Andrew Leach is associate professor at the Alberta School of Business, University of Alberta. In 2015, he chaired Alberta's Climate Leadership Panel.
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 Alberta-based 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 100,000-barrel-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, long-term 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.
Andrew Leach