Focus on Fuel Part II: Liquefied Natural Gas Economics 101

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For part one of this series, click here: Focus on Fuel Part I.

This is Part II in a five-part Martlet investigative series exploring the economic, socio-political, and environmental impacts of the B.C. government’s decision to pursue Liquefied Natural Gas initiatives. This instalment focuses on examining economic discourse around the issue.

 

“Debt Free B.C.” was the mantra echoed by B.C. Liberals this May after Christy Clark was re-elected as the 35th Premier of the province, largely on the grounds of the lofty goal implicit in her aforementioned campaign slogan. In the five months following her re-election, however, the improbability of ever reaching this objective has become increasingly apparent. When Clark was first elected to the office of premier in 2011, she inherited slightly over $45-billion in provincial debt from  incumbent premier Gordon Campbell and during her first two years in office managed to increase the debt by a staggering $10-billion. This figure is even more astounding when one considers that during Campbell’s decade-long sojourn in office beginning in 2001, his administration only managed to rack up $12-billion in provincial debt—the vast majority of which was only incurred in the years directly following the global “Great Recession” beginning in 2008.

It comes as no surprise, then, that the Clark administration has largely spent its tenure in power desperately seeking ways to not only balance the provincial budget, but also begin hacking away at the $55.8-billion in outstanding debt which is costing the province $2.4-billion annually in interest.  The projected budget surplus for this fiscal year currently sits on a miniscule margin of $136-million for a $44-billion budget; an uncontested improvement from the $1.1-billion deficit racked up by the province for the 2012 fiscal year ending last March, yet still a far cry from beginning to eliminate the massive heap of provincial debt as promised by Clark. Fortunately for the administration, Ms. Clark has discovered her deus ex machina in the form of a burgeoning new natural resource industry: Liquefied Natural Gas (LNG).

Clark’s ‘bold new vision’

In the wake of the global economic downturn which began in 2008 and the increasing innovation in North American fuel extraction methods, with recent advances such as fracking and horizontal drilling opening up massive reserves of previously unobtainable natural gasses, LNG prices in British Columbia have plummeted since their climax in 2006. With flagging provincial revenues and rapidly increasing debt, the Clark administration was prompted to offer a solution to B.C.’s economic woes which culminated in the Sept. 2011 announcement of the B.C. Liberal Jobs Plan.

The ultimate objective of Clark’s jobs plan is enticing foreign multinational corporations to invest “the first new dollar” in British Columbian industry. Central to this aggressive pursuit of foreign capital investment is the economic potential inherent in the recently revitalized LNG industry, a resource sector that analysts for the Clark government maintain has the capacity to generate upwards of $200-billion in revenues over a period of 30 years. It should be noted, however, that this projection is largely dependent on the specific form of the LNG tax regime to be announced this November. Pinning B.C.’s economic prosperity on a North American industry which is currently producing a commodity at unprecedented low prices would seem counterintuitive even to the most ignorant observer; however, the Clark administration has shifted B.C.’s attention from its southern neighbor, which currently consumes 41 per cent of the gas produced in the province, and has cast its longing gaze across the Pacific, allowing it to rest on the explosion of economic activity in emerging Asian energy markets such as those in Japan, Korea, China, and India.

“Successful LNG development requires a strong relationship with investors in Asia,” said Rich Coleman, the B.C. minister of Natural Gas Development, prior to his embarkation to the region on a business-development mission on Oct. 11. “They need to understand British Columbia is open for business and competitive with other jurisdictions.”

In the one-year update to the B.C. LNG Strategy published in February, Clark’s administration highlights the massive LNG price differential in North American and Asian markets as the primary explanans for its desire to rapidly develop the B.C. LNG industry. This aspiration to carve out a section of the Asian market for B.C. is entirely understandable when one considers that North America saw LNG prices average out to $2.75 USD per 1 000 cubic feet of natural gas (or per Mcf), while countries like Japan and Korea were shelling out $16 USD per Mcf on average throughout 2012, occasionally seeing prices rise as high as $17.50 USD per Mcf. The reason such a glaring price disparity exists between these two regions is due to the fact that a precedent was set in Asia in the 1970s that linked LNG contracts to the Japanese Customs-cleared Crude (JCC) oil price; this means that as crude prices rose over 50 per cent in the last five years to their current price of over $100 USD per barrel, LNG prices in Asian countries increased in tandem. This is contrasted to the North American market where gas prices are not linked to any other energy commodities; rather, the LNG spot and future prices are set at the Henry Hub in Erath, Louisiana; the recent glut of LNG in Canada and the U.S. has caused Henry Hub prices to remain depressed since 2008 and consequently both public and private sector institutions have begun looking elsewhere for investors in the growing LNG market.

The B.C. government has additional motives for their furious pursuit of a substantial share of the global LNG market and the primary drive is explicated by the very fact that British Columbia is already a late-comer to the LNG game. Qatar currently has the largest export capacity for LNG, producing at a level of 77 Mta (million tons per annum); the United States has already approved four permits for exporting LNG within the past two years and is expected to be exporting 50 Mta of LNG by 2025; and Australia is slated to have seven LNG facilities producing by the end of the decade and is estimated to have a production capacity of 90 Mta by 2017. These external factors have been a significant impetus in the Liberal government’s push to get at least three LNG facilities in B.C. producing by 2020 which are estimated to reach a production capacity of 82 Mta by 2018. According to the Clark administration is the potential for B.C. to be a major player in the forever-growing Asian LNG market, which is expected to increase by two-and-a-half times by 2030—but only if action is taken now.

Others, such as award-winning journalist and author of three books on the Canadian oil industry Andrew Nikiforuk, are less assured. “The price differential will be gone by the time [these facilities] are producing gas,” said Nikiforuk while speaking at the recent PowerShift conference in Victoria.  Critics such as Nikiforuk suggest that the Clark administration’s pursuit of British Columbian LNG is based on hefty assumptions about the future of the LNG market which are by no means as certain as the Clark administration would have one believe. “I can’t predict the markets,” said Nikiforuk. “I don’t know how the Clark government can.”

Prosperity funds and pipe dreams

Last February, renowned Canadian economist Timothy O’Neill published an independent report for B.C.’s finance minister Michael de Jong in which he offered an assessment of the methodologies and assumptions underlying the 2013 provincial budget. He cites consistently overly-optimistic revenue forecasts for natural gas over the past six years as the one of the main culprits behind the $1.1-billion budget deficit at the end of the last fiscal year.  Last year’s projected budget for natural gas revenues was pegged at $3.02/GJ (Gigajoule), while actual prices showed natural gas selling for about $2.15/GJ during the 2012 fiscal year; in order to avoid a repeat of last year’s large budget deficit, O’Neill suggested “down-shading” forecasted natural gas revenues in order to leave an ample margin of error for unforeseen market circumstances. The B.C. natural gas revenue forecasts are typically compiled by a group of some 20 private-sector consulting firms, the majority of which belong to the umbrella companies of AJM and GLJ Petroleum Consultants, McDaniel Consultants, and the Alberta Energy Company (AECO). O’Neill suggests abandoning the old method of dropping the high and low forecasts from these firms and then averaging the remaining forecasts to arrive at a natural gas revenue prediction, noting that this often leads to a gross overestimation of market realities.

If B.C. had stayed the course with its method of calculation for the 2013 budget, the B.C. government would have allotted $2.13/GJ in projected natural gas revenues for this fiscal year; according to O’Neill, this 46 per cent increase over last year’s median forecast is brash and unrealistic, especially for an administration so concerned with balancing the provincial budget and eliminating debt. O’Neill concludes that the safe bet for 2013 would be a forecast of around $1.85/GJ for LNG which would leave a roughly $70-million budget cushion; taking O’Neill’s recommendation to heart, the B.C. government has officially defined the 2013 B.C. revenue forecast for natural gas on the basis of this price. O’Neill goes on to note that the key issue for the B.C. budget “is what constitutes a reasonable forecast for natural gas revenues over the next 3–5 years,”  and suggests continuing to exercise conservative judgment when forecasting natural gas revenues in the future, due to the fact that natural resource revenues tend to be much more volatile than other revenue sources such as PIT and CIT (Personal Income Tax and Corporate Income Tax).

Despite the cautionary nature of the O’Neill report, it appears as though the Clark government still prefers to have an incredibly optimistic outlook for future LNG revenues, as evidenced by the administration’s February announcement of the creation of a B.C. Prosperity Fund. Beginning in 2017, an as-yet-unspecified portion of the revenues from the five proposed LNG facilities in B.C. will be deposited directly to the fund, with the Clark government estimating that over $100-billion will flow to the fund over the course of 30 years. According to the administration, the revenues deposited in the Prosperity Fund will first go to pay off all provincial debt with the remaining funds to be maintained for use by future generations.

The enactment of initiatives such as the B.C. Prosperity Fund are not unprecedented; Alberta established its Heritage Savings Trust Fund in 1976 as a depository for non-renewable resource revenues and Alaska created its Permanent Fund in the same year for similar reasons. Despite the ostensible similarity in the goals of these funds, there are important lessons for B.C. to learn from their differences, say analysts at the Fraser Institute, a Canadian think tank focused on public policy issues. For instance, in the 36 years since Alberta established its Heritage Fund, it has managed to save $16.6-billion, yet despite the stated purpose of the fund, has not deposited resource-related revenue into the fund since 1987. Furthermore, there is no mandatory percentage of resource-related revenue that must be deposited in the fund and the monies in the Heritage Fund can be used at the discretion of the current government. Compare this to Alaska which constitutionally mandated that 25 per cent of mineral resource revenues must be deposited directly into its fund and are only to be used for saving and investment in low-risk projects. The interest earned on these “prudent investments” is used to pay out dividends to Alaskan citizens in the form of yearly cheques. This rigorous management of the fund by fiat has fared well for the citizens of Alaska; the fund currently boasts over $47-billion in assets and this year over 640 000 Alaskan citizens received $900 cheques in the mail from dividends paid out by the fund.

Clearly, the success of initiatives such as the B.C. Prosperity Fund, the Alberta Heritage Fund and the Alaska Permanent Fund depend largely on the rigour of the legal measures which serve as their foundation. According to analysts at the Fraser Institute, it is imperative that the Prosperity Fund is imbued with clearly defined laws to insure its efficacy in eliminating debt. While the B.C. Prosperity Fund is not designed in such a way as to annually remunerate the citizens of British Columbia, the ones who must ultimately bear the brunt of any unintended consequences arising from the establishment of an LNG industry, the Clark government assures its constituency that there are ample indirect benefits to make up for this deficiency.

After going toward paying off outstanding B.C. debt, “The Prosperity Fund could be used to reduce the cost burden on families and make investments in health care, education and other priorities,” said a spokesperson for the ministry. The spokesperson also claimed that the Prosperity Fund would avoid the fate of Alberta’s Heritage fund by “[taking] into account principles of transparency, accountability, and good financial management.”

Jobs

In addition to providing an avenue for the complete elimination of provincial debt, the Clark government also views the prospective B.C. LNG facilities as a source for the creation of an estimated 75 000 jobs, and as a result the LNG facilities and pipelines have become an integral part of the B.C. Liberal Jobs Plan. Don’t let this seemingly exorbitant figure fool you, however; in numerous reports released by the Clark administration, the number of jobs which will supposedly be created by the B.C. LNG industry are conveniently lumped together in grand figures without specifying exactly how this number is derived. An analysis of the proposed B.C. LNG facilities released last October by the Fraser Institute suggests that roughly two-thirds of these 75 000 jobs will be short-term construction positions, with only a few thousand full-time jobs created for the management and operation of these pipelines and terminal facilities.

The Fraser Institute’s report estimates that the Pacific Trails Pipeline alone will create roughly 8  000 construction job-years over the course of its production, and the construction of all the pipelines necessary to support the five proposed LNG facilities in B.C. would generate a total of 45 000 construction job-years. The construction of the LNG liquefaction and terminal facilities needed to warrant these pipelines would generate a further 8  350 job-years, bringing the total number of construction job-years necessitated for the functioning of five LNG facilities to 53 350. This accounts for slightly over 71 per cent of the employment opportunities that the Clark administration alleges will emerge from the production of five LNG facilities.

The remaining 11 650 jobs are assumed to be created due to the exigencies of managing the new pipelines and terminal facilities. The operation of the five proposed facilities and pipelines once they are completed would generate 935 full-time, long term positions, according to projections by the Fraser Institute. Assuming that these positions would pay an average annual salary of $79 585, these jobs have the potential to generate $74.4-million in taxable labour income for the province each year. Furthermore, if B.C. does manage to ramp up its unconventional gas production from its current levels of roughly 1.3 billion cubic feet (Bcf) per day to the projected 10.3 Bcf per day by 2035, this would necessarily create an additional 6 400 long-term field positions to cope with the increased extraction rates of unconventional gasses. Despite the numerous public and private sector reports forecasting the scope of employment-generation born of the B.C. LNG industry, few of these reports indicate exactly who will be the recipients of these 75 000 jobs. Many of the pipeline and terminal projects are the brainchildren of foreign-owned multinational corporations and state companies, and all of the proposed projects run through First Nations’ territories; it is precisely for this reason that the lack of specificity regarding who will benefit from the creation of these jobs is deeply troubling. A natural gas workforce strategy released by the Clark administration this July briefly sketched a proposal of how the LNG workforce demand will be met, yet this is a far cry from implementing regulatory measures that ensure that greater precedence will be given to First Nations members and British Columbian citizens. The initial steps in this direction are being taken through worker-education initiatives in Northeastern B.C. aimed at preparing local populations for the forthcoming labour positions associated with the birth of B.C.’s LNG industry, yet only time reveal the efficacy of such projects.

As the British Columbian legislature sits idle this fall and the Clark administration deliberates on a new LNG tax regime for B.C.’s newest natural resource industry, the citizens of British Columbia are left to their own judgment to determine just how much of the Clark government’s enthusiasm for the economic promise of LNG is warranted.

For part three of this series, click here: Focus on Fuel Part III.

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