Sunday, March 25, 2018

Addressing the Costs of LNG Development in BC

While there would be clear benefits from the development of major LNG plants in British Columbia for workers and businesses directly involved in project construction, operation and upstream gas industry activity, and for First Nations and communities with business partnerships or benefit agreements, the net effects for the general public are less certain.

Though originally promoted as a great windfall for taxpayers, LNG development would provide a more modest amount of revenues to government. The recently announced tax concessions, as well as the gas royalty and other concessions previously offered to attract these projects, make clear that there is not a lot of residual value -- resource rent in economic terms -- that government could capture from even the largest of these projects.

The government has estimated that the LNG Canada project in Kitimat would generate $22 billion in tax revenues over 40 years of operation -- some $500 million per year. It is not clear that estimate  correctly indicates the incremental net revenues government would in fact receive. The economic impact studies government often relies on to develop these estimates do not consider the taxes the government would have received in any event (for example from the workers employed elsewhere or the gas shipped to other markets). And almost certainly this tax estimate does not indicate the net gain after deducting the incremental expenses that government would face, whether for the project itself or for the infrastructure and services required as a result of any project-induced influx of workers and families.

In any event, though there would be some benefit for taxpayers, it would not be a bonanza. And against that benefit one has to recognize the potential for significant costs. There are potential financial losses that BC Hydro and its customers would face as a result of the government's offer to supply electricity to LNG projects at the standard industrial tariff. And there are the costs associated with project-related greenhouse gas (GHG) emissions -- estimated at some 4 million tonnes of CO2e per year for LNG Canada operations and upstream gas production.

There would be potential losses for BC Hydro because the standard industrial tariff is less than its estimated cost of new supply. The current industrial rate for energy averages $46/MWh. However BC Hydro's estimated cost of new supply delivered to industrial customers is $92/MWh, as indicated in the BCUC-approved  two-step industrial customer tariff with its second tier rate intended to signal the long run marginal cost of new supply.

In the first five to ten years of operation of a new LNG plant and with Site C coming onstream, BC Hydro would not have to develop new sources of supply. It would be able to use the surplus it would otherwise sell in export markets to supply the plant. For that period of time there would be no loss -- in fact there could be a small gain. However, even without any use of electricity for the liquefaction process itself, the ancillary electricity requirements for a major plant like LNG Canada are very large -- they could amount to some 500 to 1000 GWh per year (up to one fifth the output of Site C).  With growing provincial requirements absorbing the surplus, BC Hydro would sooner or later have to develop new supply to meet the LNG load. And it would do so at some considerable financial loss.

The difference between the industrial rate and the cost of new supply is likely to fall, both as a result of rising rates and falling costs of new supply. But the discrepancy could still be considerable, resulting in losses of tens of millions of dollars per year.

With respect to GHGs, it is not clear to what extent LNG plants in British Columbia would contribute to an increase in total global emissions. There would be a significant increase in emissions in British Columbia, but those emissions would be offset by the reduction or avoidance of emissions elsewhere. Unless British Columbia's supply of LNG were to affect the world price and demand for natural gas, LNG from B.C. would in all likelihood displace the supply of gas from other sources. The net impact on global emissions would therefore depend on the carbon intensity of B.C. supply as compared to the displaced sources. Independent experts would be required to develop specific estimates but suffice to say the net impact, positive or negative, would likely be relatively small.

The cost of the GHG emissions from new LNG plants would not, therefore, derive from the social costs of global warming. If the plants' contribution to global emissions is small, so too would its contribution to global warming. Nonetheless, there would still be significant costs for British Columbians if the province were to maintain fixed total provincial emission reduction targets without any recognition and credit for the impact of B.C. LNG sales on emissions elsewhere.

If, as the Premier seemed to suggest, British Columbians would have to tighten their belt -- further reduce their own emissions -- to offset the GHGs from a new plant, the costs would be very high. One way to gauge this cost for LNG Canada is to consider what level of carbon tax would be needed to reduce GHG emissions by 4 million tonnes per year over and above the reductions British Columbians were already going to have to make in accordance with provincial emission targets.  Many experts suggest that carbon tax would have to be over $100/tonne, possibly $200/tonne. On that basis, the cost to British Columbians to accommodate (make room) for the GHG emissions from LNG Canada would be over $400 million, possibly $800 million per year.

The government, of course, could choose to achieve those GHG reductions with regulations and other measures as opposed to a markedly higher carbon tax. But that wouldn't change the magnitude of the cost borne by British Columbians, just the manner and transparency of achieving it.

As stated at the outset, there would be clear benefits of LNG development for those directly involved. But if the government wants the support of the general public it must recognize and address the significant costs it could entail.

With respect to electricity, the government should limit the offer of BC Hydro supply at the standard industrial rate to a period of 5 to 10 years after which the plant would have to develop or acquire from independent power producers its own new sources of supply, or enter into a contract with BC Hydro for continued supply at prices that reflect the costs BC Hydro would face to make that supply available. BC Hydro and its customers should be protected from the losses it would otherwise face.

And with respect to GHGs, British Columbia should develop a new framework for establishing emission reduction targets. We need targets that are based on our net contribution to global emissions, not simply the amount of emissions that take place in British Columbia. That requires establishing emission reduction targets that take into account the impact of our exports on GHG emissions elsewhere. Otherwise we will either be imposing major costs on British Columbians to offset the carbon content of our exports, regardless of the impact of those exports on carbon emissions elsewhere. Or we will feel compelled to forego major projects in order to avoid their GHG emissions in B.C. even though that will simply result in greater emissions elsewhere.

Monday, March 19, 2018

What to do with the Elephant- The Strategic Value of the Kinder Morgan Project

One of the key issues missing in the very passionate debate currently taking place in British Columbia on Kinder Morgan is the strategic importance of this project in the context of an increasingly unreliable trading relationship with the United States.

It is not just the mindless protectionist rhetoric coming from the Trump White House; it is the very real and mindful tariffs the United States has imposed on lumber, newsprint and other goods in its mercantalist efforts to protect politically favoured industries.

Canadian politicians of all stripes say that the American tariffs and threats are unacceptable; we must stand up for Canadian workers and industries. But the fact is we only control what we can do -- in the end the Americans, Democratic as well as Republican, will do what they perceive to be in their political interest. They are all America 'Firsters' - just some (like Trump) more obnoxious about it than others.

Diverting sales of what the US wants most from us -- abundant, low cost natural resources -- is one of the things we can and should do.  And the Kinder Morgan project could play an important role in that regard. It would provide expanded Canadian access to Asia-Pacific markets that would enable oil producers to divert some $5 to $10 billion of crude oil sales per year away from the U.S. to other markets. Whether in the context of Trump's 'zero sum game' trade policy, or simply through resulting exchange rate effects, diverting significant amounts of crude oil (and the same applies to natural gas and other natural resource sales) would make more room for US-bound exports of manufactured goods.

Critics will rightly point out that Kinder Morgan does not guarantee crude oil exports will be diverted to Asian markets. Deliveries through Kinder Morgan may simply enable more sales to the U.S. Pacific Northwest and California. The point, however, is that it provides the potential to do so, and that potential in itself not only would enhance the value of our crude oil exports, but also reduce our dependence and vulnerability to protectionist (in effect classic colonial power) politics in the U.S.

In short, in addition to the higher prices and transportation cost savings the Kinder Morgan project is expected to generate,  there is the strategic 'diversification/ reduced US dependence' value that is very important to recognize in this difficult pipeline debate.

Of course, whatever the benefits of Kinder Morgan, there are the very real concerns the project raises. There is the concern pipeline expansion will contribute to growing oil sands production and greenhouse gas emissions. There is the low probability but high consequence risk of major oil spills. And there are adverse environmental effects, most notably in the NEB final report with respect to the impact of increased tanker traffic on the population of endangered resident southern killer whales.

These are undeniable and unavoidable trade-offs which people will very legitimately value and weight differently. For some these concerns are of overwhelming significance and no matter what the government does they will remain opposed to the project. For many others, however, there are much stronger steps the government could take to lessen the risks and costs -- to make the trade-offs more acceptable.

With respect to concerns about growth of oil sands production and related emissions, the federal government could pull back from what appears to be support for all new pipeline projects. If the key benefit is reducing dependence on the U.S. market, the government could make clear while it supports Kinder Morgan, it does not support the development of Keystone or other increased access to the U.S. market. Diversification, not expansion of export capacity should be the primary goal.

With respect to oil spill risk, the government has already announced measures that would improve tanker safety and oil spill response. Indeed, the NEB concluded that these improvements may offer the coast a benefit relative to the current situation. But this is an area where British Columbians and indeed all Canadians must be satisfied that the residual risks truly are minimized, the oil spill response in fact ready and effective, and issues around marine spill liability fully addressed.

And with respect to the impact of marine operations on the resident killer whale population, the issue here is the total amount of tanker traffic, not just the increment from Kinder Morgan. A comprehensive tanker traffic plan is required, not an arbitrary restriction on one source of shipment. If limitations on the total  number of tanker transits are required, the restrictions should be imposed on the least valuable or desirable products. It is hard to imagine, for example, that shipments of strategic importance to the Canadian oil industry should be restricted before the phase-out of thermal coal export-related tanker traffic. Nor should Canadians willingly accept neighbouring U.S. calls for restrictions on Canadian oil tanker traffic without regard for the number and impact of U.S. oil-laden and other tankers destined for Puget Sound.