CERI Crude Oil Report

April 2018 CERI Crude Oil Report Policy Debates and Business Timelines Reduction in present value of net revenues from a Allan Fogwill project. When considering these impacts, it is important to separate out the revenues collected to Concerns regarding the balance of economic and pay for operating costs. Those will tend to balance environmental objectives continue to be part of the out over time. However, the net profit from a policy debate in Canada. We see concerns raised by project can be delayed. Such a delay means the Indigenous Peoples concerning the Site C hydroelectric revenue stream collected by a company has a lower facility in BC and similarly with the Muskrat Falls project present value. in Labrador. We have seen the delay or cancellation of natural gas electricity generation projects in Ontario due Delayed economic impacts from the project under to concerns from local citizens, and we have seen delays consideration - additional jobs, provincial taxes, GDP and regulatory changes associated with oil and natural – again, these impacts do not disappear. They are gas pipelines across the country. delayed, and it is the time value of money that creates the cost associated with changing the These concerns create delays in the timeline for various timeline of a project as delayed future benefits in the projects. While businesses or proponents indicate that same dollar amount are less valuable to society. these delays cost money, it is not clear how they determine the cost of these delays. Aside from the economic costs, there are some specific financial expenses which are difficult to quantify. These CERI suggests that if we want to understand the include the risk associated with stock market valuations economic impacts of delays we need to have a common and legal costs associated with policy debates that move framework for assessing it. Otherwise, the estimates put toward a provincial or federal court. The extent of these forward can be countered with alternative numbers that costs can vary widely but are a consideration by a firm as can vary significantly. Agreeing on the facts is the first it looks to pursue a project. step in attempting to reach consensus on issues of concern. Let us consider the Trans Mountain Pipeline Expansion Project to illustrate the framework. We know that there A delay in a project has three overall economic impacts is a debate underway regarding the policy implications of that can be supported in the academic literature. These this project. The principle argument is the jurisdictional include: authority of a provincial government (in this case BC) versus the federal government. Additional interest charges on the overall upfront costs of the project. Normally when firms determine In the past, jurisdictional concerns have often been the cost of the project, they estimate how long it will resolved through negotiations. In the case of the Trans take to pay back those costs either to investors (if Mountain Pipeline, that does not seem to be a realistic internally financed) or financial institutions. A one- option. As such, a reference to the Supreme Court on year delay means more interest on the same money jurisdictional authority appears to be the path which is that had been borrowed. being followed. Moreover, given that there are other matters of overlapping jurisdiction such as in health care CERI Crude Oil Report Editorial Committee: Ganesh Doluweera, Dinara Millington, Megan Murphy, Allan Fogwill and environment, such a reference would provide clarity to how the Canadian Federation is to function in the About CERI Founded in 1975, the Canadian Energy Research Institute is an independent, registered future. charitable organization specializing in the analysis of energy economics and related environmental policy issues in the energy production, transportation, and consumption sectors. Our mission is to provide relevant, independent, and objective economic research of energy and environmental issues to benefit business, government, academia and the public. For more information about CERI, please visit our website at www.ceri.ca or contact us at [email protected]. Relevant • Independent • Objective Page 2 Source: https://nativesolidarity.org/master-catalog/coast-salish-tribes-oppose-the-transmountain-pipeline So, let's return to the Trans Mountain case as an example As we noted earlier, the cost of the delay is the of the costs of project delays. additional carrying cost of the project. If the project is delayed one year, for example, the net capital costs will The Trans Mountain Pipeline Expansion Project is an have to fund an additional year. Think of it as an expansion of an existing oil pipeline from 300,000 barrels additional set of mortgage payments when you delay per day to 890,000 barrels per day (b/d). As shown on paying off your home mortgage by one year. the map, the route starts in Edmonton and ends in Vancouver. From that point, oil is placed onto ocean- A key assumption is what interest rate you use. Standard going tankers and can be sold to markets in Asia and practice is to use the weighted cost of capital which is a North America. The major policy concern is the risk of oil combination of the return to debt holders and a return spills in the coastal waters around BC. to equity investors. Ten percent (10%) is the standard rate used most often. Using this rate gives us the cost of CERI collected information on the project from Kinder a 1-year delay in the project of CAD$490 million Morgan’s regulatory filings.1 This information can be (constant 2012 dollars). considered credible as the company must attest to it in hearings in front of an adjudicator (NEB) and to which If the pipeline is not in operation, it does not generate the company and management can be held accountable revenues. It also does not incur operating costs except for its accuracy. for ongoing funding of the internal operations and project management. These are difficult to estimate. As The capital cost of the project is listed as CAD$5.5 billion such, it is the net revenues which would be a cost factor to be spent over seven years (2012-2018). When it was of a delay. adjusted for inflation and brought into constant 2012 dollars, the cost is CAD$4.9 billion. CERI Crude Oil Report Page 3 Some Trans Mountain shippers contract for firm pipeline $96.6 million plus $95.5 million plus $34.7 million for a commitments and others for intermittent or spot service. total of CAD$716.8 million. Of the 590,000 b/d new capacity, most is committed to firm contracts with 180,000 b/d assigned to the spot So, during a policy debate, the delay of this pipeline market. being constructed for one year is more than CAD$700 million. This number does not take into consideration “Annual revenues associated with these contracts were provincial, and federal taxes which would be paid if the estimated by the Conference Board to be $944 million pipeline was operational or the value people place on based on the projected capital costs of the Project and additional employment. This is but one example. Similar the toll structure that would be applied. This revenue calculations can be done using any major project for estimate only includes the fixed component of the toll.”2 which delays in the process occur. It is, therefore, important that when decision makers consider these However, that includes the full pipeline and not just the debates and listen to the concerns of stakeholders and expansion. The existing pipeline generates CAD$300 project proponents that a similar calculus occur. million annually, which is ongoing. Therefore, the total incremental revenue lost from a delay is CAD$644 Are we done with this example? No. million. That fixed component for firm shippers would be the all-in costs of the pipeline operations. That said, the In the case of our oil supply system, the market dynamics net revenues would approximate the return on equity are complicated. One of the challenges is the price (ROE) which can vary. If we assume an ROE of 15%, that discount by which Canadian producers sell their product means the net revenue would be CAD$96.6 million per to customers. Normally the price discount between year. Canadian crude and the West Texas Intermediate price is in the CAD$15 range. This goes higher and lower It gets complicated when the intermittent shipping depending on the availability of transport capacity and annual revenue of $191 million3 is considered. Often the quality of the crude exports. For instance, since firms include a smaller portion of these revenues toward December 2017, the differential was in the rage of US$15 fixed costs. If we assumed that 50% of these revenues -30 (CAD$20-40). At the same time, Kinder Morgan’s are net of cost, then the lost annual net revenue is $95.5 existing pipeline was oversubscribed in January by 35% million. and in February by 32%,5 while the Keystone pipeline was full in 2017 except for November.6 The final element of the cost of a delay is the delay in a Gross Domestic Product (GDP) contribution of the In 2017, CERI analyzed how that differential might affect project to the provincial and national economies. Again, the economic contribution to Canada of crude oil it is important to note that a delay only means that the exports. Our rule of thumb is that for every CAD$1 per benefits happen later. The cost is losing those benefits barrel of crude change in the annual average differential, for one year, in this example.

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