumstances such as this, of finding a white knight to help.
5. Hydro Quebec gave a $100 million cost overrun guarantee and absorbed much of the interest and currency risk.This was the main concession by HQ. This was part of the justification that Hydro Quebec also used in its court cases to justify the one-sided contract.
6. A final covenant that rubbed salt in the wound of NL was that preference in construction and services would go to Quebec companies.
Joey Smallwood was so humiliated by the whole thing that he did not show up for the opening ceremonies. But he was not solely responsible for the Churchill Falls disaster. His generosity in choosing Canada over NL at the pleading of Lester Pearson, along with some bad advice from investment bankers, did the damage.
Quebec nationalized Shawinigan Water and Power in 1962, for $2.225 million, and the latter owned 20% of CFLCo, the operating company of the project. That is how Hydro Quebec got its share of CFLCo.
It bought a further 5% of CFLCo for $15 million and took warrants for financing the last $100 million of Churchill Falls.
The warrants added 9.2% of ownership, giving Quebec 34.2 % ownership in all CFLCo. Hydro Quebec’s investment amounted to just $17.2 million.
Brinco owned 60% of CFLCo, the operating Company, Rio Algoma, (controlled by Rio Tinto Zinc of the UK) owned 10%, NL itself owned 10%, and Hydro Quebec owned 20%.
NL eventually bought everyone out from the holding company, so it now owns 65.8% while Hydro Quebec continues to own 34.2% of CFLCo.
Right now, Hydro Quebec exports around 26 billion KWH to Ontario and the US, almost the whole of Churchill Falls capacity, and the source of its great profits. If it did not control this tremendous asset, HQ’s exports would be almost zero.
CFLCo makes almost no profit, because HQ pays so very little for the power to CFLCo, even while Hydro Quebec sells the power at almost 20 times higher prices to the U.S. and Ontario.
Many Canadians know of Newfoundland and Labrador’s beauty and vibrant culture, but few are aware that the province is facing a catastrophic debt crisis. Without federal intervention, this treasured Canadian province will face bankruptcy and collapse. The time has come to rectify historical injustices against Newfoundland and Labrador by demanding concrete, sustainable solutions from Ottawa. Inaction will have major consequences for the people of NL, and the rest of Canada.
With debts of $27 billion (including the debt of its public utility) Newfoundland and Labrador could face insolvency within a decade. The province’s declining GDP, high unemployment rate (over 10%) and ageing population spell disaster. Between 5,000 and 7,000 citizens leave the province each year. Including the debt attached to the hydroelectric generating facility Muskrat Falls, the debt-to-GDP ratio exceeds 125% (triple that of most other provinces) while interest costs exceed 25% of what the province collects in taxes and fees. Health costs have been cut and held near $3 billion annually, with a skyrocketing elective surgery wait list as the government minimizes its health expenditures.
On July 28, 2021, the federal government announced an aid package to Newfoundland and Labrador, that gives NL $3.2 billion in royalties from Ottawa’s 8.5% investment in the Hibernia oilfield, plus two loans that totalled $2.0 billion. The announcement and media reports suggested that NL received a $5.2 billion handout. This is not the reality. Of the $5.2 billion announced, $2 billion was further loans and $3.2 billion was tied to potential royalties from the federal government’s income from the Hibernia offshore oil platform. This royalty is very problematic, given the unpredictability of oil prices, and the uncertain future of the declining field. The federal government’s gesture amounts to little more than a creative restructuring of debt. Unfortunately, payments of a little over $100 million a year over thirty years will do little to stem the tide of debt. Under the present Muskrat Falls project’s financing, electricity prices in NL will double as initially proposed, because Ottawa’s financial support is too weak.
The province will have to raise electricity prices to $0.23 KWH from $0.13 and will still have to borrow to pay the interest.
To prevent complete bankruptcy for Newfoundland and Labrador, Ottawa must step up with the following solutions:
1. NL needs to be bought out of its $5 billion or so equity position in Muskrat Falls, with a direct cash contribution. This would give NL some real control of its balance sheet. Ottawa bought Transmountain Pipeline for several billion -why can’t it give similar aid to NL and Muskrat Falls?
2. Ottawa needs to absorb the $8 billion in Muskrat Falls debt that Ottawa guaranteed. If Ottawa does not agree, NL could use the nuclear option, and voluntarily default on the debt. The federal government then has 5 days to rectify the situation and would have to take over principle and interest payments on the debt.
3. Ottawa needs to hold the investment in Muskrat Falls in conservatorship for NL until 2041, when the province regains control over the lucrative Churchill Falls contract. Churchill Falls will have income in the $1.4 billion to $1.6 billion range then, and this can be used to buy back Muskrat Falls at depreciated cost.
Economists have been calling for Ottawa to restructure its provincial equalization payments for some time. The current system does not reflect the current needs of the provinces, especially Newfoundland and Labrador. Despite its crushing debt, NL is considered a “have province” and derives no benefit from equalization payments. This is due to the fact that payments are calculated based on “taxes collected”, a method designed to keep Quebec in Confederation, but penalizes NL. In fairness, the province should receive a catch-up payment of $1.2BN - $1.4BN - the amount NL is missing from equalization. Quebec receives $13 billion a year, while New Brunswick, Nova Scotia, and PEI all receive billions. Despite being far worse off, Newfoundland and Labrador receives nothing.
In the 1960s, the Churchill Falls generating station was forced to make profit negotiations in a time of financial duress and, as a result, signed away the lion’s share of its profits to Hydro Quebec. Several attempts have since been made to renegotiate the contract, but all have failed. Hydro Quebec exports around 26 billion KWH to Ontario and the US, almost the whole of Churchill falls capacity, and the source of its great profits. In 2041 NL could be in a position to profit in the range of $1.2 billion a year from Churchill Falls. It is time for Ottawa to intervene and put Newfoundland and Labrador in a position to profit from this tremendous asset. The sale of Churchill Falls to Hydro Quebec is not the answer. Churchill Falls was robbed from NL once, and cannot be allowed to be bargained away by a federal government more concerned about an ‘Atlantic Loop’ than saving this province.
Currently, Hydro Quebec controls the watershed and shuts down flow so it can produce electricity at peak months in summer and winter, and at peak hours. This means that for six months of the year, Muskrat Falls (with little water storage behind its dam) will barely have enough water for 20% generation capacity unless backup is obtained. This would mean significant blackout periods for St. Johns residents. In order to prevent this, Ottawa must step in to provide a loan of $500 million to rebuild the Holyrood station so it can provide this backup in times of need.
Ottawa must stand up and provide real solutions for Newfoundland and Labrador. It is time to right historical injustices against this province and preserve one of our country’s most incredible regions and cultures. If the federal government is to take notice, we all must stand up and demand action. It is time to demand justice and equality for our fellow Canadians in their time of need. The future of Newfoundland and Labrador is in our hands.