Cape Breton Development Corporation (Special)

(1) Forecast data are based on actual data between April 1996 and February 1997 and a projection for March 1997.
⁽²⁾ Includes $1.5 million in current service costs in relation to the non-contributory pension plan.
⁽³⁾ Net of inventory adjustment ($0.6 million in relation to the Corporate Plan and $8.3 million in relation to the year-end forecast).
⁽⁴⁾ Excludes inventory adjustment.
⁽⁵⁾ Net of interest on the government loan to cover capital expenses and operating losses.

Source: Cape Breton Development Corporation

Revenues (net of inventory adjustment) in 1996-97 are expected to total $155.7 million. Given the shortfall in estimated sales, this is $9.8 million less than projected under the Corporate Plan. As the lion’s share of sales in 1996-97 were realized prior to the last downward price adjustment in DEVCO’s long-term contract with Nova Scotia Power, revenue per tonne sold is expected to exceed the estimated average price under the Corporate Plan.

According to the information presented in Table 1, DEVCO expects to achieve its bottom line projection in 1996-97. By year’s end, DEVCO expects to incur a loss of $34.1 million. This loss is within the financing arrangement limits approved by the federal government as part of the Corporate Plan.

SOCIAL COSTS

The cost of DEVCO’s current operations include social costs (e.g. environmental, pensions, workers’ compensation, etc.) related to historical operations, the majority of which were incurred prior to 1 April 1995, the onset of DEVCO’s commercial viability mandate. In its June 1996 Report, the Committee identified two social cost components that warranted special consideration vis-à-vis DEVCO’s Corporate Plan. These were the unfunded liability in the company’s non-contributory pension plan, and older pre-retirement and early retirement plans. Expenditures on the former are projected to be $23 million in each of the first three years of the Corporate Plan, while the annual costs of the latter are projected to average $2.7 million between 1996-97 to 2000-01. Combined, these costs are projected to total $82.5 million during the period 1996-97 to 2000-01. As a portion of these costs is directly attributed to the voluntary decisions of many workers not to participate in the contributory pension plan introduced in 1982, the Committee thought that DEVCO and its current workforce should bear some of the burden. Specifically, we recommended that "the Government of Canada provide an appropriation of $41.25 million to cover half of the cost of removing the unfunded liability associated with the non-contributory pension plan and half of the cost of payments to older pre-retirement and early retirement plans. These funds should be appropriated as the projected costs are incurred under the Corporate Plan. Accordingly, the federal appropriation would be $13.2 million in 1996-97, $12.9 million in 1997-98, $12.8 million in 1998-99, $1.3 million in 1999-2000, and $1.05 million in 2000-01."(1)

While in general agreement with the direction of this recommendation, the labour representatives who addressed this issue during our recent hearings expressed the view that all historical social costs should be borne by the federal government. In their opinion, the federal government is responsible for this debt, irrespective of the success of DEVCO. The government, on the other hand, maintains that the unfunded liability in DEVCO’s non-contributory pension plan is a legitimate operating cost. These pension funds are earmarked for both past and current workers and, as such, are considered to be DEVCO’s responsibility. The Minister of Natural Resources indicated that the government is helping DEVCO to deal with these additional costs by way of repayable loans, net of interest, to cover capital expenses and operating losses.

There is little doubt that, until March 1990 when DEVCO was officially informed of its mandate to become self-sufficient by the end of the fiscal year 1994-95, the corporation functioned as part of the government’s regional development initiatives in Atlantic Canada. When DEVCO was created, its mandate was to wind down coal operations in Cape Breton and develop alternative employment opportunities outside the coal mining industry.(2) Obviously, DEVCO has not withdrawn from the coal mining business and, as noted by the Minister of Natural Resources, taxpayers have injected some $1.5 billion into this corporation since its inception.

DEVCO’s legacy of heavy subsidization serves to illustrate the magnitude of the challenge it faces in becoming commercially viable. As noted above, DEVCO is expected to cope with the task of reducing its operating costs significantly, while at the same time covering several historical expenses, some of which the Committee believes should not be included in the Corporate Plan. If DEVCO were not required to absorb these costs, the Corporate Plan would project a substantially smaller loss in 1996-97 ($7.7 million compared to $34.1 million) and profits thereafter. If the costs associated with the unfunded liability in the non-contributory pension plan and with older pre-retirement and early retirement plans were excluded, DEVCO would realize a projected aggregate profit of $72.2 million during the period 1996-97 to 2000-01, compared to an aggregate loss (net of interest on loans to cover capital expenses and operating losses) of $10.3 million, as projected under the Corporate Plan.

These costs are substantial, inappropriate and, in our view, simply serve to undermine the efforts of DEVCO’s management and workers in their pursuit of self-sufficiency. Moreover, the Committee expects the loans required to offset these costs to continue to confound DEVCO’s bottom line well after the company has eliminated the unfunded liability in its non-contributory pension plan. Furthermore, this debt would jeopardize DEVCO’s access to a potential pool of much needed capital in the event that the corporation decides to pursue future mine development.

Recommendation

EXPORTS

In its June 1996 Report, the Committee indicated both that it intended to examine further the issue of exports and that the Cape Breton Development Corporation should take immediate steps to sell more coal profitably in the international marketplace. In view of the production problems outlined earlier, DEVCO did not enter the export market in 1996-97. In fact, DEVCO has essentially been non-existent in this market for approximately two years, and according to its Annual Report for the Year Ended March 31, 1996, the corporation has unfilled export commitments totalling some 264,000 tonnes.

During our recent hearings, labour representatives expressed the view that Nova Scotia Power is gradually reducing its reliance on DEVCO as a primary supplier. In their view, it does not make sense for DEVCO to focus on Nova Scotia Power as its primary customer. Instead, the corporation should expand its focus on the export market. While we agree that DEVCO should become more active in the export market, we also recognize that DEVCO’s operating costs must continue to fall if the corporation is to profit from international sales. Some labour representatives suggested that DEVCO’s recent losses in the export market had resulted, in part, from the movement away from long-term contracts to spot market sales, the implication being that average prices for the former were higher than for the latter. Management responded by telling us that today’s market for coal is highly competitive and that the opportunity for DEVCO to make profits in this market hinges on reducing the cost of output. We were told that, given current production costs, export sales would generate a loss of between $8 to $10 per tonne.

DEVCO must be able to compete both nationally and internationally, not just with other coal producers, but also with alternative sources of fuel. Notwithstanding labour’s objection to the Corporate Plan’s focus on Nova Scotia Power, management told us that the Plan’s emphasis on DEVCO’s primary customer had paid off in 1996-97. Despite last year’s production problems, the corporation managed to sell more coal domestically in 1996-97 than in any previous year. Moreover, the Committee was reminded that coal sales to Nova Scotia Power currently generate a better margin than any other market.

In 1997-98, DEVCO plans to fulfil its outstanding export contracts and secure new export opportunities. We were told that DEVCO is currently exploring the possibility of shipping coal to an entirely new market in northern Europe, where DEVCO is thought to have a competitive advantage over producers in the United States and elsewhere around the globe, since the location of the International Pier can provide favourable ocean transport charges to European customers, particularly Scandinavian countries.(3)

According to the available, albeit limited, information related to DEVCO’s export plans and the revised Corporate Plan, the Committee estimates that DEVCO expects to export somewhere between 400,000 to 450,000 tonnes of coal in 1997-98. This represents roughly 15% of projected sales, slightly more than one-half of those originally projected under the Plan. Despite this retrenchment in export plans, management appears to recognize the need to re-establish the corporation’s presence in the international market place and has expressed its intention to do so this year.

Provided DEVCO is able to lower its operating costs to $43.41 per tonne in 1997-98, as projected under the updated Corporate Plan (compared to $42 per tonne under the original Corporate Plan), the corporation should be able to sell this coal at a profit.(4) Thereafter, DEVCO expects to increase its presence in the international market significantly. According to the Minister of Natural Resources, DEVCO expects to export 30% of total sales in 1998-99. These sales are also expected to improve the bottom line, since the original Corporate Plan projects operating costs will decline further to $39 per tonne.

Assuming DEVCO is able to achieve its output and operating cost targets, the corporation should be able to re-establish itself as a reliable supplier in the international market and obtain long-term contracts. However, because of a lack of more detailed information, the Committee can only express cautious optimism with respect to the achievement of the Corporate Plan’s export targets.

THE DONKIN RESERVE

Undeniably, Donkin is the last major block of coal in the Sydney coalfields. It is estimated to contain roughly 1.3 billion tonnes of coal that is recoverable using present-day mining technology. The unions representing DEVCO’s workers told us that without Donkin there is no future in Cape Breton’s coal mining industry. They told us that the access tunnels are there and that, with selective mining, low sulphur coal can be produced. In their opinion, Donkin could be operational at a cost of $100 to $125 million.

The Committee fully appreciates that Donkin represents the future of Cape Breton’s coal mining industry. However, it would appear that this future rests largely on whether a Donkin mine is economically viable. The economic potential of Donkin is uncertain(5) and this is why the Committee recommended in its June 1996 Report that "the corporation and the Province of Nova Scotia immediately undertake a study to ascertain the development potential and cost of opening the Donkin Mine."(6)

Apparently, DEVCO’s Board of Directors considered all of the Committee’s recommendations, but decided not to pursue our recommendation with respect to Donkin. Moreover, DEVCO has not discussed this matter with the Government of Nova Scotia. We were told that the rationale for this lack of response was that DEVCO’s Board of Directors did not want to raise false expectations by focusing on the Donkin mine, and believe that, until DEVCO can learn to operate existing assets economically, there is no point in proceeding to a Donkin mine. The Minister of Natural Resources indicated that the government supports this view.

The Committee does not accept this position, however, and finds it puzzling that DEVCO and the Governments of Canada and Nova Scotia are not willing to take the necessary steps to acquire this very important information on the potential of Donkin. Given the commitment demonstrated by DEVCO’s workforce over the past year, the Committee is sceptical of the claim that management and workers would be distracted from their primary objective of commercial viability if the Committee’s recommendation was implemented.

As Cape Breton’s largest industrial employer, DEVCO’s economic importance is undeniable. Its direct contribution to the economy of Cape Breton was more than $170 million in 1995-96: $90 million in wages, salaries and benefits; $46 million in pensions; $2 million in grants in lieu of taxes; and, roughly $32 million in expenditures on goods and services.(7) DEVCO’s operations also confer indirect economic effects thought to be at least equal in size to the direct ones. Surely, the economic importance of this corporation has not escaped the federal government or the Government of Nova Scotia.

As both levels of government continue to have a major stake in DEVCO’s current and future success, the Committee believes that it is in their joint interests to determine the economic potential of a Donkin mine. If Donkin is not economically viable, both levels of government face a watershed in terms of Cape Breton’s future industrial development. This knowledge would better prepare both levels of government to help Cape Bretoners make the necessary economic adjustments to whatever the future holds.

Aside from the obvious regional economic interests, the federal government’s stake in the potential economic value of Donkin is augmented by the fact that, to date, it has invested more than $80 million in Donkin and it currently holds the lease on this reserve. Nova Scotia’s interest in Donkin is enhanced by the fact that it owns this resource, at least to the low water level, and would be entitled to resource royalties, like those associated with current operations, in the event that Donkin was developed.

The Committee is uncertain how much it would cost to determine the economic potential of a Donkin mine. While we recognize that such an assessment might be very expensive, we remain steadfast in our view that the economic potential of this reserve must be comprehensively assessed. The Minister told us that DEVCO will not conduct this study, but that the federal government is prepared to discuss this matter with any party that is interested in assessing the economic potential of Donkin as a private sector initiative.

While the Committee was preparing this report, it learned that DEVCO’s Board of Directors had signed a letter of intent with Donkin Resources Limited, a company from Cape Breton, to enter into an agreement to sell the land and transfer the leases related to the Donkin mine site and coal reserve. Neither the Minister nor the Chairman of the Board had indicated that such a proposal existed when they appeared before the Committee on 20 March 1997. The letter of intent with Donkin Resources Limited was signed approximately three weeks later. During the first phase of the proposal, expected to last 18 months, Donkin Resources Limited will attempt to identify the potential of a Donkin mine by studying the existing data. This phase is expected to cost $400,000, of which 75% would be funded through the Atlantic Canada Opportunities Agency.

According to the corporation’s press release dated 17 April 1997, DEVCO’s participation in this initiative would be limited exclusively to providing all of its existing information on the Donkin mine site and coal reserve. The agreement, which must be negotiated over the next 60 days, would ensure that Donkin Resources Limited was subject to all the rules and regulations governing the environment, and the development and operation of a coal mine. In addition, the agreement would protect DEVCO’s position in the Nova Scotia coal market. Thus, if Donkin were to become operational, it would compete with DEVCO in the export market.

This initiative may not only have implications for DEVCO’s Corporate Plan, but also raises a number of public policy issues. The Committee believes that a number of key questions must be addressed before DEVCO commits itself to an agreement. Among those are:

• If Donkin is developed does this mean that DEVCO would become a dedicated supplier to Nova Scotia Power and abandon the Corporate Plan’s objectives to produce for the export market?
• Does DEVCO have the legal authority or the public policy mandate to sell or transfer land or resources in which Canadian taxpayers have invested more than $80 million or to transfer leases owned by the Government of Nova Scotia?
• If Donkin is seen to be a profitable investment, should DEVCO reserve to itself the right of first refusal?

While the Committee supports a study to determine the commercial potential of a Donkin mine, until these and other pertinent questions are addressed and satisfactorily resolved, it cannot endorse DEVCO’s intent to enter into an agreement to sell land and transfer leases related to the Donkin mine site and coal reserve, and in the meantime we urge the Board of Directors not to make an irrevocable commitment on this matter.

CONCLUSION

Members of the Committee have devoted considerable time and effort to reviewing DEVCO’s Corporate Plan. We tabled a Report in June 1996 and have since revisited a number of issues in accordance with our mandate of 11 February 1997. We are pleased with the reception given to our June 1996 Report, as most its recommendations have been implemented in whole or in part.

We are struck with the commitment demonstrated by management and workers in making the first year of the Corporate Plan a successful one. Even though some objectives were not attained, the corporation achieved its bottom line objective in 1996-97 and the corporation’s workforce battled adverse conditions to minimize the shortfall in year-end output. Domestic sales reached their highest level in corporate history. In a departure from the past, there are signs that labour and management have begun to work together in the quest to establish a commercially viable enterprise. Since the Committee believes that greater co-operation in the workplace is one of the key factors in the successful realization of the Corporate Plan, all members of the Committee applaud DEVCO’s personnel for its achievements in this regard. We strongly encourage them to continue on this track.

In this report, the Committee has revisited three key issues: social costs, exports and the Donkin coal reserve. As identified in our June 1996 Report, the Corporate Plan requires DEVCO to cover some costs related to historical operations that we believe are substantial, inappropriate and undermine the corporation’s self-sufficiency mandate. As a result, we recommend that the government recognize DEVCO’s successes by forgiving annual loans required to cover capital expenses and operating costs, provided DEVCO can achieve its annual bottom line objectives outlined in the Corporate Plan.

It appears that DEVCO is establishing itself as a profitable exporter of coal, and, as a result, we conclude, with the usual caution associated with incomplete information, that the Corporate Plan’s export targets can be achieved.

Although the Committee is pleased that the potential development of Donkin will be pursued, it believes that there are a number of important issues that must be addressed before concluding the agreement .

Finally, the Committee would like to take this opportunity to thank the witnesses who shared their time and expertise, the personnel who assisted us while we observed mining operations, and those who provided background information for our report. Without this help, the Committee would not have been able to do its work.

NOTES

1. The Senate of Canada, Report of The Special Committee of the Senate on the Cape Breton Development Corporation, June 1996, p. 15.

2. Cape Breton Development Corporation, Annual Report for the Year Ended December 31, 1968, p. 1.

3. John T. Boyd Company, Report, 1995, p. 12-11.

4. In the final quarter of 1996, the average "free on board trimmed" price for steam coal at the pier in Hampton Roads and Baltimore was roughly $56.75 and $50.84 respectively (U.S. prices were converted to Canadian dollars using an exchange rate of U.S. $1 = Can.$1.3617, the average exchange rate thus far in 1997 (Coal Week International, February 1997, p.5).

5. A three-year drilling program was completed for the Donkin reserve in 1979. According to a comprehensive study undertaken by Montreal Engineering Limited (Monenco), some of the drill core samples were unreliable and did not permit an adequate understanding of the geology to properly estimate production rates. Moreover, the study could not assure the run-of-mine sulphur content or the feasibility of washing the coal. The Boyd Report, an extensive study of DEVCO commissioned by the federal government in 1995, acknowledged that the tests conducted by CANMET on coal mined at the faces of the Donkin tunnels suggest that washing would meet the coal quality requirements of Nova Scotia Power. However, the Boyd Report notes that these results are suspect because they are based on a sample that is not representative of the entire reserve. The Boyd Report also expressed the belief that because of a dip in the seam, horizon control problems make it difficult to assume that Donkin can be mined selectively.

6. The Senate of Canada, Report of the Special Committee of the Senate on the Cape Breton Development Corporation, June 1996, p. 21.

7. Cape Breton Development Corporation, Annual Report for the Year Ended March 31, 1996, p.6.