Canada has immense natural resources with which to produce hydroelectric energy and this article provides an overview of the Canadian hydropower marketplace and where it is headed.
Corpfinance has provided financing for a number of hydro projects and was responsible for financing a number of projects developed by the forerunner development companies that have now expanded into public companies (e.g., Algonquin Power & Utilities Corp., Innergex Renewable Energy Inc. and Boralex Inc.). Ball and the team at Corpfinance have worked with many hydro project developers and are responsible for early stage advisory services and the financing of power projects throughout Canada.
Editor’s Note: This article is an expanded version of the Canadian market outlook that was published in the January issue of Hydro Review.
Canada is a world leader in hydropower and is the third largest producer of hydroelectric power in the world after China and Brazil even though their populations dwarfs that of Canada. Its neighbor, the United States of America -- also with substantially larger population -- is fourth largest. In large part as a consequence of its hydro generation, Canada now has one of the cleanest supply mixes in the world, with approximately 80% non GHG emitting generation. This is recognized by the U.S. Environmental Protection Agency, which allows U.S. states the flexibility to import clean energy from Canada as a means of meeting mandated emission reduction targets.
While recognizing the situation and opportunities for hydroelectric power in Canada are very different from those in the U.S., and despite its existing build, Canada continues to have significant untapped potential in many of its 10 provinces and three territories. This potential is largely in those provinces that have the preponderance of existing development; British Columbia, Quebec, Manitoba, Newfoundland and Labrador, and Ontario. Potential returns have reduced due to increasing costs of project construction, increased regulatory burden, and the diminishing supply of sites with economical hydrological resources that are sufficiently close to power markets.
This article provides an overview of where Canada is today and where it is headed in terms of hydropower generation and development.
Understanding the situation
In Canada, the federal government, or Federal Crown, does not have direct control of hydroelectric production in the provinces or territories. The Federal Crown is charged with: making sure trade and treaties between provinces are available; ensuring power transmission runs between provinces; and determining Canada’s policies with regard to reducing greenhouse gases.
Provincial Crown corporations also have oversight of utilities, and Canadian utilities are vertically integrated Crown corporations or Crown corporations operating in conjunction with investor-owned distributors. Additionally, approximately 1,201 independent power producers also own and operate hydro in Canada.
The major Canadian utilities that provide electricity from hydropower facilities are:
-- Alberta: TransAlta
-- British Columbia: BC Hydro
-- Manitoba: Manitoba Hydro
-- New Brunswick: NB Power
-- Newfoundland and Labrador: Newfoundland & Labrador Hydro
-- Northwest Territories: Northwest Territories Power Corp.
-- Nova Scotia: Nova Scotia Power and Nalcor Energy
-- Ontario: Ontario Power Generation
-- Quebec: Hydro-Quebec
-- Saskatchewan: SaskPower
-- Yukon: Yukon Electrical Company Ltd.
Marketplace general issues
There are unique aspects to hydroelectric generation opportunities in each province, based on the provinces hydrology, its forecast load requirements, its commitment to green power, and its energy market structure. I will highlight specific provincial issues in a follow-up section. Firstly, I will outline issues that are general throughout Canada.
Increased project cost
While operating costs of hydro facilities are low, they have always been capital intensive, however costs are increasing. One of the facilities our company helped finance in 2014 cost more than US$6 million per megawatt, which is astounding. When I began participating in developing financing for hydro projects more than 20 years ago in 1992, the costs even for very small projects were less than $2 million per megawatt. In looking at the current costs, one must ask, “Why have things tripled?”
This number may be lower due to ownership of multiple sites, where the ultimate ownership is not known.
The answer: Some increased costs are related to materials and some are due to labor. Other areas contributing to higher capital costs per project include greater amounts of required detailed feasibility studies and consultations with many interested stakeholders, including native communities. Engineering costs are also a factor, but not just for the plant itself. Engineering must be done for third parties, meaning the engineering must meet approval of organizations within provinces that have environmental concerns.
Interconnection availability and costs
Hydro projects must be sited where the hydrology is feasible, and this may be unattractive from the perspective of transmission access and proximity to load. All things considered, those projects with favorable location and strong hydrology, the “low hanging fruit,” have already been developed.
Interconnection now is a big cost. Interconnection was always normally born by the utility, but as utilities want to build out their networks to new production sites, utilities want project developers to share in these higher interconnection costs. Interconnection costs are further exacerbated because the portion of interconnection infrastructure costs borne by the project often reflects a design to provide for access to potential future facilities sometimes owned by other developers. The utilities are not willing to give you unfettered ownership of the new interconnection infrastructure forever, which has always been the debate since the introduction of requiring projects to pay for a portion of interconnection costs.
These added costs are not going away.
As a consequence of permitting and other regulatory requirements, the time needed for project feasibility, development and completion has increased substantially. As noted above, this increased time from inception to completion further complicates interconnection to the grid, as evaluation of future system congestion must be incorporated in the mix. The one barrier we cannot deal with in the finance world, and it's a frustrating one, is time. Time is a killer to developers.
Developers raise money, if project development is delayed developers are only earning small amounts of interest on it while waiting to deploy the money. Developers want to put the money out as fast as possible and develop the project(s).
I have indicated above the various factors that have driven up hydro development costs. The cost of bringing new hydropower online is expensive relative to older installations and, needless to say, the cost will be passed down to the ratepayer either directly or subsidized by either the province or federal government. Unsubsidized merchant development does not take place. Any new hydropower brought online today will have to be subsidized to some degree. Given this, in addition to time requirements, system planners strictly evaluate the system requirements that can be met by hydro development, and compare these to other competitive alternatives, which have increased of late and are discussed below.
Hydro has been part of the energy business since the turn of the century. There is a long track record of well-established corporations focused on hydropower development and also disciplines of understanding how to employ hydroelectric power throughout Canada. It has a long history producing green reliable power.
However, now hydropower faces competition from newer green technologies, wind and solar. Harnessing wind generated energy has been in place in Canada for about 20 years, and solar has been part of the mix probably since 2010. Solar development to date has been primarily in Ontario.
While the cost of bringing new hydropower online is expensive and increasing in expense relative to older installations and newer technologies, costs associated with wind and solar are decreasing making them much more competitive to hydropower than in the past. Hydro projects typically enjoy higher output relative to capacity when compared to wind and solar, and produce power without degradation for long periods. However, solar panel costs are projected to continue to drop while hydro installation costs are expected to continue to rise. This may soon offset the typically higher realized output given the same size installation – let alone that hydro may not be an option in the first place if a suitable site does not exist near demand for power.
Siting is less an issue for wind and solar, and as they are less complex in engineering design, projects can be constructed in much less time.
We now look at the aspects of hydropower development unique to the individual provinces. How provinces develop hydroelectric projects depends on laws and regulations within their jurisdictions. Alberta is the only fully open access market, however, its market structure has not incented hydropower development. Ontario and the Maritimes (New Brunswick, Nova Scotia and Prince Edward Island) have competitive markets with directed investment processes available to incent hydropower.
Other provinces have open access transmission, with vertically integrated utilities that periodically purchase waterpower by way of power purchase agreements. The increased focus at the federal level towards carbon emissions may well further stimulate existing provincial interest in renewable energy sources such as hydropower.
Let us take a look at each area, beginning east and traveling west.
Newfoundland and Labrador
Newfoundland and Labrador Hydro, a subsidiary of Nalcor, which is itself provincially owned, generates and delivers electricity for Newfoundland and Labrador. The province’s hydro generation is substantial, which includes the Churchill Falls project, with a rated capacity of 5,428 MW. It supplies Quebec and the North East. The province has had limitations on the development of independent power, which in part may be due to its geographical separation from other markets. This will change in future, as it develops the Lower Churchill project with Emera (discussed below), which will include a transmission link between Newfoundland and the mainland. Nalcor also has lots of other small opportunities it will probably look at the possibility of investing in once the Lower Churchill project is complete.
Prince Edward Island
Prince Edward Island is Canada’s smallest province and does not utilize hydro.
Nova Scotia is also a comparatively small province, located next to Prince Edward Island. Its geography limits hydroelectric development potential.
Nova Scotia Power provides energy and is owned by a private corporation that is publicly traded. The company generates most of their power from fuel. They own 16 different hydro sites totaling 398 MW. At 230 MW, their Wreck Cove site accounts for more than half of their current hydro capacity. Nova Scotia Power has a joint venture with Newfoundland and Labrador through Nalcor Energy to develop the two-part, 3,000-MW Lower Churchill hydroelectric project in Labrador.
Phase 1, 824-MW Muskrat Falls, is probably about 30% through its construction cycle and there are long days yet to go. But, it is scheduled to be commissioned in about 2017. Phase 2 will consist of the 2,250-MW Gull Island generation facility. Gull Island development would follow no earlier than three years after Muskrat Falls is online.
Nova Scotia, as well as Newfoundland and Labrador, will benefit from the Lower Churchill project through the 500-MW Maritime Transmission Link that includes a 180-km-long undersea cable from Cape Ray, Newfoundland and Labrador, to Cape Breton, Nova Scotia. Nova Scotia will use the power locally and also sell some energy to the U.S.
New Brunswick has a few small hydroelectric facilities and is considering developing additional plants. This province is not a large player in the hydro market, but it is working its way through green energy requirements it must begin implementing within the next five to 10 years. This means there will be opportunity for local independent power producers as the province and New Brunswick Power work towards increasing their capacity from renewable sources.
NB Power has identified a goal of generating 40% of in-province energy through renewables, including small hydro, up from 30%. Project sponsors will be native communities and co-ops.
Quebec is one of the largest hydroelectric producers and energy exporters in North America, and export revenue has been good for the province.
It is quite interesting watching how the province views exporting power compared to British Columbia, its competitor on the west coast. The populace in Quebec believes hydroelectricity is a great product to export and Quebec does so through large DC transmission lines to New York and Massachusetts.
While Hydro-Quebec, the provincial crown corporation, has developed most of the province’s water resources, there has been involvement by independent producers.
In 2009, Hydro-Quebec launched a program for the purchase of electricity generated by hydropower plants of 50 MW or less, for a total of 150 MW. The goal of this program was to enable local, regional and Aboriginal communities to develop small hydropower projects. The Quebec government terminated this program in February 2013. Currently the focus has moved to incent independent development of wind. However, I think there is still opportunity for all people involved in the hydroelectric business because Hydro-Quebec will be willing to purchase energy, as long as the power is efficiently produced. Using a cap and trade program with California, hydropower development would still be on Hydro-Québec’s radar.
Ontario has the largest population of all the Canadian provinces and a large mixed bag of renewable energy facilities. The province basically had a mandate to increase renewable energy production and to eliminate all of its coal-fired plants. There is no longer coal generation in the province.
Ontario has a developed real time market, however, market pricing alone has been insufficient to support independent hydro developments. Ontario through, the Ontario Power Authority (now combined with the independent electricity system operator) has provided long-term contact opportunities to power developers in the renewable space, including hydropower. Since 2010, Ontario has put an emphasis on meeting its needs through renewable power generation and implemented a feed in tariff (FIT) program to enhance renewable supply.
While there have been additions from hydro and wind, recent Ontario capacity additions are solar installations. On the Canadian dollar, solar prices had been as high as 80.2 cents per kWh (58.1 cents US). Pricing has fallen and is now comparable between the technologies (i.e., 27.5 cents per kWh non-rooftop solar 500 kW project versus 24.6 cents for new water power). There is greater emphasis on bid pricing; project proponents are encouraged to offer reduced rates to add to “points” to their bid submissions. Contracts incent participation by First Nations communities and coops targeting small projects -- 500 kW capacity and below -- a detriment to waterpower projects that are usually larger installations.
There have been opportunities to tender Large Renewable Procurement (LRP) programs (renewable projects greater than 500 kW), to help Ontario meet its production target of 50% renewables by 2025. The province’s recently planned 300 MW LRP targets water power to meet 75 MW. Proposals have been submitted with IESO and responses are expected early 2016.
Again, in Ontario, capital costs have increased to such an extent that it is affecting industry competitiveness.
Ontario used to have relatively inexpensive power for industry from both its previous excess capacity when large nuclear stations came online, and when coal fired generation was prevalent. But now, despite FIT programs that are available to entrepreneurs to bring more hydro into the market, it's still challenging. Not only are feasible sites in short supply compared to sites that can be employed for other forms of renewable generation, Ontario has lots of environmental and transmission interconnection hurdles for hydroelectric sites, and the time needed for project development is protracted. But, I think there is opportunity in the market for people who are nimble and innovative enough to see ways to cut through some of the red tape that may exist.
Ontario is joining a cap and trade program with California and Quebec, which may enhance hydropower development.
Manitoba, Saskatchewan and Alberta
Manitoba, Saskatchewan and Alberta are the western provinces and two of them -- Saskatchewan and Manitoba -- have Crown corporation utilities. Alberta has privately held publicly traded companies providing its utilities.
Alberta has a new provincial government that has a strong commitment to renewables. It will phase out coal generated power by 2030. Renewable energy will provide 30% of power to the grid. How this will be achieved contractually is under review. While it is expected wind energy will be the prime beneficiary of the province’s plan, hydropower will also benefit.
One of the negatives for hydro to date has been the fact that Alberta’s open market lacks needed long-term contracts to support high leverage levels in this capital intensive industry. We'll see where that ends up. It could be the case that the government will incent hydro development in Alberta through offering the opportunity of long term contracting. It could also be the case that some of the large oil production companies and other utilities, as they green themselves up, try to reduce their carbon footprint with strategies to acquire renewable generation. And in this case, hopefully those projects offered contracts from corporate offtakers will have strong balance sheets. The contracts should be such that power purchase agreements will be the equivalent of what a utility contract offers – the ability to get the project financed and come to fruition.
Manitoba has a strong and historical amount of hydroelectric power with more than 5,000 MW of installed hydro capacity while only about 700 MW of installed capacity from other generation forms. It produces more hydroelectricity than the population can use and it is available for export. I think Manitoba is seeing advantages they can gain from production and moving that power south of the border, and maybe also to their neighbors east and west. It'll be interesting to see if they go to the next step, which is to allow a number of entrepreneurs to team up with First Nations people, producing some independent power that they can move through that marketplace.
Saskatchewan falls almost into the same type of realm as Manitoba, although to a lesser degree with 850 MW of installed hydro capacity. Saskatchewan sees itself as being able to get its renewables out, eliminate dependence on coal-fired and gas-fired plants and use its resources of wind and solar. Also, of course, this means that its hydro surpluses will also start being brought into the marketplace. Shortly, we'll probably see some introductions of First Nations joint-venturing with SaskPower and will probably be in the north of the province.
Canada’s westernmost province faces the same challenges every other jurisdiction in Canada has, which is negotiations with First Nations peoples. British Columbia must make sure it has agreeable settlements on environmental concerns (i.e., fish habitat) and land acquisition for transmission interconnection.
British Columbia has the country’s largest mountain ranges and greatest potential to generate hydroelectric energy. When you're going through mountains, it is obviously more complicated than doing the same in the middle of the plains. So, that is part of the challenge. Since 2000 and continuing to today, the province has been very aggressive and encouraged independent power producers to match BC Hydro’s power output. Through a standing offer, the province has demonstrated its continuing commitment to buy power from the private sector.
In December 2014, the provincial government announced a final investment decision, approving construction of the 1,100-MW Site C hydroelectric project at a cost of C$8.34 billion (US$5.74 billion), as well as a project reserve of $440 million. A notice of Site C construction commencing in 2015 was issued July 2015. If Site C is successfully developed, I see it eventually being a win-win for all parties as it will be able to produce enough energy such that some of it can be shipped south of the border and potentially produce the same kind of results seen in Quebec.
The 10 provinces and three territories each have their own laws, regulations and political will about how to do things. But, all we have to remember is that when you look through that and we talk about the different jurisdictions, what's the word that's always used? Hydro.
The success and continued capital improvements by well-known companies such as Ontario Power Generation, Hydro-Quebec, Manitoba Hydro, BC Hydro and others, I think, speaks for itself with regard to the high status of hydropower in Canada.
Christopher J. Ball has held numerous managerial positions within the finance industry. Ball brings over 35 years of domestic and international banking experience to the position of Executive Vice President of CFI and President of CFI Capital Inc. He joined CFI in January 1988. Ball is CFI's infrastructure and power project specialist and has been instrumental in the initial funding of several of Canada's leading hydroelectric development companies, many of which have gone on to become publicly listed entities, including: Algonquin Power and Utilities Corporation (TSX: AQN), Innergex Renewable Energy Inc. (TSX: INE), and Boralex Inc. (TSX: BLX). Prior to joining CFI, Ball was the vice-president responsible for establishing the cross-Canada presence of Standard Chartered Bank. Also, he held various managerial positions with the Canadian Imperial Bank of Commerce. Ball is an independent director of Algonquin Power & Utilities Corp. and chair of the Audit Committee, a past director of the Clean Energy BC, an advisor to HydroVision International, and a recognized speaker within the hydroelectric industry.