B.C.'s power pitch: You take the risk, we'll take the gravy

COMMENT: "But prospective investors should take this new demand for what it is: A warning sign that British Columbia is growing cool on the notion of private ownership of power generation." Whooh! I wouldn't go that far!

PATRICK BRETHOUR
Globe and Mail
June 13, 2008

VANCOUVER -- Try pitching this one to the board of directors: Let's invest billions in a capital-hungry power plant, in a risky construction environment. If all goes well, we'll earn single-digit returns.

And then, when the capital costs are accounted for, and decades of higher profits beckon - let's sell.

Such is the predicament of investors in British Columbia's power sector today, now that B.C. Hydro has given itself a pry bar to buy out any power project that seems particularly profitable. The utility has just issued a call for proposals from the private sector to build a whopping 5,000 gigawatt-hours a year of power, equal to about 10 per cent of the province's current generating output. All of it is to be clean power: hydro, geo-thermal or wind, for the most part.

Those kinds of projects are desperately needed if B.C. Hydro is to meet its own goals for clean power and energy self-sufficiency, not to mention the strictures imposed by the province's push to reduce greenhouse gas emissions. Although opponents of private power will deny this strenuously, outside investment capital is needed to make this happen. That is the foundation of the B.C. government's policy of allowing private firms to turn a profit while they help to fulfill the public interest.

The foundation has just gotten shaky, however. Buried in the depths of the document asking for proposals is a paragraph that will give B.C. Hydro the ability to buy the "residual rights" to a power project once the term of the initial electricity-purchase agreement expires.

Even though some of the agreements are for 40 years, the power plants being proposed are expected to be generating electricity for decades beyond that point, just as much of B.C. Hydro's generating capacity comes from projects built, and paid for, decades ago. Because of that, the utility's cost for producing electricity is lower than for new projects (whether it or the private sector builds them).

The turbines in NaiKun Wind Energy Group Inc.'s proposed offshore wind power project, for instance, will work just fine for 40 years.

Until now, investors have had an entirely reasonable expectation that if they shouldered the risk of construction, and operation, they would be the ones allowed to reap the benefits when their projects saw their costs drop, and profits rise.

However, B.C. Hydro is, in effect, expropriating those profits and demanding that any bidder spell out, now, how much it will be willing to sell for two, three or even four decades down the line. (In a similar vein, B.C. Hydro is requiring bidders to commit to construction costs in November for their proposed projects, while waiting until mid-2009 to actually award contracts. If, or more precisely when, costs spike in the meantime, it will be the bidders who pay the price for the utility's languid pace of decision making.)

Of course, B.C. Hydro is not so crass as to label its demand as such, or to articulate why the clause is necessary. Instead, it "invites" proponents to include a sidecar proposal on residual rights - and later spells out that the presence of such a proposal will form part of the calculus used to decide which bids will be accepted. Hint taken.

Firms preparing bids for the latest call for proposals are being circumspect - why snap at the hand you hope will feed you, after all? While the call for bids is generating enthusiasm, it's clear that those warm feelings don't extend to the prospect of having to hand over an asset just as its returns start to rise.

Bruce Ripley, president of Plutonic Power Corp., zeroes in on one practical difficulty: How exactly do you price a power plant for a sale in, say, 2048, a period in which climate change, greenhouse gas policies and energy technology are going to warp the economics of electricity. "They're going to be fascinating discussions," he says. Mr. Ripley, while measured in his critique, does allow that the residual-rights clause will make power projects less attractive for financial investors.

If one goes strictly by the numbers, the residual-rights clause might not seem like such a big deal. As Nick Hann at MacQuarie Capital Markets Canada points out, the current value of profits 40 years in the future is negligible. And firms were always going to need to renegotiate deals with B.C. Hydro, even without an explicit residual-rights clause.

But prospective investors should take this new demand for what it is: A warning sign that British Columbia is growing cool on the notion of private ownership of power generation.

pbrethour@globeandmail.com