Costs of Pipeline Obstructionism

October 2016, Vol. 243, No. 10

By Gerry Angevine and Kenneth P. Green, The Fraser Institute

Canada faces multiple challenges in its natural resource sector. World oil prices have fallen by more than 50% over the last two years. American oil and gas production have surged and threaten to reduce demand for Canadian oil in its largest (and essentially only) foreign market.

Because of a lack of tidewater access for Canadian oil, Canadian oil producers can only sell into the U.S. market, which is glutted in the Midwest and is where most Canadian oil is bought. Because of these constraints, Canadian oil sells at a significant discount compared to the price that oil such as North Sea Brent (NSB) garners in the world’s most lucrative markets. That discounting costs Canadians many billions of dollars each year.

Costs to Western Canada

The relatively low crude oil prices that Western Canadian oil producers are able to realize in the U.S. has long been a cause of concern. Both Canadian light and heavy crude oil producers are subject to substantial penalties in U.S. markets, but the heavy crude oil and bitumen blend that is mixed and priced at Hardisty, Alberta and sold as “Western Canada Select” (WCS) suffers a greater discount than light, sweet crudes.

This is because the price of WCS is affected not only by relatively long distances to refinery destinations and the higher transportation costs that the shippers must absorb, but also by quality differences.

If it were not for the quality differences and the affect that these have on refinery demand for competing crudes, the difference between the price of WCS at Hardisty AB and WTI crude oil at Cushing, OK would boil down to the transportation cost. Deducting the transportation cost from Hardisty to Cushing from the price of WTI crude at a given point in time provides an indication of the approximate value of WCS to U.S. refiners in the Cushing area.

Because Canadian conventional and non-conventional (i.e. from the oil sands) heavy crudes oils continue to suffer from price discounts relative to world region crude oil prices such as North Sea Brent (adjusted for quality differentials and transportation cost), and are at risk of being displaced to some extent by the increase in U.S. oil production, it is in the interest of Western Canadian producers to gain access to overseas markets. Access to port facilities on the west and/or east coast would allow Canadian producers to access world crude oil prices such as that for North Sea Brent crude (adjusted for transportation cost).

If such access continues to be unavailable, the value of the lost revenue will mount. We can estimate what Canada has to lose by using projections of potential additional oil production and sale into foreign markets at a range of potential oil prices.

If Canada were able to export 1 MMbpd to markets accessible from ocean ports – while continuing to sell the lion’s share of heavy oil and bitumen exports to U.S. oil markets – substantial incremental revenues could result. At a $US40/bbl price we estimate this could be as high as $2 billion per year (in Canadian dollars) compared with selling into the flooded U.S. market.

However, the cost of continued dependence on the U.S. market for heavy oil exports will continue to increase as the price of oil rebounds from the lows recorded in the first quarter of 2016. At an average price of US $60/bbl, it could reach CA$4.2 billion; and at US$80/bbl, CA$6.4 billion.

If higher netbacks from markets accessed from tidewater connections were realized by all Western Canada heavy oil production (that is, if Canada stopped selling into the discounted U.S. market entirely), at the US$40, US$60, and US$80/bbl price levels the annual benefits could reach CA$8.9 billion, CA$18.5 billion and CA$28.2 billion, respectively.[1]

Costs Alberta and Saskatchewan Governments Must Bear

Both the price of oil and the volume of oil production drive the Alberta and Saskatchewan crude oil royalty formulas. The importance of the price factor is underscored by the impacts of much lower prices on royalty revenues. In the October 2015 Alberta provincial budget royalty revenues were projected to plunge to $1.5 billion in 2015-16 from $5 billion. Royalties from conventional oil production were estimated at $0.5 billion compared with $2.2 billion in 2014-15 (Alberta Finance). Saskatchewan’s February 2016 Budget Update projected oil royalty revenue of $347.9 million in fiscal 2015-16 – 38.5% less than previously (Saskatchewan Ministry of Finance).

Our analysis suggests that annual royalty revenues in Alberta and Saskatchewan combined would decrease by approximately CA$1.2 billion as a consequence of a decrease in the WTI crude price of US$7/bbl. About two-thirds of the change would result from lower royalty revenues from Alberta oil sands bitumen production, and almost one-quarter from lower revenues from Alberta conventional crude oil production royalties.

Approximately 10% of the change would come from the effect on oil production royalty revenues in Saskatchewan.  Depending on the price difference that one assumes, this approach provides a rough indication of the extent of royalty revenues lost each year by not being able to achieve higher prices for Western Canadian oil production.[2]

Pipeline capacity to transport crude oil coastal refineries is needed to address the pricing dilemma that Western Canadian oil producers face due to heavy dependence on the U.S. Midcontinent region. Oil pipeline projects of this kind with a combined capacity of about 4 MMbpd have been proposed or conditionally approved.

These include Kinder Morgan’s proposed Trans Mountain Pipeline Expansion that would more than double the capacity to ship crude oil from Edmonton, Alberta to Burnaby, B.C. for transfer to refineries in the U.S. Northwest, California, Japan, Taiwan, China and Southeast Asia; the Enbridge Northern Gateway Pipeline proposal that would also substantially increase the capacity to transport crude oil from Alberta to Canada’s West Coast for export; and TransCanada’s proposed Energy East Pipeline to ship as much as 1.1 MMbpd from Western Canada to refineries in Quebec, New Brunswick and overseas. However, investors may now be less inclined to move ahead with such projects than previously because of the impacts of the recent oil price drop on price expectations and production growth.

Obstruction by Governments

The Northern Gateway Pipeline, the Energy East Pipeline, and the Trans Mountain Pipeline Expansion would enable about 2 MMbpd of Western Canadian crude oil to access coastal U.S. and overseas markets. But all three projects face serious challenges, both social and environmental, from Environmental Non-Governmental Organizations, First Nations, and other community groups, and have been subject to regulatory intervention by some provincial governments (Such as British Columbia and Quebec) to a level that smacks of obstructionism.

Many First Nations have vigorously opposed the Trans Mountain Expansion because of concerns about environmental risks associated with potential pipeline leaks and ruptures. Oil spills in coastal waters related to loading of tankers and tanker leakage and mishaps are also of great concern. Various First Nations also believe the review process is flawed because it doesn’t address environmental impacts of upstream (e.g. oil production) and downstream consequences[3] from operation of the pipeline. Some First Nations opposing the Energy East Pipeline Project and Northern Gateway have expressed similar concerns and sought changes to the review processes.

In December 2015, the Assembly of First Nations of Quebec and Labrador (AFNQL), the Assembly of Manitoba Chiefs (AMC) and the Union of British Columbia Indian Chiefs (UBCIC) sent an open letter to Prime Minister Justin Trudeau asking that the allegedly “broken review process for tar sands pipelines”[4] be fixed, and that National Energy Board project reviews currently in progress be halted until the process has been fixed (Quebec, Manitoba and B.C. First Nations Groups, 2015). The letter states that the current system is flawed because it has:

“Recklessly compressed pipeline reviews; sidelined critics; excluded essential considerations such as climate change; and violated Indigenous rights and sovereignty. Meanwhile, the National Energy Board (NEB) is no longer an independent arbiter in such reviews. It has become a politicized and industry-captured ‘rubber stamper’ that pays only lip service to the respect for the positions and rights of First Nations.”

The Northern Gateway Project was approved by the federal government in 2014 subject to 209 environmental and other conditions, hardly what one would consider a “rubber stamp.” By mid-2016 Enbridge had met most of them.

However, the federal government has rejected the company’s request to extend the permit expiration date as a consequence of a federal court ruling that the government failed to fulfill its obligation to consult with First Nations. As a result, the future of the project is uncertain.

With reference to the Trans Mountain Expansion and the Energy East Pipeline, the government has committed to require deeper consultations with indigenous peoples and to provide funding to support their participation. Also, to assess upstream greenhouse gas emissions associated with the projects and to make the findings public.

Further, in the case of the Trans Mountain Expansion, the government decided to appoint a ministerial representative to engage local and indigenous communities potentially affected by the project. With regard to the Energy East Pipeline, the government has sought expanded public interest[5] into the NEB Review process.

The new measures invoked by the federal government mean that additional time will be required to complete the review processes and, in the case of the Trans Mountain project, extension of the legislated time limit for the government’s decision from August 2016 to December 2016. With respect to the Energy East Pipeline, the legislated review time limit has been extended by six months (for a total of 21 months), and the time required for the government to make a decision once the NEB’s report has been tabled, from three to six months (Natural Resources Canada).

Early in 2016 the Province of British Columbia reaffirmed that the Trans Mountain Expansion project must meet five requirements for any new heavy oil pipeline to receive provincial support. Two of those conditions pertain to oil spill response, prevention and recovery systems with regard to the B.C. coastline and ocean and onshore situations, respectively.

Because the company had not provided sufficient information to allow the province to determine whether the company would use a “world-leading spills regime,” the province indicated that it is “unable to support the project at this time, based on the evidence submitted.”(B.C. Govt.).

As a further barrier to the approval of oil pipeline projects in British Columbia, the B.C. Supreme Court has ruled that instead of entering into “equivalency” arrangements with the NEB, whereby the board’s assessments would satisfy B.C.’s requirements, the B.C. Environmental Assessment Office must undertake its own reviews. The ruling stated that this is necessary in order for the province to fulfill its obligation to consult with First Nations. (B.C. Supreme Court).

Recommendation for Expediting

In view of the fact that windows of opportunity for access to new markets via new or expanded pipelines are time-sensitive, and that delays can be very costly for project investors, shareholders, and consumers alike, shortening rather than lengthening regulatory review processes should be a priority. For this reason, we propose that the provincial and federal governments establish standing committees to identify means to achieve specified reductions in times allocated for environmental review assessments, project application reviews, regulatory decisions and permitting.

This may involve specifying particular regulators to take the lead in certain cases, depending on project scope and location, such that applicants need to file with only a single entity (i.e. one-stop shopping). Such regulatory reforms would certainly result in some costs to governments and to taxpayers. However, if Canada can move its oil resource to tidewater sooner rather than later, those costs will be more than covered by the higher revenues, taxes, and royalties that Canadian oil producers and governments would receive by commanding a higher price for exported oil.[6]

Canadians are losing billions of dollars each year to pipeline obstructionism, while competitors around the world (that now includes the United States) are building pipelines, increasing production, and reducing imports. It’s time for Canadian governments to find a way to end the pipeline gridlock and get Canada’s oil moving to the world’s most lucrative markets.

Authors: Kenneth P. Green is senior director, Natural Resource Studies at the Fraser Institute. Gerry Angevine is a senior fellow with the Fraser Institute. 

References

Angevine, Gerry and Kenneth P. Green. The Costs of Pipeline Obstructionism. Fraser Institute, July 2016. Available at: https://www.fraserinstitute.org/sites/default/files/costs-of-pipeline-obstructionism.pdf

CBC. Province Reaffirms Trans Mountain Pipeline Must Meet Five Conditions. Media release. Jan. 11, 2016. Available at: https://news.gov.bc.ca/releases/2016ENV0001-000020 as at April 26, 2016.

Alberta Finance. 2015-16 Budget and Fiscal Plan: Revenue. October 2015. Available at: http://finance.alberta.ca/publications/budget/budget2015-october/fiscal-plan-revenue.pdf.

B.C. Government.  Province Reaffirms Trans Mountain Pipeline Must Meet Five Conditions. Media release. Jan. 11, 2016. Available at: https://news.gov.bc.ca/releases/2016ENV0001-000020

B.C. Supreme Court. Coastal First Nations vs. British Columbia Environment (Decision). Jan. 13, 2016. Available at: https://assets.documentcloud.org/documents/2686393/Judge-Koenigsberg-Re-Coastal-First-Nations-v.pdf

Energy East Amended Application, December 2015. Tolls. Available at:

https://docs.neb-one.gc.ca/ll-eng/llisapi.dll/fetch/2000/90464/90552/2432218/2540913/2543426/2995824/2957152/A76909-6_V3_Appendix_3-6_IHS_Report_Supply_and_Market_Sept_2015_-_A5A0K5.pdf?nodeid=2957372&vernum=1

Quebec, Manitoba and British Columbia First Nations Group. Re: Fixing the Broken Process for Tar Sands Pipelines. An Open letter to the Prime Minister.  December 17, 2015. Available at: http://www.newswire.ca/news-releases/open-letter-to-the-right-honourable-prime-minister-trudeau-562800671.html

Natural Resources Canada. Interim Measures for Pipeline Reviews. Backgrounder. January 27, 2016. Available at: http://news.gc.ca/web/article-en.do?mthd=tp&crtr.page=1&nid=1029989&crtr.tp1D=930

Saskatchewan Ministry of Finance. Budget Update. Third Quarter Report. February 29, 2016. Available at: http://www.saskatchewan.ca/government/news-and-media/2016/february/29/third-quarter

[1] These estimates assume that the pipeline toll from Hardisty, Alberta to Montreal is CA$7/bbl. This is closely similar to the 10- and 20 year tolls presented in Section 7, page 12 of the Amended Energy East Pipeline Application to the NEB (Energy East Amended Application, December 2015). They also assume that CA$1 = US$0.75; that the Brent (Montreal) and WTI (Cushing, OK) prices are at parity; and that the WCS price is 30% less than the price of WTI.

[2] For discussion of the underlying assumptions see the Fraser Institute study The Costs of Pipeline Obstructionism by Gerry Angevine and Kenneth Green. (available at https://www.fraserinstitute.org/sites/default/files/costs-of-pipeline-obstructionism.pdf ).

[3] There is no apparent limit on the scope of the downstream consequences that First Nations insist must be assessed.

[4] First Nations most likely would not be making this argument if they were in agreement with the National Energy Board’s decision. The existing review process is not flawless, but if it were, parties unhappy with the result would still be prone to blame the system rather than the rational for the decision.

[5] It is unclear how the government plans to achieve greater public interest and how the extent of such interest is to be assessed or measured.

[6] As an alternative to paying the incremental cost of expedited review processes, governments may wish to consider having project applicants desiring speeded up processes pay for the extra cost at their option.

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