Guest Editorial: The investor perspective

Editor’s note: This guest editorial is provided for the benefit of the investor community.

The Quick Take

This proposed development project has unusual and unaddressed risks, such as:

• The developer provided conflicting information to different government agencies, which then relied on this information in providing subsequent approvals. The result has to be something signficant, such as an approval is cancelled, or the construction schedule is significantly extended.
   
• The Crown refuses to acknowledge that the developer provided incorrect and misleading information and as a result First Nations were not notified or consulted on this important land issue.
   
• The developer’s construction plans have more than a one in four chance of causing flooding of Lake Muskoka, and the proposed contingency plans are unworkable.
   
• Transport Canada’s approval did not consider some important land ownership and public safety issues, and their only guidance so far is that affected people should directly sue the developer.

These are all issues which should be of concern to potential investors. Also of concern is that the developer has not refuted these.

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The Concerns

In my past experience investigating potential development-based investments, I have found that it is usually difficult to learn about the risks of technical projects. Therefore, as a service to other potential investors in this planned project to build a hydro station in Bala, Ontario, I offer the following.

Current risks for the proposed construction of a hydro station in Bala, Ontario

1) Investor risk: Before proposed construction

1. As noted here, the developer made commitments to the Ministry of the Environment which are different and conflict with information submitted to Transport Canada. This is a concern, as follows:
   • The developer’s written information to Transport Canada states that they plan work for which they do not have approval from the Ministry of the Environment. At the very least, this would result in delays while it all gets sorted out, but it also reflects on the credibility of the developer and raises more serious questions.
   • For example, delaying the start of work by the six weeks required may result in there not being enough time for the work which would need to be completed before the next spring freshet, as their upstream cofferdam must be removed by then. Therefore, work would need to be delayed until after the spring freshet, and some work may need to be repeated, such as rebuilding the upstream cofferdam. The result would be many months of delay to the schedule, and additional costs.
   • But perhaps the bigger concerns are that the developer may be trying to avoid earlier commitments without being caught, or they are demonstrating they are poor at scheduling work or that they do not have the people with the required skills and abilities to get this work done efficiently.
      
2. The Wahta Mohawks have given notice that the “Crown’s Duty to Consult has not been fulfilled”. It appears that the Crown has not responded to these concerns, as that the Crown often so chooses to do. Such actions by the Crown require that if the First Nations are serious, they need to initiate legal action.
   It should be noted that a remarkably similar situation has recently ocurred: In both cases the main decision-maker is the same person – Anthony Zwig, who is the President of Swift River Energy Limited (the Bala developer), and who is also the President and CEO of Horizon Wind Inc. (the developer for a proposed project to install approximately  20 wind turbines in Thunder Bay).
   • After years of community opposition, as reported here, in March 2014 the Fort Williams First Nations filed an injunction against the Ministry of the Environment due to their lack of consultation. As reported here, the judge heard the case in June 2014 and in July 2014 decided an injunction would be premature. However, in August 2014 the Ontario Power Authority terminated the developer’s Feed-In Tariff program contract due to project delays. Without a contract to get paid for power produced, this had the effect of cancelling the proposed wind turbine project (it is not clear whether the developer is still appealing this).
   • The summary is, after years of effort and slow progress getting approvals, this same developer has recently had a proposed project cancelled when the local First Nations claim to have unaddressed issues. If any of this is applicable to the similar Bala situation, it would be of concern to potential investors.

Potential investors would typically want these issues resolved before they invest.

2) Investor risk: During proposed construction

1. Historical data shows there is more than a one in four chance that a high-flow event would occur and the result would be the developer’s construction plans would cause flooding in one of two ways:
   • The developer claims that to avoid flooding Lake Muskoka they would quickly remove their upstream cofferdam. But this would flood the construction site, which would likely cause a year delay (as many construction stages cannot be done during certain time periods).
   • For many reasons, it is instead more likely the developer would have to let Lake Muskoka flood, and this would likely result in legal action (you can be sure that among the 3,400 private property owners on Lake Muskoka there are many very good lawyers and others with the means to pursue collecting on their losses and damages – and the publically-available flow data would later show whether the developer’s plans directly resulted in the flooding).

   It is most unusual for a developer to not have acknowledged or addressed this major risk with their proposed start of construction only months away.

2. Most every aspect of the proposed construction site would result in difficulties and therefore additional time and cost required:
   • The site is very small, is surrounded by water, highway, or designated heritage lands – and the entire site would need to be excavated, leaving no room for materials or equipment storage.
   • All equipment and materials storage would need to be stored either across a one-lane temporary construction bridge or across a highway with a complicated access.
   • The majority of the local population do not want this proposed project, making for a more difficult work environment.
   • Traffic managment and flagmen would be required for all site entrances.
   • The highway guardrail would need to be removed for some construction stages, but this would likely endanger the public.
      
3. All of the above increase the likelihood of delays, and delays would be a problem as:
   • The upstream cofferdam must be removed for at least April and May.
   • In-water work is not allowed from April 15 to July 1.
   • Work in the winter may be too difficult and slow (for example, after construction began, the developer for the Wasdell Falls hydro-electric project, which is 40 km south, decided not to work through the winter).

   The result is that any delays would quickly multiply and may become a year of delays – and the resulting extra costs would also quickly multiply.

The potential flooding risk appears to be significant and should be addressed before investors commit. It would be helpful to see a detailed schedule to see how likely it would be that the upstream cofferdam would need to be reinstalled after the spring freshet. Other construction risks would be factored into the return expected from this investment opportunity.

3) Investor risk: During proposed operation

1. The MNR apparently believes that marine navigation on the Moon River and the riparian rights of downstream property owners would not be affected because Transport Canada has provided approval under the Navigation Protection Act.
2. Also, the developer would permanently obstruct and eliminate a historic portage and the alternate routes suggested have significant land ownership and safety concerns.

Transport Canada has apparently not assessed either of these issues because the developer did not “opt-in” under the NPA, as the Moon River and Mill Stream are “non-scheduled waterways”. Transport Canada states it would be up to individuals affected to resolve this through the Courts.

The result may be lawsuits, with a result that the proposed generating station may not be allowed to operate in the summer. This would certainly significantly affect the on-going profitability of the proposed project.

Potential investors would typically want these unknowns to be resolved before they invest.

Background context

While investors in development projects will be flexible about when operations and payments to them begin, investors will need credible information that:

1. They will not lose any money (that is, the project would always be worth at least what they invested in it). In the Bala situation there would no guaranteed value to any of the money that would be invested, as the MNR will always own the land and the government could cancel all permits and approvals without compensation.
    
2. Additional investment will not be required, for example, for cost overruns due to unexpected construction or technical difficulties. This is a concern because as detailed above, there are many risks, several of which the developer should have addressed already, but has not.
    
3. They won’t have any liability for losses, for example to pay to make the site safe if the project must be stopped and abandoned, or the project is sued due to being found to have caused flooding, or there is a fatality when someone gets caught in the intake or tailrace (while insurance covers this risk for every other hydro station, this site is unusual being very close to both in-water recreational areas and private residences).

The problem in this situation is that Swift River Energy Limited and its parent company do not have staff with experience and history with hydro-electric power  development. They use contractors, so do not have company history and knowledge with hydro-electric power development. The contract project manager does not appear to have experience with managing an entire hydro-electric development project of this size through to commercial operation. The fact that the developer has been pursuing this project for ten years and does not have all required approvals, and as listed above, there are significant outstanding issues does not provide comfort.

Projects such as this are typically built through the creation of a partnership:

• The developer becomes the General Partner, and contributes the opportunity, their expertise and industry experience and contracts, years of planning and approvals, the detailed design, and day-to-day management of the project.
• The investors become Limited Partners and contribute most of the funds – often 85% in return for ownership of 50% of the project and therefore they would receive 50% of the profits from operations.

This arrangement has proven to work very well for experienced developers and for projects which do not have cost overruns. The weakness of this leveraging is how to handle cost overruns.

Potential investors would feel they have already taken their risk by investing their money and would expect the developer to pay any cost overruns, as the developer would be responsible for all of the project planning and management, contractor selection, and detailed design. This can quickly become a big problem. For example, if the proposed Bala hydro station is expected to cost $30M to build, then the developer might contribute 15% of this, which would be $4.5M. If the developer values their contribution of the opportunity, design and approval work at $2.5M, then they may only contribute an additional $2M of cash to the partnership. If there is a 5% cost overrun then an additional ($30M x 5% =) $1.5M of cash would be needed.

Typically, when addtional cash is required, the project is already delayed, so the investors would be losing confidence and may decide to not contribute addtional cash. The developer may offer to contribute the cash required in return for increased ownership of the partnership and a priority on receiving payments (which would permanently reduce or even eliminate any profits from their investment). If neither party contributes the required funds then the project would likely go bankrupt and be abandoned, with resulting years of lawsuits on outstanding debts or costs to make the site safe (as the developer’s signed Lease to Contruct with the MNR requires).

Summary

The overall summary is that for me, and at the current time (January 2015), this proposed project has too many significant and unaddressed risks.