These terms of reference were presented to Grant Thornton at the inception of our review. They have been subsequently revised as follows:
"Should the Government of New Brunswick accept N.B. Power's 1998 fixed asset write-down of $450 million and are there any other observations relative to your review that should be brought to the attention of the Province of New Brunswick"?
As a result of the reduction in the pre-refurbishment life expectancy of Point Lepreau, N.B. Power reduced the carrying value of Point Lepreau by $450 million in its 1998 year end financial statements, being the unamortized capital cost that would remain in 2008. An offsetting deferred charge in the same amount was also recorded by N.B. Power in anticipation of a new revenue stream being identified and authorized specifically to recover the deferred charge.
The Province of New Brunswick (the Province) uses the modified equity method of accounting for N.B. Power. Under this method, the 1998 net equity of N.B. Power was recorded as an asset (Investments) in the amount of $425.3 million on the Statement of Financial Position of the Province and changes in the net equity of N.B. Power were reflected in the Province's Statement of Revenue and Expenditure.
The deferred charge accounting treatment adopted by N.B. Power, with respect to Point Lepreau, resulted in no net change to the earnings of N.B. Power and therefore no reduction in the Province's carrying value of N.B. Power.
The Auditor General of New Brunswick qualified the financial statements of the Province because he concluded there was insufficient evidence to support the recoverable value of the deferred charge. The Auditor General also concluded that the Province should have recognized a reduction in its investment in N.B. Power in the amount of $450 million.
N.B. Power had historically prepared financial statements in accordance with generally accepted accounting principles appropriate for a rate-regulated entity. In recent years, N.B. Power has been moving toward adoption of accounting principles generally accepted in the non-regulated sector as defined by the provisions of the Canadian Institute of Chartered Accountants' Handbook (CICA Handbook). The decision to record the deferred charge was an exception to this movement towards generally accepted accounting principles.
To this point in time, no new revenue stream specifically designated to recover the deferred charge over a future period has been identified and authorized. N.B. Power has indicated that if no new revenue stream was identified by the end of fiscal 1999 the deferred charge would be written off to income at that time.
The energy industry in North America in general and, more specifically, in Atlantic Canada and the eastern seaboard of the United States is likely to undergo significant change over the next number of years. The possible introduction of competition, completion of the natural gas pipeline from Sable Island, significant planned expansion of generation assets in New England and uncertainty about the useful economic life of Point Lepreau all create significant uncertainty about the future. The degree of uncertainty is much higher than has been the situation historically.
Accordingly, in calculating any impairment in the value of Point Lepreau there are many variables for which there is a broad range of possible outcomes and with respect to which small differences in assumptions lead to large changes in computed results. In the presence of this magnitude of uncertainty, it is not possible to compute an amount for impairment that is reasonably precise and which has a high probability of reflecting what will actually happen.
Notwithstanding the foregoing degree of uncertainty, there are some facts that appear to be generally accepted and which suggest there may in fact be impairment at Point Lepreau. The facility has, for most of its life to date, operated at a level well in excess of that originally intended. Although there is uncertainty as to how long it can be economically operated without refurbishment, it appears generally accepted that the point of shut down or refurbishment will be earlier than 2014 (which was the original estimate and the basis for the amortization used to and including fiscal 1998 by N.B. Power).
In addition to the above uncertainty specific to Point Lepreau, there is potential for significant change in the energy industry which could have a major impact on the value of Point Lepreau. Changes include new transmission access regulations, availability of natural gas, development of future natural gas-based operations and changing competitive and regulatory regimes elsewhere throughout North America. In fact, uncertainty about the future of the industry creates uncertainty regarding the value not just of Point Lepreau but also for all of N.B. Power's generation assets.
The CICA Handbook states in Section 3060.42:
The net carrying amount is the cost of an asset less accumulated amortization and the amount of any write downs. The net recoverable amount of a capital asset is its estimated future net cash flow from use together with its residual value. Management of N.B. Power subsequently completed a calculation of the impairment of Point Lepreau applying provisions of the CICA Handbook and arrived at an amount of $528 million. In view of the significant imprecision inherent in the impairment calculation, it was decided to leave the write down at $450 million.
Given the inclusion in the carrying value of N.B. Power's capital assets of significant amounts that would have been expensed under the current accounting practice, the prevalent view that the Belledune facility is over valued, and the approval by the auditors of N.B. Power of the write-down of the carrying value of Point Lepreau by $450 million, we conclude some write-down of the carrying value of the capital assets of N.B. Power is appropriate. Accordingly we recommend the Government of New Brunswick accept the 1998 write-down of $450 million.
It is apparent that the provision of an adequate, dependable supply of power at a competitive price is critical to the development and future prosperity of New Brunswick. The degree of uncertainty about the future of the energy industry has never been greater. This uncertainty significantly increases the need and challenge of devising an appropriate strategy for N.B. Power.
We have the perception that Government is not well informed about N.B. Power's strategy going forward.
It also appears from our discussions, there is not a clearly articulated and communicated strategy for N.B. Power nor is there consensus among the Government, N.B. Power Board, and N.B. Power management on what constitutes the appropriate strategy and direction.
The greater the uncertainty about the future, the greater the importance of an appropriate governance structure and an effective working relationship between Government, the Board of N.B. Power and its management. Similarly, the greater the uncertainty about the future, the greater the need for appropriate consensus on strategic and operational plans.
We recommend that the approved governance structure include appropriate Government input into the development of strategies for N.B. Power. Any strategies adopted for N.B. Power should have the strong support of the Government, the Board and management.
Section II(a)
Terms of Reference
"To recommend an amount to record for the impairment of the Nuclear Generating Station at Point Lepreau owned by N.B. Power".Background
In 1997, New Brunswick Power Corporation (N.B. Power) engaged Hagler Bailly Consulting Inc. (Hagler Bailly) to complete a comprehensive analysis of short and long-term technical and economic factors affecting the future performance of the Point Lepreau Nuclear Generating Station (Point Lepreau). The analysis indicates Point Lepreau will not be able to operate until the year 2014 as originally planned without a major refurbishment somewhere around the year 2008. It is not at all certain, at present, that a refurbishment will be financially justified in or around 2008. However, if the refurbishment is done, Hagler Bailly has indicated that the operating life of Point Lepreau would be extended by 25 years to 2032. Scope of Review Procedures
We reviewed the appropriate provisions of the CICA Handbook which codify generally accepted accounting principles in Canada. In addition we considered accounting practices used by certain entities in rate-regulated industries. We reviewed the report prepared by Hagler Bailly Consulting Inc., the report of the Auditor General of New Brunswick and the Auditor's Report on the financial statements of the Province of New Brunswick. We conducted interviews with senior members of the Government, N.B. Power Board of Directors and management, the Auditor General and members of his office and representatives of Deloitte & Touche, the auditor of N.B. Power. We also reviewed considerable documentation that had been prepared by N.B. Power, senior members of the Office of the Comptroller and Deloitte & Touche analyzing the Point Lepreau situation and the alternative accounting treatments considered. We reviewed various studies and documents which focused on changes in the electrical utility industry, future trends, effects of deregulation and commentary related to the possible future of N.B. Power.Analysis
In assessing whether the Province of New Brunswick should accept N.B. Power's 1998 fixed asset write-down of $450 million, we considered a variety of factors. In this section we will comment on these factors under the following headings:
Uncertainty
Impairment Calculation
Other Professional Assessments
Export Markets
Capitalization Policy
N.B. Power's Cash Flows
Other Generation Assets
Uncertainty
As is set out in more detail below, the CICA Handbook defines the approach to be adopted in calculating impairment. Applying that approach to Point Lepreau is difficult because of the significant uncertainty regarding many of the components of the calculation. More specifically, it is difficult to determine, with precision, the date on which the facility will require a major refurbishment or shut down. In the period prior to refurbishment or shut down, it is difficult to determine the degree of utilization that will be achievable from the facility and the cost of required maintenance. It is similarly difficult to estimate the cost of decommissioning the facility and the cost of refurbishment in the event a decision to refurbish is made. The extent of uncertainty is well documented in the Hagler Bailly report which states "uncertainty dominates current estimates of total going-forward costs".Impairment Calculation
N.B. Power has provided $450 million for impairment of Point Lepreau. The number is the expected remaining net book value of Point Lepreau in 2008 which is the approximate timing of a possible refurbishment. Selecting the book value at the time of refurbishment as the amount of the impairment is not consistent with the rules for calculating impairment in accordance with the CICA Handbook.
"When the net carrying amount of a capital asset, less related accumulated provision for future removal and site restoration costs and future income taxes, exceeds the net recoverable amount, the excess should be charged to income".Other Professional Assessments
Hagler Bailly completed a comprehensive analysis of the short and long-term technical and economic factors affecting Point Lepreau's future performance and concluded the facility will not be able to operate until 2014, as planned, without a major refurbishment somewhere around the year 2008. In addition, Deloitte & Touche, the auditors of N.B. Power, have examined and accepted both management's calculation of the impairment of Point Lepreau and the $450M write down.Export Markets
N.B. Power has enjoyed significant contributions from its ability to export excess power. We understand new natural gas generation facilities are being planned or constructed in the eastern United States. These facilities could seriously erode the export market for N.B. Power and accordingly could create impairment of the value of some or all its generation assets.Capitalization Policy
In the past, N.B. Power prepared its financial statements in accordance with accounting principles appropriate for a rate-regulated entity. These principles permitted the capitalization of many costs that would not have been capitalized under the accounting principles generally accepted in the private non-regulated sector. N.B. Power management has specifically identified $152 million of these costs and has indicated there are more that have not been specifically identified. As a result, the capital assets of N.B. Power include significant amounts that would, under its current application of accounting principles, have been expensed.N.B. Power's Cash Flows
N.B. Power is presently producing positive cash flow. This cash is expected to be sufficient to both fully fund capital requirements for the next five or more years and significantly reduce long-term debt. Assets that generate cash flows are not commonly written down. At the same time, the threats to N.B. Power's revenue stream outlined previously could eliminate the ability to continue to generate strong cash flow.Other Generation Assets
Serious questions have been raised by a number of interested parties about the recoverable value of some of the other generation assets of N.B. Power. For example, the Belledune facility experienced cost over-runs and had amounts capitalized, the appropriateness of which has been questioned, particularly in view of the accounting principles presently in effect. Competitive technologies today are purported to be able to produce the same output as Belledune at a much lower capital cost. Concerns have also been raised about other N.B. Power generation facilities. To date, no assessment of the possible impairment of the other generation facilities has been completed by N.B. Power management.Conclusion
Some of the above factors, including a high degree of uncertainty regarding the actual estimate of impairment of Point Lepreau, the absence of any detailed assessment of possible impairment of other capital assets and the probable ability of N.B. Power, at least for the immediate future, to generate strong cash flow which can be applied to debt reduction, would tend to support a decision by the Province not to accept a write down at this time. However, many of the above factors call into question the carrying value of the capital assets of N.B. Power and therefore the value at which the Province of New Brunswick carries its investment in N.B. Power. Threats from the impact of natural gas generation, potential loss of export markets, increased competition, significant carrying value attributable to capitalization policies no longer being applied and comments from Hagler Bailly and Deloitte and Touche all suggest there may well be impairment of the capital assets of N.B. Power.Observations
During the course of our review, we conducted discussions with senior members of the Government, the Board of N.B. Power and N.B. Power management about a wide variety of issues concerning N.B. Power, its administration and its future. Our terms of reference call for us to make observations, relative to our review, that we believe should be brought to the attention of the Province of New Brunswick. In this regard, we have the following observations:Recommendations
We recommend high priority be given to a reassessment of the governance structure between the Government, the Board and management of N.B. Power. Recommended changes arising from such a reassessment should be implemented promptly.
