Last week, the government of Justin Trudeau took a surprising and dramatic step to salvage the $7.4 billion Trans Mountain pipeline twinning project.
The project is critical to oil producers in Alberta, since it would expand the current pipeline’s capacity of 300,000 barrels per day to 890,000.
But after facing lengthy delays, legal challenges, public protests and opposition from the John Horgan government in B.C. and the cities of Burnaby and Vancouver, Kinder Morgan Canada (TSX:KML) threatened to cancel the project.
The government announced it will buy out Kinder Morgan’s Trans Mountain pipeline assets and assume the financial and political responsibility for getting the twinning project built.
Q: What is Canada buying and how much will it cost?
A: Ottawa is buying Kinder Morgan Canada’s existing Trans Mountain pipeline and associated assets for $4.5 billion, which includes the $1.1 billion Kinder Morgan has already spent on the expansion project.
Assets include the Westridge Marine Terminal in Burnaby, Puget Sound pipeline, a jet fuel pipeline to Vancouver International Airport and terminal and tank farms in Kamloops and Sumas. It does not include assets unrelated to the pipeline, like the Vancouver Wharves bulk terminal. The sale is worth $13 per share to Kinder Morgan shareholders.
Q: What will Ottawa own now and why?
A: The existing Trans Mountain pipeline is a critical piece of the $7.4 billion twinning project. One cannot be built without the other. The new line generally shares the same pipeline corridor as the existing one, and requires expansions to key pieces of Kinder Morgan infrastructure, including Westridge Marine Terminal.
Kinder Morgan felt that because of opposition from the B.C. government, there was too much political uncertainty to move forward on the expansion project, and Ottawa agreed, saying it is better positioned to deal with B.C.
“What we have here is risks and delays caused by political uncertainty,” federal Finance Minister Bill Morneau said. “A private actor can’t deal with that uncertainty between provinces. We’re saying, in order to deal with that uncertainty … we’re exerting our federal jurisdiction by purchasing the project. Over the next stage we are looking to move this project back into the private sector.”
Iain Black, CEO of the Greater Vancouver Board of Trade, said, “The government made the best decision from a list of really bad options.”
Q: How does this deal work?
A: Kinder Morgan has agreed to immediately resume construction of the $7.4 billion expansion project, with Ottawa agreeing to cover the costs. The sale of the Trans Mountain assets is expected to close in August and is subject to a vote by Kinder Morgan shareholders.
In addition to Kinder Morgan’s assets, Ottawa will acquire the management team assembled to build Line 2. Kinder Morgan and Ottawa will try to find a buyer for the existing pipeline and twinning project.
Kinder Morgan’s team will essentially end up building the project on behalf of the new owner – the Canadian government – unless some other company steps in right away and buys the project outright.
Q: What if Canada can’t find a buyer? Is this a bad investment?
A: If Ottawa can’t find a buyer, Canadian taxpayers will be stuck with a highly profitable pipeline.
The existing Trans Mountain pipeline made $300 million in revenue last year, with a 9.5% return on equity, according to University of Calgary economics Prof. Trevor Tombe.
But Morneau has made it clear his government has no desire to be a long-term pipeline owner.
Tombe doesn’t think Canada will find a buyer until after the twinning project is complete, however.
“The tricky part is getting it completed,” he said. “But once it’s complete, it’s a very valuable asset.”
As Tombe points out, pipelines receive stable revenues from petroleum producers, regardless of where oil prices go, so they are reliable money-makers.
“Once it’s built, they’ll easily be able to offload the asset to a private buyer,” he said.
Solomon Associates consultant Jihad Traya agrees: “Bluntly, this is a great asset. It’s a very profitable, very strategic asset.”
Q: Are revenue-sharing agreements with B.C. and First Nations still on the table?
A: Yes. Morneau said existing benefits agreements negotiated by Kinder Morgan with First Nations will remain in place. The Ministry of Finance has also confirmed that the $1 billion revenue-sharing agreement that Kinder Morgan struck with the former provincial government remains in place.
The federal government might take some heat for that because the revenue-sharing agreement was part of a bargain with the B.C. government, which has since reneged on its support for the Trans Mountain project.
The revenue sharing – which would provide B.C. with $25 million to $50 million per year once the twinning is completed – was one of five conditions the previous BC Liberal government set. All five had to be met before the provincial government agreed to support the project.
But the new BC NDP government essentially withdrew the provincial government’s support. The B.C. government’s attempts to halt the project are what led to Ottawa committing $4.5 billion to acquire Trans Mountain assets and potentially at least $7.4 billion more to complete the twinning project.
Q: Will tolling rates change for the 13 shippers?
A: That is a question that the Finance Ministry was unable to answer and which Alberta oil producers like Cenovus Energy Inc. (TSX:CVE) will be asking, as the deal is finalized.
Thirteen oil producers in Alberta made long-term commitments for Line 2. Their main concern now is that if the project goes significantly over budget, they could be asked to pay higher toll rates.
“As a committed shipper on the project, we will be looking for more details to ensure that our commercial terms will remain reasonable,” said Cenovus CEO Alex Pourbaix, a former longtime CEO for TransCanada Corp. (TSX:TRP).
“It is our hope that this additional financial certainty, combined with the federal government’s ability to assert jurisdiction over national infrastructure projects, will allow the project to proceed without further undue delays or significant cost overruns.”
Q: How does this new arrangement address opposition from B.C. and anti-pipeline protesters?
A: As a private company, Kinder Morgan does not have the authority to overrule a hostile provincial government – but Ottawa does. B.C. Premier John Horgan has even conceded it will be easier for him to deal with Ottawa, rather than with Kinder Morgan, when addressing provincial concerns over the pipeline.
“I do believe that the federal government now is totally accountable, not just for regulation and approval of a pipeline, but they now are responsible from wellhead to tidewater and beyond, and I think that allows me to have more candid discussions with the owners of the pipeline than I would have been able to when they were shareholders in a Texas-based oil company,” Horgan said. “The federal government now is completely accountable, and I think that is probably at the end of the day a good thing.”
As for protesters, some of whom have shown up at Kinder Morgan shareholder meetings, their adversary is no longer a big Texas pipeline company, but their own federal government. Last week, they were already showing up to protest Morneau’s appearance before the Calgary Chamber of Commerce.
Q: Who might ultimately end up owning and operating the expanded pipeline?
A: It could be some other midstream company, or a joint venture that might include pension funds, First Nations, and oil producers that would use the new pipeline. Kinder Morgan itself could even end up being one of the shareholders.
“I would not be surprised if it’s the same group, reconstituted with some sort of ownership structure change,” Traya said. “Theoretically you can still have Kinder Morgan having portions of it.”
The Cheam First Nation is one Indigenous group that is interested in taking a stake. Chief Ernie Crey said one way of gaining equity is through the federal government’s reconciliation efforts.
“Definitely I see an open door to the possibility of taking out an equity position in the pipeline as part of what I would describe as economic reconciliation with Canada,” Crey said. “But for sure we would have to go to large lenders and borrow funds to take out a stake in the pipeline.”
Q: What happens if the $7.4 billion twinning project goes over budget?
A: Ottawa and Alberta have agreed to indemnify the twinning project, should it encounter unforeseen delays or cost escalations as a result of “political uncertainty.” Alberta has committed $2 billion to cover such unforeseen overruns. Any money Alberta spent would be converted to equity in the pipeline.
Moody’s Investors Service says the deal is “credit negative” for Alberta.
Some observers have predicted the twinning project’s cost could ultimately be as high as $12 billion.
But if the project goes over budget, it will still be a valuable, revenue-generating asset for decades to come, Tombe said.
“Even if it gets as high as $12 billion, it’s still economic in terms of the ability to generate revenue once it’s completed.”
Q: What cases are still before the courts that could jeopardize the project?
A: None, according to Robin Junger, a lawyer specializing in Aboriginal and environmental law with McMillan LLP.
More than a dozen court challenges against the Trans Mountain pipeline project have failed. Cases still in play include the B.C. government’s referral to the BC Court of Appeal to clarify whether it has the authority to restrict the flow of diluted bitumen from Alberta through B.C.
The best the province can hope for is acknowledgment that it has the legal authority to impose some conditions on the pipeline under provincial environmental laws, Junger said.
“There is no scenario in which the BC Court of Appeal says you can stop this pipeline,” Junger said. “The only question is this: ‘If you have the ability to regulate bitumen at all … how far can you go without stopping it?’”
Another important case is still before the Federal Court of Appeal, with a ruling expected any day. In that case, five First Nations argued Canada failed to properly consult Aboriginal stakeholders.
It is essentially the same argument made against the Northern Gateway project. In that case, the same court ruled Canada had failed to properly consult, essentially ordering the government to redo its consultations. That never happened, however, because the new Trudeau government put an end to the Northern Gateway project.
The worst that could happen is additional delays to the project – delays the federal government is now prepared to indemnify.
“If you lose a duty-to-consult case, it’s not the end of the world for a project,” Junger said. “You go and consult some more and then you redo the decision.”
Q: What message does this send to international investors?
A: Nationalizing Trans Mountain addresses one particular project, business leaders say, but more generally it sends a very negative signal. The Trudeau government has essentially conceded that, even though it claims to have jurisdictional authority, it cannot exert that authority without owning the project.
“We view the announcement as negative for entities considering large, resource-focused capital investments in Canada such as LNG, pipelines or oilsands projects, given the inability for the rule of law and regulatory approvals to allow projects to move forward,” GMP Securities said in a note to clients.
“We are left questioning why any company would pursue large capital investment in Canada.”
Jerry Bailey, a former Exxon Mobil Corp. (NYSE:XOM) executive and CEO of Petroteq Energy, which is focused on oilsands production in Utah, said the Canadian government’s decision to nationalize the pipeline was the right one. He expects it will renew investment confidence in Alberta’s oilsands.
“I think it will be a big boost,” he said. “There’s no point in investing in anything if you think you’re going to be stuck with a product with no way to get it to market.”
But Canadian business leaders say Canada needs to address the deeper problem of a dysfunctional regulatory and political system that has resulted in cancellation of multibillion-dollar projects, divestment from the oilsands by major oil companies and a general flight of capital – all of which are signs that Canada has become unsafe for investors.
“All of this talk about investment slowing down – it’s for real,” said Brad Hayes, president of Petrel Robertson Consulting.
“Canada has always sold itself as being a low political risk and great regulatory regime. But it is, for real, developing the reputation of being a higher political risk, not because there’s any dictators that are going to take over or whatever, but just because you propose something reasonable and somebody says they don’t like it and it gets ground to a halt.”
The Greater Vancouver Board of Trade’s Iain Black called the project “a poster child for why we have to have a very thorough review of what’s going on and fix the problems that are inherent.”
Greg D’Avignon, president of the Business Council of British Columbia, agreed, saying controversy over the pipeline “has shone a light on what companies have known for years: Canada is too costly, too complex and takes too long to come to a decision and get things done.
“The system has broken down to the point where taxpayer dollars are required to complete major infrastructure projects that support our collective prosperity when there have been willing private-sector, taxpaying investors.”
nbennett@biv.com
@nbennett_biv
