The prospect for Canadian LNG landing in Asia Pacific is viable, but timing is critical and several factors, such as a planned “LNG tax” in British Columbia could derail the industry before it gets started, a new report by the University of Calgary’s School of Public Policy said Thursday.
Canada, the authors stated, has almost everything going for it: political stability, free market principles, immense resources, extensive infrastructure and industry experience.
“Everything, that is, except a co-ordinated regulatory and policy regime,” said the report. “Without that, Canada could be shut out, stuck on relying on a single U.S. gas export market that, increasingly, does not need us.”
The authors of the report (it can be accessed by clicking or tapping here) are Michal Moore, Dave Hackett, Leigh Noda, Jennifer Winter, Roman Karski and Mark Pilcher, who noted that the market for LNG is becoming increasingly crowded and competitive.
The report criticized a proposed British Columbia LNG tax, arguing it could negatively affect both the cost of financing and the ability to access markets in a timely fashion.
“The producers of natural gas, they’re already paying royalties on production, and that goes to the government, which holds the resource,” Winter, a research associate with the School of Public Policy, said during a press conference held in Vancouver. “If the British Columbia government is concerned that the citizens are not getting their fair share, that should be addressed in the royalty taxation system, not through an LNG tax.
“Essentially, it would be like levying a special tax on refineries or auto manufacturers, just singling out a single industry. That will make B.C. even less attractive to potential investors relative to other jurisdictions.”
B.C. Natural Gas Minister Rich Coleman during a recent speech in Calgary stressed the province’s fiscal regime is competitive.
“We’re taking all the pieces that would affect an LNG operation — pipeline and the whole package — we’re putting it into a master development agreement.
“We will have the offsets nailed down, we will have what the emissions are nailed down, we will have the taxation nailed down. And we already know, by the way, the tax is competitive because we sat down with companies and told them what it is.
“We know we’re competitive, we’ve been told we’re competitive and now we’re going to give them certainty with master development agreements that will give them that certainty. Then we’ll go into our legislative assembly in the fall and we’ll pass legislation to lock it down.”
The B.C. government proposed a special LNG tax in its 2014 budget.
Provincial governments — with some exceptions — own mineral rights in Canada, and typically auction these rights to firms, and then levy taxes on production (royalties) to recoup the value of the resource that the firms produce on behalf of the government, the report noted.
These royalties are above and beyond corporate income taxes, and are designed to ensure the owner of the resource — the government acting on behalf of the citizens — receives its “fair share” from the development of the resource.
The proposed B.C. LNG income tax is in addition to corporate income taxes paid and the royalties paid by the producers of natural gas. This tax is, essentially, a special income tax levied on a specific type of manufacturing — LNG production.
“The effect of this tax is to raise the effective tax rate on capital, but only for LNG projects, putting them at a disadvantage relative to other forms of capital in B.C.,” the report said. “Moreover, it disadvantages project proponents in B.C. relative to projects in other jurisdictions.”
And, additional costs could make projects’ rates of return too low to make it a feasible investment.
The B.C. government claims it is introducing the tax to ensure British Columbians receive an “appropriate return” for the natural gas produced in B.C.
“However, given that the province already collects royalties on production, there is no need for an LNG income tax to ensure a fair share to the province — unless royalties are too low, which is an entirely different issue,” said the authors. “The LNG income tax is a poor policy and appears to be solely a revenue grab. It may be enough to prevent the development of the LNG industry in British Columbia, and continued uncertainty about its form can only delay investment decisions, putting Canada further behind in the race to supply Asia.”
There are other obstacles that could slow or derail the success of a future Canadian LNG and natural gas industry, according to the report. These were grouped under three main categories in the report: finance and fiscal relationships, political and regulatory uncertainty and environmental and social justice co-operation.
Currently there are more proposed LNG export projects around the world than are required to meet projected demand for the foreseeable future, the report said. While the growth period is likely to extend as much as 20 years into the future, it becomes more uncertain as time goes by, and given the contract nature of the buyer/seller relationships that are fundamental to this market, delays will allow those contracts to be signed with other nations and/or companies, effectively reducing the volume that can be shipped unless alternative buyers can be arranged.
However, there are already significant projects in the Middle East, Australia and the United States Gulf Coast that are capable of capturing a significant fraction of current and near-term demand increases, said the report. Some of these, such as Sabine Pass, are coming online to diversify and serve the expanding Japanese market. Others, such as the Cameron LNG project in Louisiana, are creating excess capacity to serve a market as far as 10 years in the future.
“We expect that Asian demand for natural gas will grow steadily but will be differentiated by country due to the timing of distribution network growth coupled with a lack of interconnection between countries, and the affordability of gas derived from LNG in developing economies,” the report said. “Although the supply of Canadian gas is abundant, access to tidewater ports is not.
“If access to ports is approved in the future, Canadian supplies can serve a significant but not unlimited portion of the market demand. Since approvals for new export capacity are likely to be completed in phases rather than all at once, we believe the staging will allow a consistent penetration of the market at consistent rates (relative price levels), without gaps or excess (surplus) supplies accumulating.”
Canadian exports of natural gas in the form of LNG will primarily be sold under long-term sales contracts to buyers who are also equity participants in the LNG export projects.
“We believe that this will be the hallmark of the co-ordinated development of both port facilities and the incremental improvements of the supply chain in both British Columbia and Alberta,” the authors wrote.
The ability of the natural gas system to expand and serve an international market will depend entirely on the characteristics of land-use and permit approvals, both from the federal and provincial governments as well as the landowner and public at large.
“For instance, one of the ports may be developed with oil supply pipes in the same right of way. This will complicate the approval and port-management issues,” the report said.
Lacking a co-ordinated and timely approval of projects, including pipeline rights-of-way, agreements with First Nations and demonstrated safety and handling plans will erode the confidence and interest of the financial community. This will add costs to project finance agreements. This “risk” characteristic is also known to the buyer community, which will see additional offers as surplus supplies from unconventional gas projects begin to appear on the market.
“Uncertainty is difficult to price or evaluate in advance. However, the nature of regulatory delays or project-mitigation costs can be serious enough to delay or impose excessive costs on projects, potentially defeating them,” the report noted. “Just as serious, though, are projects that are not burdened with these reviews and requirements, later deemed by the financing community as likely to fail and cause future unfunded liabilities.”
Taxation and royalty concerns at all levels of government will be a key issue for discussion, since success of the industry will depend on co-operation between governments for siting, tax levies and support of employment needs for the projects.
“Ultimately, this can be a deciding factor in project success, since excess levels of tax or inappropriate tax applications can render projects unfeasible in the marketplace,” the report stated.
Environmental standards and compliance, and social approval of new coastal facilities, are critical for the industry to develop.
“This will mean additional attention on the part of developers and the public regulator to conditions and standards that will withstand scrutiny from observers and indemnify all parties with regard to potential upsets or damage in the future,” the report said. “While the LNG shipping industry has an extremely good track record, marine safety will prove to be a significant regulatory concern; added costs here may demand collective or novel approaches to guaranteeing a high standard of safety and oversight within Canadian national waters and beyond.”
The overriding environmental issues surround pipeline location and right-of-way impacts, inspection and leak detection and air quality issues associated with electric power operations necessary to maintain liquefaction and port facilities.
“The ruggedness of the terrain and its seismicity could add to costs and time for identifying suitable pipeline routes, securing right of ways and permits and constructing pipelines across the Coastal range,” the report said.
Electricity is likely to be provided totally onsite with gas-fired power generation, with no grid support, for economic performance and to satisfy likely regulatory and policy concerns.
“This will potentially raise costs and make it difficult to meet the government’s greenhouse gas emissions targets. The availability and cost of labour for remote project sites will be an issue, affecting the cost and schedule of export projects.
“Right of way and access challenges from landowners, First Nations and environmentalists are likely to dominate decision forums as the projects are advanced, and the standards and mitigation requirements are likely to impose additional project costs that may reduce the profitability and incentive for any given project,” the authors noted.
