Sunday, January 10, 2010

Having Your Power

The sale of NB Power to Hydro Quebec is controversial (in NB) for all the wrong reasons. First, no one who supports capitalism has any reason to be upset at this. I am not trying to make an ideological statement here or win cheap political points for the left. I'm trying to state a fact. Regardless of whether NB Power is a public utility or a private company this is what happens in a capitalist economy: larger companies buy up smaller companies. That is "the nature of the beast": to not like it is to not like capitalism. Second, I might be really wrong in this but I can't help but think that there is some anti-Quebec feelings mixed into this equation. I hope not, but I wonder if we'd get the same type of reaction if the company looking to by NB Power was from Ontario? (A quick footnote, I think we'd get even more negative reaction if the company was American.)

What people should be concerned about is the rationale for this purchase. The NB government wants to sell NB Power because it is loaded with debt and mired in an antiquated pollution making stock. The debt is the big issue. Hydro Quebec will, in effect, absorb something like 25 or 30 per cent of the provincial debt. With the deficit skyrocketing, the provincial government was looking for ways to shed debt. This will allow them to go to the electorate with an economic platform that will not increase taxes and will keep debt servicing charges (interest) lower than historic levels even with increased deficits. In the intermediate run it will make it easier to balance the provincial books and allow this government to claim that they are good financial managers. This sale, in other words, creates  financial space for Graham government and that is its main rationale.

Here is the issue: why is NB Power loaded with debt? The answer is also pretty simple: New Brunswickers have not wanted to pay the full cost of their power. Here is the problem: if you don't pay the full cost, the price of power doesn't magically sink. Someone else has to pay that cost and that someone else, in the case of a provincial crown corporation is the taxpayers or ... exactly the same group of New Brunswickers who don't want to pay the full cost of power. In order to keep power costs low for political reasons, the NB government (both Liberal and Conservative) have allowed cash shortfalls to be run up as debt, rather than increasing taxes to pay for them. In this sense, NB taxpayers traded short term lower power costs for long term debt in a crown corporation, that is a corporation that is owned by the taxpayers.

You can think of it this way. Imagine your ... let's say car payments go up from $100 to $110 per month. Now you don't want to pay this extra amount and so you create a company, owned by your family, to manage your car payments. You tell that company that they cannot increase your car payments beyond the $100 at which they now stand. But, the cost of the car is actually $110 a month. So what does this company -- remember you created it and you own it; that is why you can tell it not to increase the car payments and it has to do what you say -- do? It borrows the money. The bank, of course, does not  just lend you this money gratis. It charges an interest rate. I'm making this up so let's imagine that the interest rate is 10%/month to keep it simple. The first month, the company is in debt only $10. It is a small amount; no one notices and not a drain on anything. After one month, however, it is now in debt $11 because of the interest rate and in month two you add another $10 to that debate because another car payment is due. So at the end of month two, this company is in debt $21 in revenue shortfall and interest. Now add 10% and that is increased to $23.10. Let's do one more month: 23.10 + 10 = 33.10 + interest = 36.41.

So, in order to keep your car payments lower then the cost of those payments, the end result is that at the end of three months, the company you set up to manage payments is $36.41 in debt, or one third of pay. And, here is the kicker: $6.41 of that debt are interest. It has been accrued as the cost of service on month your company borrowed. It produced nothing so in effect there is nothing to show for you. One could argue, and I would, that there $30.00 of that interest represents the real cost of the car and so you have driving the car to show for. However that other $6.41 produced nothing at all. No roads, it is excess what one would have paid for the  car had one gone along. Now, imagine that your car needs a repair. You've already told that company that it cannot charge you more then $100 a month so it goes out and borrows the money for the repair and this ads another $5 to your bill. And on and on and on .... The only problem is that you own the company that manages your car payments. After a year, this company is deeply in debt with no way to pay that debt. I don't have good math skills so I can't say quickly how deeply in debt it would be but it would have $120 in payments along, but all that interest compounded, plus repairs. The bill would likely be over $150.00 or more than a  car payment and a lot of that would have been accrued as debt serving or interest.

The real problem is that you've lost track of things or weren't paying close enough attention and are shocked, now, to find out at the end of the year that you have a big honkin' bill to pay and forget that the reason you have to pay it is because you didn't want to pay smaller bills as you went along. What's worse, let's imagine that the economy has turned bad and while you have not lost your job, you did not get your hoped for raise this year and your hours have been cut so that the company you work for can balance its books. So, now you have a big honkin' bill and no way to pay it. What is more, the interest on the debt you've run up is greater than the difference of the payment that you did not want to make and  the real pay. In my example, remember, you were trying to avoid paying an extra $10 a month. Well, if your company is $150.00 in debt, the interest is now $15/month. In other words, you're paying more in interest then the cost of originally biting the bullet and paying the extra tab in the first place.

This is what happened to NB Power and this is why this sale should be controversial. It is not whether or not someone else  can run NB Power more efficiently or any "economies of scale" that might or might not come from being part of a larger company. The issue that we should be thinking about is why is NB Power so debt laden. In effect, no one wanted to give New Brunswickers the bad news: there is no free lunch. If you want power, you have pay for it. Instead, government after government said "well, we'll make NB Power swallow the bill" as if NB Power were not owned by the taxpayers. In other words, to give short term lower cost power, the government said "you can pay more -- and much more -- in the longer run by having NB Power run up a debt" and New Brunswickers, for one reason or another, said "yes, we like that deal." Maybe they were ill informed; maybe they thought "economic growth will solve the problem in the longer run;" maybe they thought NB could sell power to the US and make a profit (although exactly where this power was to come from is not clear); maybe they just didn't know any better.

There is a further problem here. In lowering the cost of power, NB has actually increased consumption and whether we should have or not is another important issue. Consumption of power is bad for the environment. And so in keeping power costs low, NB has actually worked against environmental protection by putting more pollution into the environment than would have been the case.

These are, in my view, the issues we should be thinking about with regard to this sale.

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