By David Yager, October 27, 2016
Entrepreneur. Consultant. Journalist. Political Activist.
In mid-October Alberta’s NDP government announced another “expert” panel to study future policy. This time it was the Energy Diversification Advisory Committee (EDAC) “to help diversify the energy sector and explore opportunities for more investment in energy industries in Alberta”. EDAC’s mandate is to find ways to do more with oil and gas and create jobs in the general areas of partial upgrading (eliminate diluent), refining, petrochemicals and chemicals manufacturing. After a year of study EDAC will report in the fall of 2017.
The government expects EDAC to answer the question, “What additional steps can Alberta take to build a more diversified and resilient energy economy that works with industry and communities to create jobs, moves the energy industry up the value chain, and diversifies the energy industry into new end products?”
Considering the enormous amount of existing expertise in Canada and globally in turning 95 million b/d of oil into a dizzying array of commercial and industrial products, the panel is extremely light on industry talent. But under the NDP the days of consulting only industry experts are long gone. A co-chair a Jeanette Patell, now government relations and policy leader for GE Canada who was a former Canadian diplomat. The bright spot is director Carol Moen who now runs APEGA after spending 26 years at DOW Chemical, a bona-fide petrochemical producer. Another person who will certainly know who to ask for expert input is Leo de Bever, respected former head of AIMCO and other major public investment funds.
That’s as close EDAC gets to hands-on experience. The rest are part of the NDP family of extended stakeholders. The other co-chair is Gil McGowan, President of the Alberta Federal of Labour and long-time NDP loyalist. He is joined by directors Marie Robidoux, a surveyor by trade who consults on land management and First Nations issues; Rocky Sinclair, CEO of the Alberta Indian Investment Corporation; and Warren Fraleigh Executive Director of the Building Trades of Alberta and former officer of the International Brotherhood of Boilermakers 146.
While consultation with a wide range of stakeholders is becoming essential for any new oil and gas developments, advice from everyone (including the public) will only go so far. Ultimately whatever direction government and industry takes will come down to what products will be sold where to who plus what cost and transportation. Will the mandate request for “new end products” be things new to Alberta or the world? Cost and economics should be critical.
To listen to the ongoing public debate about hydrocarbon resources and energy diversification the uninformed would get the impression no-value added processing takes place making Albertans typical Canadian hewers of wood and drawers of water. Wrong. What comes out of the ground is worthless without some sort of separation, treatment, processing or upgrading. This is already a huge and essential component of the oil and gas business.
According to the Alberta Energy Regulator web page “Plants and Facilities”, Alberta has over 30,000 oil treatment facilities of various sizes and nearly 21,000 for natural gas. Some 500 gas plants extract NGLs and 10 fractionation plants turn NGLs into numerous other products. With the recent growth in NGL production this area is expanding. Eight straddle plants extract NGLs from natural gas pipelines then deliver them to the NGL fractionation industry. The petrochemical business based primarily in Joffre and Fort Saskatchewan already has annual revenues of $13 billion and employs 9,500 directly.
Five refineries process over 450,000 b/d of oil for local consumption. Six bitumen upgraders turn nearly 1 million b/d or almost 50% of total oil sands output into light synthetic crude. In 2007’s now-infamous New Royalty Framework Premier Ed Stelmach wanted even more upgrading declaring that selling raw bitumen was like “a farmer selling off his topsoil”. The fact Alberta had virtually unlimited supplies of “dirt” and could sell it profitably without ever running out did not temper growing public demands the government do more to facilitate upgrading and refining.
The major government support that moved Alberta’s industry from nothing to what it is today has been a hands-off policy framework that encouraged oil and gas development, respected private property, kept taxes low, provided transparent regulations and oversight, and for the most part collected competitive royalties. Industry did the rest with private capital.
But for enhanced hydrocarbon processing as per the EDAC mandate there have been three big projects that would not exist without significant provincial financial support. These should be examined in detail before EDAC makes any new recommendations. (This assumes EDAC is unlikely to recommend the government cut taxes, royalties, red tape and regulations to make private sector investment more attractive as the best way to fulfill its mandate).
The first was Premier Peter Lougheed’s vision of creating what is now the world’s largest land-locked petrochemical industry, Nova Chemicals at Joffre. In 1973 NOVA, an Alberta Corporation (formerly Alberta Gas Ethylene Ltd., a unit of government mandated Alberta Gas Trunk Lines created in 1954) committed to build an ethylene and derivative manufacturing plant. The Nova Chemicals website reads four years later “Arrangements for long-term financing of the ethylene plant were successfully concluded…after several months of negotiation”. It was game on and Lougheed was labelled a visionary. The original plant was expanded in 1981 with approval required from the province through order in council.
Financial support to make the project viable came from a supply of ethane feedstock at prices that assured the plant would make money. Back then ethane did not have great commercial value and remained in the natural export stream on its way out of the province. Deep cut plants were built in places like Empress to extract the ethane and supply Joffre. This worked well for years but as the market for ethane improved it became more complicated because the feedstock was technically owned by producers through their P&NG licenses. Today Nova Chemicals is a wholly-owned by the International Petroleum Investment Company, a unit of the government of Abu Dhabi.
The point for EDAC is to ensure Joffre is profitable and sustainable today and do a comprehensive cost/benefit analysis of the government support it received versus the job and tax benefits created in the past 40 years. Could be a clear winner and a driver for more industry and investment. But as a private operation owned half a world away no one knows except the owners and managers.
The second big investment, also under Lougheed, was the Bi-Provincial Upgrader at Lloydminster in 1984. Financial support was provided by the governments of Alberta, Saskatchewan and Canada which owned 73.33%. Major regional heavy oil producer Husky Oil committed to 26.67%. Husky already operated a 25,000 b/d refinery at Lloydminster. The original AFE when construction began in 1988 was $1.267 billion, a figure that ballooned 29% to $1.632 billion before completion. The original plan was to convert 46,000 b/d of heavy oil into synthetic light crude which could be refined into commercial products. After startup the partners had to contribute further cash to offset operating losses. Alberta’s total contribution to 1994 was $424 million. It then sold its interest to Husky for only $32 million resulting in a $392 million loss.
Again, EDAC should perform a total economic cost/benefit analysis to determine if this investment somehow had a net benefit. Maybe it did. Having construction jobs and economic activity in the dark days of the late 1980s; taxes from workers, suppliers and the operator since it started; and possibly royalties on oil that might not have otherwise been produced could all appear on the plus side of the ledger. The offset would be the carrying costs on the $392 million loss for many years because the funds were borrowed. At that time Alberta was running steady deficits at much higher interest rates than today.
The elephant in the EDAC meeting room today should be the North West Redwater Refinery (NWRR) scheduled for completion next year. Phase one will process 50,000 b/d of bitumen but the design anticipates expansion. This is more of a refinery than an upgrader as the final product mix will be 40,000 b/d of diesel, 8,800 b/d of gasoline feedstock, 28,000 b/d of diluent/naphtha and 3,400 b/d of butane and propane. It is a 50/50 joint venture owned by privately owned North West Upgrading and a unit of Canadian Natural Resources Ltd.
This project has been controversial since inception. As part of the New Royalty Framework, Ed “topsoil protector” Stelmach re-created the formerly dismantled Alberta Petroleum Marketing Commission (APMC) and used it to collect and market the Crown’s bitumen royalties through BRIK, or Bitumen Royalty in Kind. The government then make it known BRIK barrels would be available as feedstock for “merchant upgraders”, companies that wanted to go into this business but didn’t own production. At one point before the last recession there was said to be some $100 billion worth of various upgrader projects on the books.
That all ended in 2009. Suncor, for example, in January of 2009 walked away from its massive $11 billion Voyageur upgrader in Fort McMurray incurring a loss of $5 billion in sunk costs because Canada’s largest oil sands producer figured it would never generate a return. The skeleton stands on the west side of highway 63 across from the entrance to Suncor main plant. Other projects were mothballed or cancelled. When companies like BP and Husky wanted upgrading for their growing bitumen production they found it cheaper to add an upgrading coker to an existing refinery than build a new one, which they did in Ohio. Only one merchant upgrader proceeded and it is doing so only with massive government support.
The financial underpinning of NWRR is government loan guarantees for construction and a guaranteed processing fee on each barrel of throughput. Operating losses (if required) will be covered by APMC providing Crown BRIK feedstock barrels at whatever price NWRR requires to sustain operations and service debt. Costs have ballooned from the original estimate of $5.7 billion to $8.5 billion. In an article by former finance minister Ted Morton in July, 2015 Morton estimated that over the life of project the total potential liability of Alberta is $26 billion.
The only way the province won’t have to provide financial support is if it able to sell its BRIK barrels to NWRR at market price and the spread between the feedstock and sale price of refined products is at or exceeds its government-guaranteed processing fee. How much NWRR will eventually cost Albertans is unknown.
Once again, with NWRR nearing completion it would be prudent for EDAC to look hard this project’s economics and the industry’s reluctance to build more upgraders and refineries before formulating any new bright ideas. It is much easier to perform a review on existing public-supported projects than try to figure out who might be buying what hydrocarbon products in 10 or 20 years and how the government might help, particularly in a world increasingly determined to quit using carbon-based energy altogether. But a flaw with governments is they want policy for the future, not the past.
Early this Alberta committed $500 million in royalty credits to private sector investors willing to expand the provinces petrochemical industry. There are said to be 16 projects under review. The message from the half-billion stimulus program is Edmonton already understands government financial support may be required to get this sector moving. Is this necessary because of higher corporate tax rates, the pending carbon tax and transportation restraints are pushing investment economics in the wrong direction? Or the oil price collapse?
With government support, Nova Joffre, the Lloydminster upgrader and NWRR have indeed created and sustained (hopefully) jobs that would not otherwise exist. But at what cost? There must be a number at which government subsidized employment makes no sense. It is one thing to hire or retain a teacher at $80,000 a year. The number is known, capped and transparent. The position accepted by all as essential.
But when taxpayer support for new jobs includes capital investment, subsidized feedstock, ongoing operating costs and unknown future markets the total cost of each job must be calculated and disclosed. Knowing what the jobs cost from these three case studies is a good starting point.
What is the best way to grow this business? Assuming forces like carbon taxes, pipeline opposition and anti-oil campaigns will allow it to grow at all. Is it an attractive investment climate to let the private sector invest its own money, the regime that got Alberta most of the way to its current success? Or more government support and subsidies? That’s the direction the current administration appears to prefer.
Hopefully EDAC heeds Santoya’s sage advice as its first order of business.
About David Yager – Yager Management Ltd.
Based in Calgary, Alberta, David Yager is a former oilfield services executive and the principle of Yager Management Ltd. Yager Management provides management consultancy services to the oilfield services industry in a number of areas including M&A, Strategic Planning, Restructuring and Marketing. He has been writing about the upstream oil and gas industry and energy policy and issues since 1979.
David Yager can be reached at Ph: 403.850.6088 Email: [email protected]