The flaws in the Duke Point deal

Dan Potts
Joint Industry Electricity Steering Committee
Special to the Vancouver Sun
16 Nov 2004

COMMENT: After BC Hydro was denied a permit in September 2003 for its gas-fired generation project at Duke Point, it began a year long process - the Call for Tenders (CFT) - to find the lowest cost generation solution to meet a 2007 shortfall on Vancouver Island.

Critics of the process ranged from environmentalists and community groups to industrial users. In a mini-hearing in late 2003, the BCUC said that the CFT could proceed, but that questions about the process and decision criteria in the CFT would be addressed in their review of any electricity purchase agreements applied for following the Call.

This opinion from the industrial users of electricity is a major shot across the bow of the EPA. - Arthur Caldicott

The proposed award of a power supply contract to Duke Point Power Limited Partnership raises important concerns.

The contract to build and operate a 252-megawatt gas-fired combined-cycle power plant at Duke Point, near Nanaimo, includes the provisions that the site and equipment BC Hydro has acquired at Duke Point will be sold to Duke Point Power for $50 million and, if the contract is approved by the B.C. Utilities Commission, the company will construct and operate the plant.

Total reported capital cost of the facility is $282 million. This leaves Hydro with a write-off of $70 million, which it also intends to collect from customers.

In proposing to proceed with the sale and power purchase agreement, BC Hydro is effectively reactivating the project previously rejected by the BCUC in late 2003. Just one year after that rejection we are right back where we started, proposing the same questionable project but with a different owner.

Ratepayers have serious reservations regarding the economics of this proposal. To attract proponents, BC Hydro has had to structure the bid solicitation very differently than would normally be the case when purchasing power from third parties.

Normally a contract with an independent power producer would involve the purchase of a certain quantity of electric power at an initial price plus some allowances for price increases related to inflation over time.

Once the contract is signed, the price and quantity of electric power can be estimated rather closely over the term of the contract.

Not so in this case. Here, the proposed contract includes annual payments to Duke Point Power for the fixed costs of supplying the capacity, and then an amount per kilowatt hour when the power is produced using natural gas paid for and delivered by BC Hydro.

To estimate the cost of the power you must estimate the cost of the gas for the length of the 25-year contract and also estimate the amount of time the plant will operate. Both estimates are subject to an extreme degree of uncertainty and will likely render the plant uneconomic for much of its useful life.

Market conditions for natural gas and electricity for 2004 up to November illustrate the problem. For a plant of the type proposed for Duke Point the price of importing power from the U.S. was less than the fuel cost for this plant for 80 per cent of the time.

Since power is available for import at lower costs than the fuel cost, the plant would operate economically for 20 per cent of the time and may also operate to alleviate transmission constraints during brief periods of extreme winter cold on Vancouver Island.

But under the proposed contract, the payments for capacity, sufficient to pay the fixed costs and provide a reasonable rate of return to investors, will continue. This raises the real possibility that high fuel costs and low utilization will make the power from this plant horrendously expensive.

BC Hydro is a regulated utility with a guaranteed rate of return of 13.91 per cent on equity. Rates are set by the BCUC to recover costs and provide that rate of return. Energy costs above projections flow into a deferral account for eventual payment by customers, and customers are the ones that will bear the full brunt of both the gas price and utilization risk associated with the proposed plant at Duke Point.

BC Hydro is expected to shortly make application to the BCUC for approval of the proposed contract. We would hope that the BCUC will require BC Hydro to provide some real alternatives for an economic comparison.

These alternatives could include increased maintenance for the existing transmission lines, management of industrial load to reduce peak power requirements, the possibility of expediting construction of additional transmission capacity to the Island and the alternative of generating power using available, lower-cost fuels.

Better options must be developed if BC Hydro is serious about supplying reliable low-cost power for generations.

Dan Potts is the executive director of the Joint Industry Electricity Steering Committee that represents the major industrial users of purchased electric power in B.C.'s pulp and paper, mining and mineral processing, and electro-chemical industries.

(c) The Vancouver Sun 2004