The Canadian LNG Export Industry Progress and Prospects

ABA Section of International Law 2016 Fall Meeting Tokyo, Japan

Al Hudec, Farris LLP, Vancouver Don Bell, Torys LLP, New York John Mackay, Latham & Watkins LLP, Singapore Karen Ogen, First Nations LNG Alliance, Wet’suwet’en First Nation

2 Introduction

• Canada began to develop a legal regulatory and fiscal regime for LNG exports in 2012 • This regime is now largely in place and 3 large projects and one smaller project now have full regulatory approval • If built, these proposed Canadian LNG liquefaction facilities will be among the largest and costliest energy projects ever built

3 Driving forces behind the Canadian industry • The ‘shale gas’ revolution has made the U.S. self sufficient in oil and gas and has shut in abundant Canadian supplies • The obvious solution is for Western Canada to replace its U.S. and Eastern Canadian markets with Asian exports • This requires a return to JCC oil index based pricing – B.C. announced an LNG strategy in 2012 when price was U.S.$18.11 – Price now U.S.$6.32 – Break even for the Canadian projects is about U.S.$10.30

The view from Asia • Asia is the principal market for Canadian LNG LNG Importers (2013)

OTHER ASIA 15% EUROPE 15% Belgium, France, Greece, Italy, India, Indonesia, Malaysia, Lithuania, Netherlands, Portugal, Pakistan, Singapore, Taiwan, Spain, Sweden, Turkey, Thailand MIDDLE EAST 4% U.K.

SOUTH KOREA 14% AMERICAS 9% Argentina, Brazil, Chile, Dominican Rep, Mexico, Puerto Rico, Canada, USA CHINA 8% JAPAN 35%

Source: International Group of LNG Importers

4 5 The view from Asia

• Population growth, rising incomes and the desire to replace coal favour LNG • But: multiple and complex counter-forces  Russian – Chinese pipeline deals  Nuclear energy in Japan and Europe  Shale gas (now China too!)  Tremendous increases in world liquefaction capacity outpacing growth in demand  Growth of Spot Market 6 Spot and Short-term Market

• Variety of factors push growth of spot and short-term market: • LNG contracts with destination flexibility, chiefly from Atlantic Basin and Qatar • LNG glut and price disparity in different basins has created spot arbitrage opportunities • Large growth in LNG fleet - allows industry to sustain the long- haul parts of the spot market • Decline in competitiveness of gas relative to other fuels (including coal and shale gas) has freed up volumes to be re- directed elsewhere • Buyers such as JERA have emerged, which take huge volumes and increasingly favour mid-term and short-term contracts or spot purchases

7 Spot and Short-term Market • Rapid rise in spot volumes traded:

• Threatens Canadian projects (most of the spot trade is from non-project financed projects) • Challenge for long term JCC oil-indexed supply agreements, allowing price offtakes pursuant to formulas based on U.S. Henry Hub pipeline gas pricing • Spot LNG (Japan) fell from U.S.$15.21 per MMBtu (July 2014) to U.S.$6.32 per MMBtu as of Sept 2016) 8 Spot and Short-term Market

Spot and Short-term Market Development - 1995-2014

Source: Waterborne LNG Reports, U.S. DOE, PFC Energy Global service 9 The view from the United States

• The U.S. and Australia are Canada’s principal competitors • U.S. ‘brownfield’ projects on the sites of existing import facilities have significant timing and pricing advantage 10 First LNG tanker through the enlarged Panama Canal 11 Proposed Canadian LNG Projects 12 Affiliated Pipeline Projects 13 Leading Canadian Projects

• Pacific Northwest LNG – Petronas • LNG Canada – Royal Dutch Shell • Kitimat LNG – Chevron, Woodside • Woodfibre LNG – Royal Golden Eagle

14 PNW LNG 15 PNW LNG

• Majority owned by Petronas with participation by Japex, Sinopec, Indian Oil and Brunei Petroleum • $36 billion, 19 million tonne/year facility • Includes $11.4 billion export terminal, $5.2 billion upstream acquisition, $12 billion of upstream development and $6.7 billion TCPL pipeline • Located on Lelu Island in Prince Rupert Harbour in territory subject to overlapping claims of five First Nations 16 PNW Project Timeline

• Feb, 2013: PNW submits its project description to CEAA • Apr, 2013: Japan Petroleum Exploration Co. Ltd. agrees to buy 10 per cent of the offtake over at least 20 years • July, 2013: PNW applies to the NEB for a licence to export up to 19.68 million tonnes of LNG annually for 25 years, beginning in 2019 • Dec, 2013: The NEB grants PNW a licence to export up to 22.2 million tonnes of LNG annually for 25 years • Feb, 2014: PNW submits its environmental impact statement to the Canadian Environmental Assessment Agency • Mar, 2014: The federal government approves PNW's export licence • June, 2015: PNW announces conditional FID – it will proceed with the project as long as it satisfies two conditions: approval of a project development agreement by the B.C. legislature and clearing the federal environmental assessment review process • July, 2015: The B.C. government passes legislation that ratifies a project development agreement with PNW • Mar, 2016: The federal government grants the CEAA more time to review the project • Sept, 2016: The federal government gives conditional approval to the project

17 LNG Canada 18 LNG Canada

• Shell Canada, Kogas, Mitsubishi, PetroChina • 24 million tonnes per year at full buildout • Located in Kitimat on the Haisla First Nation Reserve • 700 km pipeline owned and operated by TCPL

19 Woodfibre LNG 20 Woodfibre LNG

• 2.1 million tonnes per annum • Located on a brownfield pulp mill site near Squamish in territory of Squamish First Nations • Using pipeline gas as feedstock; electrically fuelled

21 Next Generation Projects

Project Proponents Capacity Status

WCC Exxon/Imperial 30 MTPA 25 yr. Export Tuc Inlet, license, EA pre- Prince Rupert Harbour application stage Aurora LNG Nexen (60%), 24MTPA 25 yr. Export Digby Island Inpex and JGC (40%) license, EA pre- Prince Rupert Harbour application stage

Woodside Petroleum LNG Woodside 20MTPA 25 yr. Export Grassy Point, license, EA pre- North of Prince Rupert application stage

22 The Canadian advantages

• Abundant low cost resource base • Climatic advantage • Proximity to Market • Stable fiscal/regulatory regime • Strong local government support • Diversity of supply 23 Western Canada Unconventional Resource Plays 24 Canadian challenges

• High Capital Cost of Greenfield Projects • Pipeline Infrastructure requirements • Potential cost pressures • Dynamics of International LNG Pricing • Requirement for First Nations Support

25 Developing a legal framework for LNG 26 Regulatory timeline

• Feb, 2012: LNG Strategy announced • Oct, 2014: Greenhouse Gas Industrial Reporting & Control Act announced • Oct, 2014: Liquefied Natural Gas Income Tax Act and a Natural Gas Tax Credit under the Income Tax Act announced • Feb, 2015: the Federal Port Development Act is introduced • March, 2015: The administrative and enforcement components of the Liquefied Natural Gas Income Tax Act are introduced • May, 2015: British Columbia reaches a Project Development Agreement (PDA) with PNW and a Long-Term Royalty Agreement (LTRA) with the North Montney Joint Venture • June, 2015: The Liquefied Natural Gas Income Tax Act Regulations are deposited 27 Export Permits

• 40 year export permits issued by National Energy Board • Sole test is whether the quantity to be exported is surplus to Canadian needs, taking into account trends in the discovery of the resource • Simplified process – recent applications approved without a hearing • Expert evidence utilized to determine excess • Extensions of term to 40 years for projects which already have 25 year licenses are being readily granted “Taking into consideration the significant investments required for liquefied natural gas projects, and their significant anticipated economic benefits, the Government is taking additional steps to support the LNG industry and other natural gas exporters by extending the maximum limit of natural gas export licences from 25 to 40 years, to improve regulatory certainty,” (Canadian Federal Government Economic Action Plan 2015)

28 Environmental Assessment

• Liquefaction facilities are regulated under the Canadian Environmental Assessment Act and the B.C. Environmental Assessment Act • MOU on the Substitution of Environmental Assessments • 3 stage process: – Application Information Requirements – Application Review Stage – Decision Stage 29 First Nations Consultation

• First Nations have a constitutional right to be consulted with respect to all resource development projects within their traditional territories • Supreme Court of Canada historical cases which assert Aboriginal Title to the land does exist:  1997: Delgamuukw  2014: Tsilhqot’in Decision • UN Declaration on the Rights of Indigenous Peoples 30 Challenges to First Nations Engagement

• 600 Indigenous Nations in Canada: 203 are in B.C.  Treaty Nations vs. Unceded Territory • Of the 50 First Nations in Northern B.C., more than 40 are impacted by major LNG projects • Hereditary Chiefs system vs. Elected system • Revenue sharing and equity ownership  Needs to be fair and equitable: benefits must outweigh the risks • Every First Nation community will be different 31 How to Engage with First Nations

• Consultation and accommodation must be fair, reasonable, respectful and equitable  Start early in the life of the project – make a meaningful effort to learn about the community, its culture and history  Fully inform the community about all aspects of the project  Maintain consistency in building and nurturing the relationship over the life of the project • Project must meet the highest environmental standards – this is a prerequisite for First Nation support • Share project benefits with First Nations  Financial benefits/equity ownership  Training and jobs  Contracting opportunities

32 United Nations Declaration on the Rights of Indigenous Peoples • Does the UN Declaration on the Rights of Indigenous Peoples impose greater consultative obligations? • According to the Office of the High Commissioner, in terms of resource development, the Declaration:  outlaws discrimination against indigenous peoples and promotes their full and effective participation in all matters that concern them  It also ensures their right to remain distinct and to pursue their own priorities in economic, social and cultural development • The Declaration explicitly encourages harmonious and cooperative relations between States and indigenous peoples

33 Compliance with International Standards

• The international banking community has established standards to assess environmental and social issues • IFC Performance Standards on Environmental and Social Sustainability • Various Multilateral and Export Credit Agency standards • Equator Principles for commercial banks 34 Compliance with International Standards (continued)

• Historically, compliance has only been required for large-scale projects in developing countries • Canadian projects are likely to require lending consortiums of commercial lenders and agencies • Australian LNG experience shows that IFC Performance Standards are likely to be applied in Canada • Early diligence is key for Canadian projects “Action Plans” to ensure gaps between standards are identified

35 Regulation of Construction/Operations

• Regulated by the B.C. Oil & Gas Commission under the Oil and Gas Activities Act – Liquefied Natural Gas Facility Regulation • Incorporation by reference and delegation  Federal Port Development Act  Canada Marine Act Amendments 36 Carbon Tax

• British Columbia has had a revenue neutral carbon tax since 2008 • Currently $30/tonne • Canada is a party to the Paris Climate Agreement – federal phase in of a $50 tax • Recent Climate Action Plan includes measures to reduce upstream carbon impacts

37 Carbon Tax

• British Columbia has had a revenue neutral carbon tax since 2008

Source: “State and Trends of Carbon Pricing”, World Bank Group, 2015 38 Regulation of GHG Emissions

• Tough standard of 0.16 carbon dioxide equivalent tonnes per tonne of LNG produced • Flexibility in options to meet standard  Facility design  Purchase offsets in local market  Contributions to technology fund at a rate of $25/per tonne of CO2e • LNG Environmental Incentive Program 39 B.C. LNG Income Tax

• Tier One (1.5%) until initial operating losses and prescribed CAPEX recouped; Tier Two (3.5%, increasing to 5% in 2037) • Capital expenditure account includes costs of constructing LNG facility, storage tanks and marine loading systems, but not feedstock pipeline • Taxes “any person that engages in or has income derived from liquefaction activities” - income derived from the liquefaction process whether  by virtue of being the processor; or  having the right to acquire the product • Novel transfer pricing rules • Natural Gas Income Tax Credit

40 B.C. LNG Income Tax (continued)

• Discriminates against non-integrated projects • Taxes offshore owners of gas where not resident in B.C. and no permanent establishment in B.C. • Transfer pricing rules do not recognize the complexity of international LNG pricing 41 Project Development Agreements

• Built on the Australian model • The Province contractually indemnifies the proponent and partners against  Changes in the LNG Tax or the Natural Gas Tax Credit  Discriminatory changes in the Carbon Tax rate or the GHG emissions benchmark • Long Term Royalty Agreement – initially 6.06%, rising to 13.36% in 2038; minimum infrastructure investment requirements

42 Project Development Agreements (continued)

• Ratifying legislation requires that PDA be governed by B.C. laws and that B.C. is venue for any proceeding • PDA provides that all disputes be resolved exclusively by arbitration under the Rules of the B.C. International Commercial Arbitration Center • Assignable as security – agreed form of Direct Agreement gives lenders notice and cures rights • Covenant not to challenge the LNG Tax • MFN clause where appropriate to achieve equitable terms and conditions 43 Investment Treaties

• Canada currently has 36 “Foreign Investment Promotion and Protection Agreements” (FIPAs) and is progressing another 25 (e.g. Canada–China Foreign Investment Protection and Promotion Agreement ratified in 2014) • Canada is actually fifth in the world for treaty arbitrations instituted against it • Typically no “umbrella clause” protection in Canadian FIPAs, but they do typically include expropriation protection as well as rights to fair and equitable treatment, MFN national treatment and access to justice and fair procedure • A treaty claim allows international ICSID arbitration before the International Center for Settlement of Investment Disputes

43 44 Project Structures

1. Integrated Model 2. Tolling Model 3. Merchant Model 45 Integrated Model

Common ownership/affiliation

Natural Gas LNG Upstream Joint Integrated Project Downstream/LNG Venture Company Buyer(s) Gas Sales LNG Sale and Agreement(s) Purchase Agreement(s) 46 Tolling Model

Common ownership/affiliation

Liquefied Tolling Agreement (LTA) Upstream/ Natural Project Tolling Downstream/LNG Gas Owner(s) Company Buyer(s) LNG Natural Gas

LNG Sale and Purchase Agreement(s) 47 Merchant Model

Unaffiliated Gas Sale LNG Sale and Unaffiliated LNG Merchant Project Upstream/Natural Gas Agreement(s) Purchase Downstream LNG Company Agreement(s) Owner(s) Buyer(s)

Natural Gas LNG 48 Sources of Financing

1. Project Financing 2. Internal sponsor funding 3. Export Credit Agencies Project financing

• Ideally lender recourse is limited to SPV • Risk allocation through turnkey EPC contract, tolling agreement, long term offtake agreements • Basel III may raise the cost of financing • Example – $34 billion floating ICHTHYS project north of Australia (Inpex and Total)

49 50 Internal sponsor funding

• Financing sourced from internal cash flow or balance sheet borrowing • Gives sponsors more exclusive control over project decision making, transaction cost savings • May be only alternative where Project deploys new or untested technologies • Example – The massive Gorgon Project in West Australia funded directly by Chevron, Exxon Mobil and Royal Dutch Shell 51 Export credit agencies

• Direct financing or credit support driven to assure supply or to contracting opportunities • Example – Exxon Mobil’s PNG LNG Project in Papua New Guinea involved participation of 6 export credit agencies 52 Are the Canadian projects financeable?

• Generally yes, if there is a return to long term JCC oil index based pricing • Sponsored by large international players, with buyer equity participation • Probable access to U.S. commercial bank and bond markets • Interest of Export Credit Agencies yet to be determined • Facilities using known technologies, but long distance large diameter pipelines must be laid over rugged mountainous terrains • Risk of labour material price inflation if projects proceed simultaneously • Abundant secure gas reserves • Continued challenges of Aboriginal consultative process where there are territorial overlaps or linear projects transversing multiple territories

53 Overall Assessment – are the Canadian Projects competitive internationally?

• Not right now – the Canadian projects are high cost, particularly relative to the U.S. brown field projects which have existing infrastructure and pipelines • The Canadian Projects require a return to higher oil prices and oil indexed pricing of LNG to become competitive • The leading Canadian projects are at or near shovel ready; and are in a position to make a FID when world pricing conditions improve

54 Industry wish list

• Continue to engineer costs out of the Projects • Continue to work with governments to develop a labour strategy • Lobby for relief on restrictions on the use of foreign workers • Lobby against federal phase in of a $50 carbon tax • Lobby for relaxation of the stringent 0.16 emissions‎ limit and the right to purchase offsets outside of the Province • Consider powering liquefaction from the electrical grid rather than gas; implement upstream improvements to reduce emissions • Challenge the legality of the LNG tax • Lobby for relief from Provincial sales tax on imported equipment and for relief federally from excise tax • Continue to work with First Nations to build support and strong working relationships

55 Contacts

Al Hudec John Mackay Cell: (778) 886-9356 Tel: +65-6437-5407 Email: [email protected] Email: [email protected]

Don Bell Karen Ogen Tel: (212) 880-6118 Tel: (604) 612-5980 Email: [email protected] Email: [email protected]