General weakness across provincial bonds is now rippling through to smaller holdings such as the three connected to the Muskrat Falls dam project in Newfoundland and Labrador.Andrew Vaughan
Dwight Ball won a commanding election victory two weeks ago in oil-producing Newfoundland with a pledge to stoke the province's economy and open the books on its flagship energy project. Bond investors aren't as optimistic as voters. Bonds for the $7.7-billion Muskrat Falls hydroelectric dam and a pair of related transmission lines, though federally guaranteed, are among the five worst performers this quarter among the top 50 provincial issuers on the Bank of America Merrill Lynch index.
While Mr. Ball's Liberal election platform is bullish on Newfoundland's economy and power sector, the projects have run into setbacks in recent months, including a cost overrun and subcontractor insolvency. That has been compounded by contagion from general weakness across Canadian provincial bonds, only now rippling through to smaller, less-liquid holdings such as the three connected to Muskrat Falls.
"You've seen a very quick reversal" to match pricing with, likely, very little actual trading, said Heather McOuatt, portfolio manager at Franklin Bissett Investment Management, which manages $5-billion in fixed income. "The trajectories are in line with what I'd expect with just a catch-up trade."
The Canadian provincial bond market is down 1.6 per cent since July, led largely by Ontario, on selling pressure driven by the Chinese yuan devaluation in August and a subsequent search for liquidity, Ms. McOuatt said. The smaller bonds related to Muskrat Falls were spared at first, but have since joined the rout.
Muskrat Falls is an 824-megawatt generation facility in Labrador; 1,600 kilometres of transmission lines known as the Labrador Island Link would connect it with the existing Churchill Falls project and the island of Newfoundland, while the Maritime Link would hook it up to Nova Scotia.
The dam is a massive project for the Atlantic province of 528,000 people – Muskrat Falls' cost exceeds the provincial government's total annual budget, which sits at $7.2-billion this fiscal year. Nalcor Energy Corp., a utility owned by the Newfoundland provincial government that is developing the project, announced on Sept. 29 costs had risen 10 per cent.
Canadian provincial bond spreads widened in the third quarter of 2015 largely because of external factors, said Avery Shenfeld, chief economist at CIBC World Capital Markets. That included a higher risk premium in global markets on non-sovereign debt, driven by a boost in liquidity of corporate bonds and a slowing global economy, which increases credit risks, he said.
Canadian federal government bonds still trade at historically low yields, Mr. Shenfeld said. "Even with wider spreads, high-grade provincial and corporate bonds are also still being bought at relatively low rates," he said.
On Nov. 30, Newfoundland voters delivered what polls had long projected – a landslide victory for the Liberals, who won 31 of 40 districts, and an end to the Progressive Conservative government that approved the Muskrat Falls project. Mr. Ball chided Nalcor for cost overruns during the campaign and pledged to "open the books on Muskrat Falls." The Liberals also committed to "minimizing its burden" on taxpayers and detail funding.
"We continue to make steady progress in all areas of the project across the province," Nalcor spokeswoman Karen O'Neill wrote in an e-mail response.
Nancy O'Connor, a spokeswoman for Mr. Ball, declined to comment, saying his administration hasn't yet been briefed on the matter. The government takes power today.
The federal guarantee – agreed to by Prime Minister Justin Trudeau's predecessor, Stephen Harper – is supporting the value of the bonds amid uncertainty, Ms. McOuatt said. Mr. Trudeau has hinted at doing the same for other projects, campaigning on a promise to use the government's "strong credit rating and lending authority to make it easier and more affordable for municipalities to build the projects their communities need."
The bar will remain high on such projects, Ms. McOuatt said.
"I don't foresee them getting involved with too much of these types of things in the future, if they're not of this scale and same sort of significance," she said.