Energy prices and economic development

Not that I want to raise this issue, again, but I listened to the Spin Reduxit podcast for this week and wanted to make a little clarification as is my wont. Let me say first, however; that I hope the Spin Reduxit podcast continues as we don’t have a lot of this type of online audio commentary on NB politics and I am increasingly relying on audio for my information needs.

I think it was Dan McHardie that said large industrial electricity users were ‘subsidized’ by other rate classes insinuating that they were getting a deal and pushing up the rates of the other guys.

While this may be true on a superficial level (i.e. take NB Power’s total costs and divided them per kW and then look at the rates paid by various classes) but the truth is – as mentioned by Gaetan Thomas on several public occasions – that the large users are critical to his business because of a basic accounting concept called contribution margin. I have talked about this before but it is worth mentioning again.

NB Power’s cost structure is relatively inelastic meaning that if the company loses a large customer (say $5 million/year in revenue), it can only decrease its costs by a marginal amount meaning the loss of that customer would be a huge blow to NB Power. McHardie’s inference is that the large guys are being subsidized. If they are, why not let them leave NB Power for good? Presumably, NB Power’s books would be stronger if the big guys are subsidized (be definition). But that ignores contribution margin.

In a corporate setting – say a private sector utility – the supplier of electricity could reduce the rates paid by large users right down to the point where the contribution margin effect drops to zero (i.e. the loss of the large customer can be compensated by an equal reduction in cost).

Now at some point in the future when we are buying half or more of our electricity from hydro-Quebec, it may make sense to drop the large industrial users if their rate is below the cost of buying the power (a real subsidization). However, NB Power will have still have significant stranded debt servicing costs on top of the cost of buying power from HQ or wind producers, etc. (what, you didn’t realize the debt associated with all that wind power was not on NB Power’s books?).

I have argued for – and mostly lost the argument – that energy prices should be determined with at least one eye on economic development. If we want to attract new energy-intensive projects, we should try to have rates that are competitive. There is a greater public good argument that could and should be made here.

I’m not saying it isn’t a complicated calculus but someone somewhere should be thinking long and hard about this.

I believe that we should have an NB Power Industrial or some other separate entity that can price energy competitively for large industrial projects (for example, a new natural gas fired electricity plant right now could offer rates – with full debt service costs – well below current industrial rates at NB Power). I realize that moving large industrials out of NB Power’s current client mix would be problematic for NB Power but I would at least like to see some scenario planning in this area.

What we normally end up with is a few, isolated workarounds (like what NS Power is doing with the forestry industry in that province) but that isn’t growth oriented. That is focused on salvaging a few large mills. I would like to see a power regime – electricity and natural gas – that is set up fro growth.

Now some would argue that cheaper energy doesn’t matter and we should focus elsewhere. Okay. Give me the elsewhere.

I was kind of hoping New Brunswick could have attracted a slew of data centres. I realize they are energy hogs and don’t provide a lot of jobs (but the jobs are good paying). I just liked the idea of Google, Yahoo!, Microsoft, Amazon, etc. putting down roots in New Brunswick. If we had an “NB Power Industrial” model, maybe that vision could have worked.

PS (added a bit later):

Just to head off the usual criticism that I am a lackey of the province’s large industrial companies, this really isn’t about them.  I am searching for the next growth engines for the New Brunswick economy.  When I read that Enbridge isn’t forecasting a single new large industrial client in their next 10 year projections – that is what pisses me off.  The three big industrial customers that are upset now are a concern for me but my biggest worry is that we have all this natural gas – from offshore NS, from LNG and even from local sources – and it’s priced for industrial users at the highest rates in North America (except those clients with a single end use franchise – they have competitively priced gas).

Even NB Power, if you read the forecasts of the NBSO, just assumes no new large load.

It’s s pathetic if you really think about it.  We are all in the process of engineering our own slow decline and not even recognizing it.

I want NB Power to be forecasting a 50% increase in industrial load over the next five years (as optimistic provinces such as Ontario build into their projections).

I want Enbridge to aggressively forecast 20 new large industrial clients over the next decade.

That will mean hundreds of new jobs and tens of millions in new tax revenue for government.

I’m sick of this managing decline mindset in New Brunswick.     The Dept. of Finance tells the universities to get ready for fewer students.  The Department of Education is figuring out what schools to close.   It’s all about managing decline.

Let’s manage growth, folks.  Let’s expand our economy.  Let’s drive an economic expansion that requires young families to move here and repopulate our schools.  They can’t build schools fast enough in Alberta.

I spend my days thinking about how this place could grow and it seems like everyone else is thinking about how to manage decline.

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13 Responses to Energy prices and economic development

  1. Tim says:

    Great article, but a couple thoughts…

    Your argument surrounding contribution margin works when considering decline (loss of business), but what about in expansion? It does not work in the context of expansion.

    Further, if we create a context of expansion – expanding our power generation capacity in order to create economic development, then we subsidize this expansion – and avoid fully incenting innovation and cost restructuring in the power generation side.

    Healthy economic development will have to play to our regional strengths. Our strength , it would seem, is not power generation (as we seem to be more costly than most), therefore building economic an development strategy that hinges on cheap energy will not be sustainable… as any heavy energy consuming output will be taxed by an inefficient energy infrastructure. Furthermore, there is a danger that a “shell game” will result, that will tax ALL our productive output, as these large energy consumers attempt to externalize these costs.

  2. Tim says:

    …BTW, did I just describe out current dilemma as well?

  3. Someone asked me if I had my coffee before writing my postscript above. Admittedly, no but I now have had coffee and I feel the same way. We are living is some kind of Alice in Wonderland world where everything is turned upside down. The head of the EUB should be kept up at night because his two biggest energy suppliers are not projecting any new industrial customers. Why? He/she should be livid that our energy system is not a tool for economic development. The public intervener should be aggressively advocating for lower industrial energy rates – because thousands of jobs – honest, blue collar jobs – rely on them. We set up this faux debate about the big guy vs. the little guy. We are all little guys. There may be some big firms but they employ average every day New Brunswickers and if we force them to divest out of this province they will just move their capital elsewhere while our neighbours will be out of work.

    Economic development should be a prime consideration for the EUB and for the public intervener.

  4. Tim, it depends on the marginal cost of power. If the incremental cost of new natural gas fired electricity was $45/MW and NB Power could sell it to industrial users at $50/MW it would still ‘contribute’ five dollars per MW to NB Power’s shared, fixed overhead. The problem is – like Enbridge – NB Power is a revenue maximizing utility and if it can charge $70/MW that is exactly what it will charge even if it eventually squeezes customers out of the market. It’s part of this decline mentality. NB Power doesn’t see a lot of growth in the future, so it will need to squeeze the existing lemon that much harder to get juice.

  5. mikel says:

    Very good post. But companies don’t use low taxes to determine location, do we KNOW they use energy costs? Quebec has dirt cheap energy, yet big industrials are plummetting there as well.

    As for the chest thumping, that kind of patriotism is very important-the blog wouldn’t exist without it. However, from here in Waterloo I can offer another perspective:

    And thats that data banks are LOUSY repetitive technical jobs. I’ve BEEN a computer ‘technician’ and with the price and complexity of parts I can say that most data centre jobs mean replacing power supplies and testing hard drives. It is the ‘forestry job’ of the 21st century.

    Although I don’t think the government’s view it in this way, the way of the future in a knowledge economy is KNOWLEDGE. Waterloo and Kitchener now have DOZENS of empty warehouses, so if you asked Waterloo Hydro their future plans for big industrial players, they would say the exact same thing as NBPower. One building has finally been turned into a Nissan dealership, while another next to it is now filling with internet startups. NUMEROUS internet startups which have VERY low energy needs. What they use is BRAIN power.

    And the energy cost of using your brain is one power bar-in a wrapper from a store (or make your own). It is not providing massive power to some industry player who will pack up and leave as soon as he finds cheaper power next door. The simple question to ask Irving is-if power rates are so much cheaper in Quebec, why are you still in St.John? There are LOTS of empty mills in Quebec. So obviously something else is at play. To my mind the ‘culture of defeat’ is just as apparant in the idea “lets go out and find a multinational who will move in here and give jobs to all these stupid people who are too lazy to be competitive”.

    I think it would be as irresponsible for governments to act like their political leaders. During the election Alward says that money grows on trees, even now he is ‘cautiously optimistic’, meanwhile virtually every day there is some new government failing listed in the media, either dialysis machines or MRI’s, and thats JUST the healthcare and those are JUST the ones we know about. At the federal level, Harper says almost the same-a balanced budget, lower taxes, and pie for everyone. Sadly, like most plans, they all rely on the economy. With a new free trade system being touted for Europe and India, it certainly won’t be from new industrial players-heck, I’m a blue collar schmoe, and its telling that the best chainsaws in the world that I can buy for a reasonable price come not from Canada (which makes garbage), but from a european country that hardly even has any trees!

    Go into a grocery store sometime and count how many products you find from Switzerland. A little tiny country with fewer people than canada, four linguistic cultures living together, and a system of direct democracy. And yet there is virtually no poverty there. People speak four languages and the number of engineers per capita is highest in the world. The way of the future is knowledge, and that means virtually every man, woman and child. It means education and science. It means NOT relying on cutting down trees or being other companies ‘data bank’. It means NEEDING a data bank in some god forsaken cheap ass place to hold the data from some innovation.

    Why its hard is, well, because it relies on PEOPLE, and people have very different interests, motivations, and needs. Its harder than going to big companies and getting on your knees and begging them to come set up in your backyard because you’ve done such a lousy job in educating them that this is your only hope. It is HARD, but it is NECESSARY. Especially now when its getting pretty obvious that the pool of people to beg at is getting smaller, and often they are looking for a place that HASN”T done such a lousy job at educating their citizens.

  6. Tim says:

    @David Campbell
    David, in regards to marginal costs – I agree, it depends on our assumptions surrounding the MC function. My assumptions were based on considering expansion as very “chunky” (with small expansion as having very high MC, and large expansions having extremely high MC – but eventually being lower as the productive consumption catches up). So – the size of any anticipated expansion may not not bring MC back down to a level before the expansion after a “chunky” investment is made. So, resolving this argument means clarifying our assumptions.

    To find some further common ground – I to believe there are economies of scale. BUT, only if the utilities and large consumers are incented to seek innovative solutions. And my concern is that the current behaviour implies what (if any) these incentives that we have are not working.

    I would like to see a smart study the considers incentive that naturally direct decision making to achieve optimal expansion – and these incentives must also include considerations for economic development. We can probably both agree – we are not seeing such a vision.

    I’m a believer in price mechanisms, with proper regulator control – so my preference would be to have pricing mechanisms creatively utilized to incent economically beneficial behaviour (I’ll admit, for brevity sake – I’m being a little “loose” here). Subsidization should be part of the mix as well, but only with a clear “exit strategy”. Subsidies should be supported through a sound economic evaluation that clearly demonstrates they are only required to an interim need.

  7. Chris Baker says:

    David –

    You are correct in the main point that you make at the end of this post – Is NB interested in economic growth or is it chiefly concerned with managing our economic decline?

    If actions speak louder than words – and they do – what course would you (and the readers of this blog) say that NB is on?

    Chris

  8. Don Dennison says:

    David, you have re-opned a critical debate. Are we going to lever the few advantages we have, e.g. sitting on a gas pipeline, or are we going to worry about whether big NB companies are getting too good a deal (one reason the HQ deal cratered – NB’ers thought it was ‘too good’ for Irving). It is a question of confidence – do we have any, or do we just hunker down and hope to ignore or stem our decline?

  9. richard says:

    “It’s s pathetic if you really think about it. We are all in the process of engineering our own slow decline and not even recognizing it.”

    If you are a politician (or a CBC commentator, for that matter) it is much easier to play the populist card on these issues than outline the dire circumstances the province is in. Easier to pretend you are for the little guy, when in fact you are leaving the little guy with few options but relocation.

    I am sure that there are conversations going on between GNB and some of the industrial players re energy pricing. The industry players tried to have a discussion with the public, but that did not resonate too well and politicians are afraid to say anything that would cause upset amongst the electorate. Anything from the Irving press is dismissed as being from the Irvings (i.e. the press monopoly has come back to bite them in the ass).

    I would like to think that giving the EUB more authority would be a good start, but that perhaps won’t help much unless we have some political leaders willing to say what must be said. Currently, hiding information seems to be the preferred approach (eg continued BS from Leonard and Alward re the Lepreau deferral acct). An honest conversation among the electorate can’t begin until we get some political leadership that will state the obvious out loud.

    “The simple question to ask Irving is-if power rates are so much cheaper in Quebec, why are you still in St.John?”

    No need to ask them, as they no doubt ask themselves the same question on a regular basis. Perhaps it hinges on wood supply, perhaps stubborness, who knows? Family operations sometimes make decisions that more widely-held corps would not make, for good or bad. The weird thing is, if the mill closed many would celebrate the Irvings’ ‘failure’. The Irvings would spend more time in Bermuda, and more NBers would ‘celebrate’ by going on the dole.

  10. Tim says:

    I’m originally from Moncton. I’m also just old enough to remember when CN was _the_ employer in Moncton (as a child, that when the CN horn blew, it was time to come home for “supper”). (..and to clarify, none of my family worked for CN… so it was a general “community” feel that I picked up)

    When the CN yard shutdown, everyone seemed pretty negative about Moncton’s economic prospects, but instead of crumbling, Moncton emerged as a regionally diversified local economy. Also, though I don’t have any data to back this up – I now find the “feel” of Moncton much more entrepreneurial.

    I’m not arguing that the sole contributor for this diversification was the demise of the CN yard; but I’m sure this event was a positive contributor.

    Once everyone accepted CN was not going to provide the “good jobs”, it galvanized a community to take it upon themselves to drive growth.

    … but, I’m not attempting to whip up “big NB company” bashing. Big companies in a small communities have both pros and cons. Balance, I could argue both sides, so balance is key.

  11. mikel says:

    That’s to be expected Richard, the mill only employs 300 people and look at the massive pollution it causes. It’s a pretty cynical view to assume that people just hunker down and wish ill of other people for no good reason. Even anti-union biases usually have some grounds in them.
    BTW, I think your sentence of “Who knows” kinds of detracts from your other sentence of “No need to ask them”. No doubt THEY know, but WE don’t. What we know is that Irving gets direct loans from the province, we know they get subsidies from the government, we know that their print newspapers benefit from having a pulp mill close by, we know that they have a real fear that simply bailing in such a symbolic way would have people seriously considering boycotting their gas stations, stores, and media-and those DO have competition.
    We also know that right after they made that complaint that the government came in with yet another bailout for the mill. So like I said, energy is something these guys complain about, but they make up for it in other ways. Think back to when the dollar was cheap and the US economy good-how often did you hear industrialists complaining about the price of energy? Never, because when you have markets, you don’t care. What has happened is their markets have crashed. When you have fewer customers, then suddenly these things become an issue.
    I’d join any criticism of NB Power, it seems a huge bureaucracy that even has the government over the barrel. However, thats a whole other issue.

  12. richard says:

    “Moncton emerged as a regionally diversified local economy”

    Ah, yes, Moncton. A wonderful example to us all, or an artifact of regional displacement and govt spending? I guess we will see, now that the hinterland has been drained and the govt taps are about to be turned down.

    “the mill only employs 300 people”

    Oh, well, let’s close it then. What do you suppose that 300 jobs translates into as an economic impact? Then there would be the plant suppliers and their employees. We are talking about a lot more than 300 jobs (in a region with few if any new jobs). Its that leverage that gets them the govt grants.

    “No doubt THEY know, but WE don’t”

    If the Irvings were as omnipotent as you suggest, then they would not have altered their business plans to the extent they have. If I was an Irving, I would have left NB long ago. There is more money to be made elsewhere – the McCains had the right idea – leave a few buildings in place, erect a few monuments, but move your money somewhere else. I suspect however that the Irvings now lack the brains of their grandad and can’t see the writing on the wall.

  13. mikel says:

    The mill isn’t ‘ours’ to close. The relevant question to be asked is what is the cost benefit of the mill. How much subsidy is worth pouring into it before you just find it cheaper to write a cheque to the workers. Who ever said the Irvings were omnipotent? The Irvings, of course, DID leave NB long ago. They are an international company, take a look at the flags on their ships-they aren’t canadian flags. They are the largest private landowner in Maine now. And as a private company we have NO idea what business interests they hold elsewhere.
    But that really isn’t the point. The writing IS on the wall, federal money went into building a wallboard factory, and already they are griping that they may close it down.
    If you really want to get the most out of natural resource industries, heck, just nationalize them. Then at least the money stays local, you know what you are paying and what the costs are. Other than that, if your argument is that mills should be subsidized no matter what, that’s fine, just don’t expect people other than mill workers to agree. And if the argument is to subsidize large industrial players, then why WOULDN”T small businesses argue that they should also be subsidized? It only makes sense.

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