Why Al­berta should com­mit to a Key­stone XL con­tract

The Globe and Mail (Atlantic Edition) - - OPINION -

ANDREW LEACH As­so­ciate pro­fes­sor at the Al­berta School of Busi­ness, Univer­sity of Al­berta. In 2015, he chaired Al­berta’s Climate Lead­er­ship Panel.

Al­berta is al­ready dou­bled down on oil, and this would be an­other bet in that di­rec­tion. How­ever, as long as we’re still pro­duc­ing bi­tu­men and ac­cept­ing it in kind for roy­alty pay­ments, max­i­miz­ing the value we re­ceive for our bi­tu­men is im­por­tant.

When news broke ear­lier this month that Tran­sCanada was look­ing to the Al­berta gov­ern­ment to sign on to the Key­stone XL pipe­line as a long-term, con­tract ship­per, my hope was that the prov­ince would do just that. Now, Tran­sCanada has an­nounced that it has suf­fi­cient com­mer­cial sup­port to pro­ceed with Key­stone XL.

There are good rea­sons why Al­berta should have acted to se­cure space on the Key­stone XL pipe­line for ship­ping bi­tu­men roy­alty in kind (BRIK) bar­rels and no com­pelling rea­sons not to take such ac­tion. I hope, when the list of ship­pers is re­leased, that we see Al­berta’s crown pe­tro­leum cor­po­ra­tion among them.

Pipe­lines of­fer pri­or­ity ac­cess and lower-cost ship­ping to those with long-term, locked-in sub­scrip­tions called take-or-pay con­tracts (such as your news­pa­per sub­scrip­tion, where you pay whether you use it or not). By sign­ing th­ese con­tracts, pipe­line com­pa­nies hedge them­selves against quan­tity risk as the con­tracted rev­enue will be enough to cover a rea­son­able rate of re­turn on cap­i­tal.

This de-risk­ing al­lows a lower-cost cap­i­tal to build the pipe­line, low­er­ing the even­tual cost of ship­ping.

So, why should the gov­ern­ment take on a sub­scrip­tion on Tran­sCanada’s pipe­line? There’s a ba­sic com­mer­cial case for it, as the gov­ern­ment re­quires mar­ket ac­cess for the sig­nif­i­cant vol­umes it takes from pro­duc­ers in lieu of cash roy­alty pay­ments. Sec­ond, be­cause the gov­ern­ment of Al­berta has a stronger credit rat­ing than most Al­bertabased oil com­pa­nies, its par­tic­i­pa­tion will lower the over­all risk of the project and should pro­vide for lower over­all sys­tem tolls, in­creas­ing the value of all Al­berta crude and the prof­itabil­ity of Al­berta’s in­dus­try. Al­low me to ex­plain each in turn.

Al­berta al­lows com­pa­nies to pay roy­al­ties in kind (i.e. com­pa­nies can lit­er­ally pay their roy­al­ties with bi­tu­men). This oil is then mar­keted via the Al­berta Pe­tro­leum Mar­ket­ing Com­mis­sion (APMC). The APMC had pre­vi­ously taken on a 100,000bar­rel-per-day sub­scrip­tion for trans­porta­tion ser­vices on En­ergy East to ship th­ese bar­rels to mar­ket. With the can­cel­la­tion of En­ergy East, the APMC now finds it­self with­out enough guar­an­teed, longterm ship­ping ca­pac­ity.

If pipe­line ca­pac­ity is con­strained, as ap­pears likely, Al­berta roy­alty bar­rels would face steep dis­counts, since they’d need to ei­ther be shipped on much higher in­ter­rupt­ible pipe­line tolls, on rail or sold at a dis­count to those with firm ship­ping ca­pac­ity. To se­cure the value of our oil, the APMC must act to se­cure ac­cess to mar­kets which, to­day, means se­cur­ing firm ship­ping com­mit­ments on one of the main­line pipe­lines to ma­jor mar­kets or tide­wa­ter. With the Trans Moun­tain ex­pan­sion project fully sub­scribed, Key­stone XL is the best and only avail­able op­tion.

While the com­mer­cial case alone should have been enough to mo­ti­vate the APMC to act, there are also po­ten­tial in­cre­men­tal ben­e­fits to Al­berta from do­ing so. Al­berta ben­e­fits when the over­all value of oil is in­creased – pipe­line con­straints hurt Al­ber­tans as re­source own­ers as well as in the way low­ered re­source value rip­ples through our labour mar­kets and the rest of our econ­omy. We are all worse off if we sell our oil at a dis­count, which we will do if ad­e­quate pipe­line ca­pac­ity is not built to larger mar­kets than our own.

By se­cur­ing the ac­cess it needs via a long-term com­mit­ment, the APMC is also lend­ing its credit rat­ing to the project. With the exit from Al­berta of global ma­jors Royal Dutch Shell PLC and Cono­coPhillips Co., the com­bined credit rat­ing of en­ti­ties look­ing to ship bar­rels from Al­berta has dropped – while Conoco’s credit is solidly in­vest­ment-grade, Cen­ovus’s credit is barely so to­day. Cana­dian Nat­u­ral Re­sources Ltd. re­tains an in­vest­ment-grade rat­ing, but is far less di­ver­si­fied than Shell or even Sun­cor En­ergy Inc., and so its debt has a lower rat­ing. If you’re go­ing to loan money to Tran­sCanada on the ba­sis of the con­trac­tual com­mit­ments they have in place, KXL looks like a much riskier project than it once did. Al­berta’s par­tic­i­pa­tion could im­prove its odds of suc­cess. A suc­cess­ful KXL means a more suc­cess­ful and prof­itable Al­berta oil in­dus­try, which in turn is good for Al­berta.

There are, of course, some risks to mak­ing a decades-long, multi­bil­lion-dol­lar com­mit­ment to ship oil, al­though th­ese seem rather muted. Al­berta should see suf­fi­cient BRIK vol­umes of bi­tu­men to, once di­luted, fill a sig­nif­i­cant sub­scrip­tion to KXL. The only com­mit­ted draw­down on BRIK bar­rels at present is the 37,500-bar­rel-per-day Red­wa­ter Re­fin­ery slated to come on line shortly. If BRIK vol­umes are not suf­fi­cient, the APMC would likely be able to re­mar­ket firm ca­pac­ity on KXL to smaller firms who would not be able to qual­ify for the lower tolls, likely at a net gain but al­most cer­tainly with no net loss, mit­i­gat­ing the risk to the gov­ern­ment.

Al­berta is al­ready dou­bled down on oil, and this would be an­other bet in that di­rec­tion. How­ever, as long as we’re still pro­duc­ing bi­tu­men and ac­cept­ing it in kind for roy­alty pay­ments, max­i­miz­ing the value we re­ceive for our bi­tu­men is im­por­tant. In oil mar­kets, easy wins and sure bets are hard to find. For a prov­ince such as Al­berta, how­ever, a long-term com­mit­ment to KXL is as close to that as we’re go­ing to get. I hope the gov­ern­ment chose to sign us up.

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