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    The economic case for postponing the Trans Mountain Expansion Project


    William Pearce

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    In light of new global conditions, Canada's federal government needs to rethink its commitment to build the Trans Mountain Expansion Project

     

    NEW FACTS HAVE EMERGED since the NEB approved the Trans Mountain Expansion Project (TMX) on May 29, 2016 which make it likely that an expanded pipeline will not be needed or will ever be used, providing compelling reasons why the federal government should push the pause button on its construction.

    There are three pipeline projects which will address Alberta’s need for pipeline capacity. The first is Enbridge’s Line 3 and additional mainline optimizations which will soon add 450,000 bbl/day. The next pipeline to be completed will be Keystone which will add another 830,000 barrels per day (bbl/day). And finally there is TMX which will add 690,000 bbl/day.

    On March 31 Premier Kenny announced Alberta would take a $1.5 billion equity stake in Keystone and provide it with a $6 billion loan guarantee to help finance the constructions costs. He stated: “We are hopeful the Trans Mountain Expansion will get done. This is our insurance policy.” In other words, he wants to ensure the Keystone is built so that if TMX is not built for any reason, Alberta producers will have their needed pipeline capacity with the Keystone.

    When the federal government decided to buy Trans Mountain and the rights to build TMX there was considerable doubt Keystone would ever be completed. The landscape has changed so much since then that premier Kenny and his government felt confident that Alberta tax dollars would be well spent to provide Keystone a financial backing that will likely guarantee completion of its construction.

    This leaves the question as to whether TMX will be needed, because if Keystone is the “insurance” for a TMX failure it is also true that if Keystone is built and built before TMX is completed, as presently scheduled, TMX will not be necessary.

    This was the conclusion of a June 2019 Report of an Evaluation of the TMX project conducted by Dr Thomas Gunton and Dr Chris Joseph of SFU. Using the Canadian Association of Petroleum Producers (CAPP) 2018 supply forecast and an “under construction” forecast based on projects that were under construction at the time of writing the report, Gunton and Joseph concluded that the construction of TMX along with the other two mentioned pipelines would create significant surplus pipeline capacity.

    In particular they concluded that a combination of Enbridge expansions and the Keystone pipeline would accommodate demand until 2035 emphasizing “there is no likely scenario” in which building both Keystone and TMX would be required before 2035.

    They went further to say that there is considerable uncertainty regarding future oil markets and oil production and that stronger climate change policies to meet our Paris commitments and new fuel regulations that would impact heavy oil demand would likely result in future oil production being lower than the CAPP estimate and that the Enbridge expansions may alone be sufficient to meet Western Canada production needs.

    That being the case it would be an irresponsible use of taxpayer‘s money to commence construction on a $12.6 billion project for which there may be no need. The federal government should stop construction now and wait and see if Keystone proceeds to completion, as most people now expect will happen notwithstanding legal hurdles that have to be overcome. To postpone the commencement of construction will not affect the ability of Alberta producers to get their product to market given the considerable extra capacity that will be provided by the Enbridge Line 3 and related projects.

    If Keystone does proceed to completion, TMX can then be shelved most likely for all time. If on the other hand in the next six months Keystone is stopped in its tracks the federal government could commence construction after doing its due diligence to ensure the pipeline is still needed and will definitely be used.

    When Gunton and Joseph concluded that Enbridge expansions alone might be sufficient to meet western producer’s needs it was before the COVID-19 pandemic. We are now realizing that patterns of human behaviour may never return to the pre-COVID “normal”, and that permanently changed patterns will lower demand for oil to much lower levels than was predicted before the crisis. Lower demand will naturally affect the amount of oil that will be produced in the oil patch.

    Lower demand for oil during COVID has had a material impact on the price of oil apart from the Saudi/Russia price war impact which saw the price go slightly below $5/bbl at one point. As this is written, which is post oil war, the price of Western Canadian Select (the benchmark of diluted bitumen produced out of the oil sands) went briefly into negative territory. The past month the price has been largely below $10. The price in Asia would be lower still because of the higher transportation costs. Experts are saying that even when we recover from the virus we may see oil priced at $20. This in turn will greatly affect oil production from the oil sands and bring into question the need for any of the three major pipeline projects.   

    All of these developments make it a real possibility that even in the long run the Enbridge expansions alone will be sufficient to meet producer needs. And if that proves to be the case TMX would have to be shelved even if Keystone never proceeds to completion.

    But let us also consider the possibility that Keystone is not built but the Enbridge expansions don’t begin to meet producer needs. Due diligence would still require the feds to assess whether, if the TMX was constructed, there would be a market for Alberta oil to justify its construction. The feds must not only be satisfied there will be a market for Alberta heavy oil but that it can be sold at a profit over the long term. Current prices will not cover the cost of production and transportation. They are not sustainable for any length of time.

    Gunton and Joseph estimated the toll costs of the TMX at $10.78/bbl based on a projected construction cost of $9.3 billion. Since the federal acquisition of Trans Mountain, construction cost estimates have skyrocketed to $12.6 billion, which would take the toll cost to $14.60/bbl($10.43US).

    It is hard to find information on shipping costs from Canada to Asia but assuming the tanker is a Very Large Crude Carrier (VLCC) the cost of shipping oil from the United States to North Asia is currently around $5US which happens to be $1.20 more than the cost of  transporting a barrel from the Middle East to North Asia. I would imagine this might be indicative as to what the costs are for Canadian shipments to North Asia.

    As to production costs, the Canadian Energy Research Institute (CERI) in its July 2019 report calculates the plant gate cost of crude bitumen for greenfield steam-assisted gravity drainage (SAGD) projects  to be $40.61 ($28.72US). Costs for mining and upgrading projects are higher. To transport bitumen to Asia, there is an additional cost to transport the bitumen to Edmonton (where the TMX commences) and to blend it with  diluents to allow the product to be piped through the TMX and then a shipping cost is required to get it across the Pacific. And this would only be done if they received a price on a sustained basis that would leave producers with a reasonable profit.

    For new projects, the Alberta government has estimated the cost of production for SAGD projects to be $50 to $80/bbl. Tech Corporation recently walked away from its proposed Frontier project citing as one of its reasons the need for oil to be $75 US. One can quickly see that Alberta producers would need a price that would be multiples of the estimated $20 post COVID-19 price. This is a pretty high bar in a world which is awash in oil with a diminishing demand for oil as we transition away from fossil fuels.

    A further problem lies with the fact that oil producers have made commitments to Trans Mountain to pay tolls to pay for the initial estimate of $7.4 b in construction costs for the TMX, but they have not made any commitment to pay for tolls to cover the estimated $12.6 billion in costs. Nor is it likely they ever will give their OK until they have the confidence the price of oil will go back to its old heights and stay there.

    This leaves the federal government in the dilemma of whether to subsidize the $5.2 billion difference which might be political suicide with a public that is seriously worried about the GHG fallout of an expanded oil sand production and the negative impact on Canada’s ability to meet Paris commitments. Even if the feds decided to subsidize the $5.2 billion difference with tolls appropriate for a $7.4 billion project Western Producers still need much higher oil prices to make their operations economically viable.

    Trans Mountain was touted as being needed to provide Alberta with access to the Asian market. One must first determine whether Asian countries want Alberta’s heavy oil when they have as their main source Middle East light crude which is a better quality oil which is cheaper to produce, cheaper to transport to Asia, and cheaper to refine. What we must ask ourselves is, given the fact Canadian producers have always had access to the Asia market with the ability to ship their heavy oil via the existing Trans Mountain pipeline, why are they not using it more than they have? Perhaps it might have to do with the fact there is little demand in Asia for Alberta’s heavy oil.

    David Huntley, a professor emeritus in physics at Simon Fraser University has been monitoring tanker traffic from Burnaby’s Westbridge Terminal for years and told Briony Penn, a writer for Focus magazine, in September 2019, that only 20 crude oil tankers have left Westbridge Terminal for China since 2014 and that most of the tankers have been headed for California. To that I would add that even though oil producers have made commitments to use 80 percent of the TMX capacity once built, no contracts have so far been signed with Asian buyers.

    As to the California market, based on 2017 data, only 3.4 percent of California’s foreign crude imports came from Canada. That same year, half of the state’s imports came from Saudi Arabia, Ecuador and Columbia which can all produce at far lower costs than Alberta.

    The bottom line is that the construction of TMX may not translate into significant sales in  Pacific markets. The evidence so far demonstrates there is very little proven interest in Alberta’s more expensive heavy oil. Further, there is considerable doubt that future oil prices will ever reach a level where it would be economic for Western Canada producers to use TMX. The feds should insist on seeing evidence of buyer contracts and foreseeable sustainable oil prices going forward before giving the green light to construction.

    In summary, it would be irresponsible for the federal government to ignore the changing landscape as outlined and proceed with construction with a project that will never be used if Keystone is completed. At the very least, TMX must be postponed to see what happens to Keystone. If Keystone is scrapped it would be irresponsible of the federal government not to exercise due diligence to ensure that not only is there a need for TMX given Enbridge expansions, but there would be a sustainable market for Alberta oil in the Pacific if TMX is built.

    William Pearce is a retired lawyer formerly employed with the BC Ministry of Attorney General. He has had a lifetime interest in environmental and global issues and is president of the Victoria chapter of the World Federalist Movement of Canada.

     

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