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Hydro-Quebec's Plan Questioned

Analysts point to weak earnings and doubt demand for power from new dam complex

HYDRO-QUEBEC'S plan to build a huge power project on the Great Whale River in northern Quebec, already challenged by environmentalists, faces a new attack from financial analysts who question whether it may not be a white elephant.

Hydro-Quebec plans to spend $51.7 billion (Canadian; US$43 billion) by the year 2000 on capital projects, $33 billion of it on dams like Great Whale and new transmission lines. Three-fourths of the funds would be borrowed, much in bonds repayable in United States dollars.

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But some economists and analysts wonder whether spending such a huge sum on these projects makes good business sense, especially if a greater push toward alternate energy sources and power conservation could greatly reduce demand.

Others question the company's exposure to foreign-currency exchange losses should Quebec secede from Canada. They also raise doubts about the profitability of recent mega-projects.

"Hydro-Quebec has these grand plans for producing cheap, abundant electricity, but technically it's not that cheap," says Damian DiPerna, utilities analyst at the Canadian Bond Rating Service in Montreal. "We feel there's a high risk building dams worth billions just to export electricity to a US market that may not buy it."

Though already owing about $30 billion, Hydro-Quebec says borrowing $54 billion more between 1992 and the year 2001 is no trouble. Some debt will be paid down, keeping the company at a desired debt-to-equity ratio of 75 percent debt to 25 percent equity.

Further, Hydro-Quebec's debt is guaranteed by the province, which is also the owner. And the company has programs to mitigate the currency-exchange risk on dollars borrowed abroad. Besides, officials say, the new projects will be moneymakers - and will provide jobs.

"We wouldn't build Great Whale or any other project if we didn't have the demand growth, whether it be internally or for exports," says Richard Drouin, chairman and chief executive officer of Hydro-Quebec, in a recent Monitor interview. "Otherwise, it would be sitting there, a white elephant, where we would have to cover the financing of it without using the power coming from it."

Moody's and Standard & Poor's, US bond-rating companies, seem to agree. They give the company and province a good rating. At the same time, there is recognition that borrowing $54 billion over the next decade ($5.8 billion last year) is unusual.

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"For that amount of money, you could effectively buy enough utilities to serve the entire state of California and have a pile of money left over," says Robert McCullough, a former utility executive hired to analyze Hydro's finances by Quebec's Cree Indians, who oppose Great Whale. Uncertain demand

While Mr. Drouin says Hydro will not build a "white elephant," economist H. Connor-Lajambe says this is precisely what happened with James Bay I, a mega-project begun in 1971. By 1979, she writes, turbines were providing 5,000 megawatts of surplus power, forcing the company to send millions of wasted megawatt hours down spillways.

Hydro-Quebec swung into gear, sopping up excess capacity by giving away electric appliances and promoting electricity for home heating. It also lured metal smelters and other power-guzzling companies to the province. By 1988 the surplus was gone. Hydro forecasts 2.2 percent annual growth in energy demand in Quebec through the end of the decade, though that hinges on new industrial demand.

Cushioning Hydro-Quebec's earnings is one of its spectacular financial successes: a 1960s contract to buy power at exceedingly favorable rates from the Churchill Falls Corporation hydro project in Labrador. Hydro-Quebec realized an estimated profit on the contract of $928 million in 1990, according to Norman Hawkins, a Montreal accountant. Labrador cash cow

"Since Hydro-Quebec's reported net profit for 1990 was only $404 million, it is obvious that Hydro-Quebec would have shown a substantial loss if it did not have the contract," wrote Mr. Hawkins in a January letter to Brian Craik, a Cree advisor. Hawkins says this shows that Hydro's recently built mega-projects, far from being big winners, are only marginally profitable.

"If you look at Hydro-Quebec's net income at the end of 1991, it was $760 million," says bond analyst DiPerna. "But they actually lost money on their own system. Churchill Falls is really keeping them in the black."

Hydro-Quebec officials reject this argument, stating that the contract is a fact of life, and that even if they had not signed such a pact, they would have built other lucrative sites in Quebec.

Hydro-Quebec last week announced a price agreement with Newfoundland to develop the lower Churchill river, a project similar in magnitude to Great Whale, and a possible replacement should Great Whale be delayed for environmental reasons.

Another cushion to earnings, says Mr. McCullough, the former utility executive, is the company's legitimate, but unorthodox depreciation schedule.

The effect of this "sinking-fund" depreciation method, he says, has been to make Hydro-Quebec's annual net profit appear several hundred million dollars higher than it would be if a traditional "straight-line" schedule were used. The deferral of depreciation expenses undercuts future years' earnings, he says.

"What Hydro-Quebec is doing is not in sync with generally accepted accounting procedures," McCullough says. "It's not unethical, and you don't go to jail for this.... It is, however, a business practice that brings the company's financial statements into some question; they are not comparable to similar statements from other large utilities."

To such allegations, Drouin responds that Hydro-Quebec's reputation is solid: "The credibility of our name is very high. You have to expect that the people who buy these bonds are people ... that have all the experts to analyze the financial statements of a company like ours, and be able to see the financial results."

Such assurances are little comfort to Daphna Castel, a spokeswoman for Au Courant, a Quebec citizens group critical of Hydro-Quebec. She worries that residential customers will end up footing the bill for new mega-projects through higher electric rates.

"They are planning to borrow billions to produce power at a cost only marginally lower than what they will sell it for," she says, citing analysis that Great Whale power will cost nearer 6 cents per kilowatt hour, not 4.4 cents as the company says. Key New York contract

Great Whale's future will likely depend on the outcome of a pending $17-billion contract with the New York Power Authority. Finalization of the 21-year pact was delayed a year until Nov. 31. Because of forecast low demand, New York is renegotiating the start date, to 1998 or beyond. The price in the proposed contract is 6.5 Canadian cents per kilowatt hour. That's already close to the 6 cents Ms. Castel says is break-even, and the contract price might be negotiated downward.

Robert Blohm, a US investment banker in Montreal, says the company wants to sell power from Great Whale in the US whether it makes a profit or not - mainly to gain US dollar income.

"If Hydro doesn't have sufficient US dollar income, then rating agencies would require them to keep Canadian dollars on hand to meet any potential loss," Mr. Blohm says. "The big question is whether Hydro or Quebec have enough cash on hand to cover potential foreign currency losses if there is independence."

Of Hydro-Quebec's $30 billion debt, about $9 billion is US dollar debt that Blohm says is unhedged, although the company insists it is. If Quebec separates from Canada, Hydro-Quebec might be stuck trying to repay its US dollar debt in a weak new Quebec currency, creating a possible repayment problem, he says.

Drouin responds: "You can talk of separation, but with Hydro-Quebec, it's a business that's going to sell electricity whether we're separated or not. We've always respected the financial criteria that make ours a sound company to invest in."

Others are less certain.

"Hydro-Quebec is a solid company," DiPerna says. "We're just questioning the need to go out and build these dams when there doesn't appear to be a need to build the dams."

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