Energy East pipeline: Risky business gamble or Liberal regulatory, political machinations?

TransCanada blames “regulatory uncertainty” for Energy East withdrawal, evidence thus far supports that view

Someone is lying about why the Energy East pipeline project was cancelled. Either it’s TransCanada, which blamed the “substantial uncertainty around the scope, timing and cost” of the federal review. Or it’s Prime Minister Justin Trudeau, who on Saturday penned a Facebook note blaming “market forces” for the $15 billion project’s death and vigorously denied his government’s energy regulatory reforms were responsible. 

In yesterday’s column, I demonstrated that TransCanada had customers committed to long-term – likely 20-year – contracts for the 1.1 million b/d of crude oil capacity of the pipeline. Furthermore, that those customers were on the hook to pay the Energy East tolls regardless of the price of oil or their own profitability.

Rather than a failing business case due to current low oil prices, the market forces alluded to by the Prime Minister, TransCanada probably had a good business case (though, to be fair, industry sources do say Energy East economics were not as robust as some other proposals).

But on Monday, respected energy economist Andrew Leach published an op-ed in The Globe and Mail that provided a hypothetical alternative for the Calgary-based pipeline giant’s decision.

Leach’s argument is that President Donald Trump basically killed Energy East when he approved Keystone XL (in late January), TransCanada’s controversial and long-delayed 890,000 b/d pipeline from Alberta to the Texas Gulf Coast.

According to Leach, Keystone XL’s open season, in which oil producers contract with the proponent and commit future supply to a pipeline, left it short 235,000 b/d short.

This put TransCanada in a bind.

Energy East was fully committed, but faced a daunting regulatory and political gauntlet in Eastern Canada, especially Quebec, where it was opposed by over 50 Montreal-area mayors.

Keystone XL was approved (though it still faced some state approvals), but couldn’t find enough supply to justify construction.

The solution? Cancel Energy East, take a $1 billion charge, and hope that some of the shippers would shift their business to Keystone XL.

“Was TransCanada making a business decision when they cancelled Energy East? Of course. It was a decision that will likely allow them to save Keystone XL,” concluded Leach.

The University of Alberta economist’s argument is plausible, but jam packed with qualifiers (the word “likely” makes frequent appearances) and cites no sources or other evidence to confirm his hypothesis.

Rebuttal to the Leach hypothesis

McConaghy is a former TransCanada vice-president, where he oversaw the Keystone XL pipeline project that figures so prominently in Leach’s op-ed. While he acknowledges he is no longer an insider with the company, he is intimately familiar with the Keystone XL project and the Canadian pipeline business, and still plugged into the industry network in Calgary.

He says while Leach doesn’t understand how the business works.

“Gaining a regulatory approval has a real value. TransCanada and its shippers could rationalize the incremental cost of obtaining an approval for Energy East and then holding it into the next decade,” he said in an email.

This is an important point.

McConaghy argues that “perverse” outcomes can always happen.

Trans Mountain Expansion is facing a firestorm of opposition in Vancouver from First Nations, environmental groups, and local governments. The project is currently the subject of a judicial review by the Federal Court of Appeal, to which the new NDP government of John Horgan is an intervenor.

Does the Trudeau Government have the political will to face down angry British Columbians and a promised Standing Rock-style protest movement with the 2019 election looming and 17 Liberal seats on the line?

Keystone XL still requires approvals from the state of Nebraska and some local governments, but landowners are just as determined to stop construction. What happens when Hollywood celebrities and the environmental protest machine get cranked up again, as they were prior to the Sept. 2015 rejection of the project by former President Barack Obama?

“Any fair-minded observer would concede that if (underscore “if”) all three pipeline projects that are more advanced than Energy East , (KXL, TMX, and Enbridge Line 3 expansion), were all to be constructed and in operation by the end of 2019, the resulting incremental capacity would be more than adequate to accommodate anticipated growth in oil sands production, as per the latest Canadian Association of Petroleum Producers’ forecast, for much of the next decade,” says McConaghy.

“But there are no guarantees that any of those three pipelines will be built within the next two years. Energy East provided an important hedge on those outcomes. Having Energy East at least efficiently permitted would have been valuable not just to TransCanada and its shippers, but also to the Canadian economy.”

According to McConaghy, if the National Energy Board had granted a permit for Energy East, TransCanada was not obligated to begin construction immediately. The company could have delayed building the pipeline if business prospects dictated such a decision.

Finally, what is the likelihood that TransCanada would cancel a $15 billion project and take a $1 billion loss in the hope, not the certainty, that shippers would sign up with Keystone XL?

That seems like a pretty risky gamble for an industry known for its conservative business practices.

The NEB “modernization” and federal regulator conundrum

The Leach op-ed also fails to provide an explanation for the puzzling hard turn the Trudeau Government made between the release of the NEB modernization expert panel report on May 15 and the posting of the government’s discussion paper on June 29.

As I explained in Monday’s column, the report crafted a good compromise, giving pipeline opponents more input and influence, while giving industry a three-year timeline with determination of the public interest up front during the first year, followed by a two-year technical review.

Then six weeks later came the Natural Resources Canada discussion paper, which proposed that opponents get everything recommended by the panel and industry get almost nothing.

My sources say that was a huge red flag for industry. We can assume TransCanada was not pleased.

Then in Sept. the NEB announced it was including downstream GHG emissions in the Energy East assessment. This decision came out of the blue and surprised TransCanada’s management.

Downstream emissions (e.g. refineries, consumer automobiles) have never been included in a pipeline review before.

The combination of “regulatory uncertainty” and downstream emissions was a bridge too far for TransCanada. The “straw that broke the camel’s back,” as McConaghy puts it.

Here is an excerpt from the company’s letter to the NEB withdrawing the Energy East application:

“…there remains substantial uncertainty around the scope, timing and cost associated with the regulatory review of the Projects. There is also the question of jurisdiction that arises from the NEB’s Decision [re. downstream emissions].

After completing its careful review of these factors, the existing and likely future delays resulting from the regulatory process, the associated cost implications and the increasingly challenging issues and obstacles facing the Projects, the Applicants will not be proceeding further with the Projects…”

My sources tell me TransCanada “agonized” over what to say in the letter and the press release announcing its decision. In the world of regulators and pipeline companies, those are harsh words.

If TransCanada’s strategy was to terminate Energy East in order to save Keystone XL, as Leach argues, why would it risk alienating the regulator that oversees the operations of its many other pipelines in Canada?

Why would it risk alienating the Canadian government?

If Leach is correct, why didn’t TransCanada just withdraw and move on without picking a fight over NEB modernization and downstream emissions?

TransCanada’s behaviour doesn’t mesh with Leach’s conclusions.

Risky business gamble vs. Machiavellian regulatory machinations – Which makes more sense?

Canadians have to ask themselves which of these two scenarios is more probable.

That TransCanada took a write down of $1 billion and cancelled a $15 billion pipeline project for which it had 20-years of guaranteed tolls because oil prices are low and they hoped – with no assurances – that Energy East shippers might sign up for Keystone XL, which still has not received final approval in the US. Furthermore, gambling that the Trans Mountain Expansion pipeline to the West Coast would be built despite fierce opposition in Vancouver.

Or that the Trudeau Liberals – with only a 10-seat majority in the House of Commons and facing the certain loss of seats in the 2019 national election in the lower mainland of BC because of the Kinder Morgan controversy and facing the probable loss of Quebec seats because of Energy East opposition – made a political calculation between May 15 and June 29 to jerry rig the NEB modernization process to favour pipeline opponents (particularly indigenous communities), knowing that at the very least it would give them some political cover in Quebec and BC?

Best case scenario, the Liberal emerge as champions of First Nations, environmental groups, and local communities opposed to new pipelines by being tough with Alberta-based TransCanada, where the Liberals are also almost certain to lose a few seats.

Keep in mind there are no new pipeline projects on the horizon. It is quite conceivable that with Energy East out of the way, the Trudeau Liberals may never have to subject a pipeline project proponent to their now – or soon to be, it appears – skewed NEB review process.

Trudeau and company enjoy all the political benefits of pleasing Energy East opponents while never suffering the political pain that would surely come should some brave company attempt a new application.

Admittedly, my scenario is as much a hypothesis as Leach’s argument about cancelling Energy East in the hopes of salvaging Keystone XL.

So, readers are welcome to make up their own minds about which scenario best explains the Energy East controversy.

But only one is consistent with the facts as we know them today.