Energy East: Canada’s Oil Imports, Pipelines and the East-West Equalization Conundrum

Canada has the ambition to become an energy superpower. By 2025, Alberta oil output will more than double to 3.5 million barrels a day.[1]

One persisting enigma is that Canada still buy imported crude from the Atlantic Basin priced on Brent and sells low its landlocked production (priced on WCS and WTI). Apart from a quality differential , the price differential highlights the importance and potentially the value of pipelines in Canada that move oil on an east-west axis.

Suffice to say that pipeline construction is the cornerstone in Canada’s national energy strategy. Economists have estimated that it costs the canadian economy between 15B$ and 23B$ per year [2] .

Energy East

Energy East Pipeline is 2800 miles pipeline that will carry 1.1-million barrels of crude oil p/d from Alberta and Saskatchewan to refineries in Eastern Canada. Trans Canada Pipelines [who is also the sponsor for Keystone XL] has the ambition to convert an existing natural gas pipeline to an oil transportation pipeline, construct new pipelines in Alberta, Saskatchewan, Manitoba, Eastern Ontario, Québec and New Brunswick and build two marine export terminals. The proposal could the Canadian Oil Imports/pipeline conundrum. 

WTI Spot Cushing minus WCS Hardisty, WTI ex chicago minus WCS ex chicago and the forgotten Brent/WCS Montreal

WTI Spot Cushing, OK minus WCS Hardisty, AB WTI ex chicago minus WCS ex chicago and the forgotten but thirsty Brent/WCS Montreal

Regulation, Environment and Politics

Canada is a democracy based upon federalism and pluralism. In a federation, the federal government and the provincial governments , each with their own jurisdictions, experiment with different ways of doing things, thinking, which in a democracy enable to find the best solutions through healthy discussions and competition of ideas.

Once the politics have decided what are the national priorities, the National Energy Board (NEB ) regulates international and inter-provincial aspects of the oil, gas and electric utility industries among other things: the economic, technical and financial feasibility, and the environmental impacts of the project.

NEB is independent from the government and its main advantages are consolidation of agencies, lobbies, into a single hearing/arbitration process; reducing cost and time.

Pipelines are under the federal jurisdiction, provinces have still a say but aren’t entitled by any forms of tolls or tariffs from transiting barrels coming from other provinces (i.e Quebec or B.C). The constitution is clear that resource revenues belong to the producing provinces.

In Canada, another “implicit” tariff determines the acceptance, neutral acceptance or rejection of a pipeline: Equalization.

Equalization. 

Equalization is a process wherein the federal government makes transfer payments from the rich provinces to the poor provinces.

“Parliament and the government of Canada are committed to the principle of making equalization payments to ensure that provincial governments have sufficient revenues to provide reasonably comparable levels of public services at reasonably comparable levels of taxation.” (Subsection 36(2) of the Constitution Act, 1982)

Interesting aspects:

  • Equalization payments are unconditional – receiving provinces are free to spend the funds according to their willing.
  • Equalization calculation is subject to changing ratings, Constitution has not provided a calculation basis.
  • One main basis in Equalization is energy and natural resources.
  • Provinces with high earnings are generally net creditors for provinces with lower taxable basis and/or higher spending propensity.
  • Manitoba and Quebec are two big hydropower producers and subsidize hydro power heavily.
  • Hydro revenues aren’t subject to the same treatment as revenues from non-renewable sources such as oil extracted in Saskatchewan and Alberta .

In return, energy has a positive correlation with Canadian dollars, hurting competitiveness in provinces with exports as a main component of GDP( Quebec, Manitoba, Ontario, New Brunswick). (some may see a form of dutch disease within the eastern provinces).

enbridge. energy east pipeline project

Ontario (3B$), Quebec (9B$), Manitoba (1.8B$) are equalization receivers. [only for year 2013-2014]. That’s their equalization “Pipeline toll”since major part of this comes from Western Canadian Provinces’ ability to generate revenues through O&G.

In Quebec, Equalization is a huge component in their annual economic planning. Giving green light to a pipeline is possible if new generated revenues aren’t offset by decrease in equalization. [3] This is simply a rational economic behavior.

Allowing a pipeline will increase Alberta’s revenues basis while not challenging Eastern provinces’ equalization status, hence I believe that these governments are likely to neutrally accept Energy East.

British Columbia and Enbridge’s Northern Light

Enbridge’s Northern Light Pipeline from Alberta to Northern British Columbia is a special case. The B.C. Liberal government faces opposition from inside, from their supportive base and from a coalition of environmentalists and medias.

In the Equalization system, British Columbia is a net credit creditor (they contribute) but they’re not a O&G producing province. This is a part of the answer that explained why they don’t feel they have anything to lose by rejecting/delaying Enbridge’s Northern Gate.

B.C has different plans…

One of BC’s five minimum requirements that must be met for the province “to consider the construction and operation of heavy oil pipelines within its borders it that it receives a fair share of the fiscal and economic benefits of a proposed heavy oil project that reflects the level, degree and nature of the risk borne by the province, the environment and taxpayers”. Not surprisingly according to Professor Bankes from the University of Calgary, B.C’s legal basis is weak. [4]

Kinder Morgan in B.C

It is worth mentioning that Kinder Morgan (KM) already owns the only pipeline delivering oil from Alberta to Vancouver-based, Chevron refinery and Anacortes U.S Refineries. Northern Gateway is a direct competitor with existing Trans Mountain Pipeline and KM is also petitioning pipeline capacity expansion with the National Energy Board (NEB).

2_0203_rb_transmountain

Kinder Morgan vs Enbridge Competition in B.C ? just saying

Chevron Corp. in British Columbia.

Chevron Corp.’s refinery in Burnaby  may be unable to compete with bidders from China and India for diluted bitumen being shipped from the Alberta oil sands via Kinder Morgan’s pipeline to the West Coast, despite surging production from Canada’s oil sands, refineries are operating below capacity and are struggling to compete against “super” refineries in India and in China. “Chevron is being outbid for the oil, because there are more bidders coming into the process,” Stewart said in an interview, citing conversations with the company. MP Kennedy Stewart, NDP – Vancouver Sun 03/04/2012

The Trans Mountain tariff defines “Priority Destination” as a refinery, terminal or other facility connected to, or capable of receiving petroleum from, Trans Mountain or its Puget Sound pipeline “and so designated by the National Energy Board by reason that it is not capable of being supplied economically from alternative sources.”

For Chevron, the word “economically” in the tariff refers to the manner in which crude oil is delivered, rather than the way  in which the refinery is operated and the profitability of the refinery is not relevant in assessing whether or not the refinery can be economically supplied from alternative sources…

Although small, Chevron’s refinery in British Columbia is the company’s most profitable refinery by margins. 

A large spread has emerged due surge in North American oil production along with subdued U.S. demand and the limited ability to ship it out to international markets.”

On this crude market disconnect, it is like real estate, “It is location, location, location, and our large coastal refineries are distant from where these advantages really are.” -Mike Wirth, executive VP, Downstream and Chemicals, Chevron Corporation, Conference Analyst Call, 2/11/2012

The National Energy Board has finally denied Chevron’s request to deem its refinery in Burnaby, B.C., a “priority destination” for crude shipped on Kinder Morgan’s Trans Mountain pipeline from Alberta.

Premier Clark firmly opposed to Albertan pipelines but in love with gas.

During last campaign, Premier Christy Clark has repeated that B.C doesn’t need Alberta and has a plan to make B.C. an energy superpower if more natural gas was developed and delivered through pipelines, as opposed to “allowing” oil pipelines to “crisscross” British Columbia more than they already do.

One major player is also Chevron Corp with the Kitimat LNG project:

  • Awaiting for LNG exports licences in U.S.
  • Hedging Long-Term contract made with Asian Buyer on Australia’s Gorgon LNG rising costs.

http://www.worldoil.com/Chevron_reveals_concerns_about_rising_costs_for_Gorgon_LNG_project.html.

Curiously, Kitimat, B.C is the same port chosen for both Chevron LNG project and Enbridge’s Northern Light oil pipeline. In B.C, BG, Shell, Exxon, companies with enormous B/S have competing projects.

Chevron is showing combativeness and aggressiveness, they are in the business of exploration/risk and changing markets, they seem to live comfortable with “all what we’ll do isn’t always 100% exact”, but their strategy is global and ultra-adaptive, they seek to take advantage of any possible options to make money.

Like I suggested in the LNG Marginal Supply Cost Curve Shipping HH/Asian LNG spread and The Politics of the Deadweight spread,  USGC gas economics makes sense, but companies need licences (sizable annual export capacity).

1. U.S shale gas will start flowing Eastern Canada to catch a favorable basis. [it is already the case]

2.  If you listen to the market, gas from the south will flow to North-Western-Canada to catch the export basis and facilitate future drilling in the Rocky Mountains.

Conclusion.

Canada’s institutions and federalism mechanisms are facing a major test.

The construction of pipelines are a strategic priority that is aimed to offer crude oil marketing opportunities for buyers/sellers and economic opportunities for Canadians in both West and Eastern Canada.

Northern Light is extremely contentious because of B.C’s claims on Alberta. Behind this, is it reasonable to say that two pipelines companies are competing for the same oil capacity source ? About Oil or Gas,  they are like mac&cheese so why not considering both ?

You have had an overview of current energetic issues in Canada.  It’s becoming apparent that pipelines/refiners/governments bodies are in a competitive mode i.e markets.

Who can pretend that a single entity called Big Oil still exist ?

© 2014 The Trade, Shipping and Finance Wizard

References

[1]http://www.financialpost.com/news/sands+double+output+2025/3132332/story.html

[2] http://www.fraserinstitute.org/uploadedFiles/fraser-ca/Content/research-news/research/publications/canadian-oil-transport-conundrum.pdf

[3] http://blog.questerre.com/en/?p=577

[4]http://ablawg.ca/2012/07/25/british-columbia-and-the-northern-gateway-pipeline/,

 

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