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Prospects for a Canadian LNG Export Industry - Master Slides (FINAL)
1. The Canadian LNG Export Industry
Progress and Prospects
ABA Section of International Law
2016 Fall Meeting
Tokyo, Japan
Al Hudec, Farris LLP, Vancouver
Don Bell, Torys LLP, New York
John Mackay, Latham & Watkins LLP, Singapore
Karen Ogen, First Nations LNG Alliance, Wet’suwet’en First Nation
2. Introduction
• Canada began to develop a legal regulatory and fiscal regime
for LNG exports in 2012
• This regime is now largely in place and 3 large projects and
one smaller project now have full regulatory approval
• If built, these proposed Canadian LNG liquefaction facilities
will be among the largest and costliest energy projects ever
built
2
3. Driving forces behind the Canadian
industry
• The ‘shale gas’ revolution has made the U.S. self sufficient in
oil and gas and has shut in abundant Canadian supplies
• The obvious solution is for Western Canada to replace its U.S.
and Eastern Canadian markets with Asian exports
• This requires a return to JCC oil index based pricing
– B.C. announced an LNG strategy in 2012 when price was
U.S.$18.11
– Price now U.S.$6.32
– Break even for the Canadian projects is about U.S.$10.30
3
4. The view from Asia
• Asia is the principal market for Canadian LNG
LNG Importers (2013)
4
Source: International Group of LNG Importers
OTHER ASIA 15%
India, Indonesia, Malaysia,
Pakistan, Singapore, Taiwan,
Thailand
EUROPE 15%
Belgium, France, Greece, Italy,
Lithuania, Netherlands, Portugal,
Spain, Sweden, Turkey,
U.K.
MIDDLE EAST 4%
AMERICAS 9%
Argentina, Brazil, Chile,
Dominican Rep, Mexico, Puerto
Rico, Canada, USA
JAPAN 35%
SOUTH KOREA 14%
CHINA 8%
5. The view from Asia
• Population growth, rising incomes and the desire to replace coal
favour LNG
• But: multiple and complex counter-forces
Russian – Chinese pipeline deals
Nuclear energy in Japan and Europe
Shale gas (now China too!)
Tremendous increases in
world liquefaction capacity
outpacing growth in demand
Growth of Spot Market
5
6. Spot and Short-term Market
• Variety of factors push growth of spot and short-term market:
• LNG contracts with destination flexibility, chiefly from Atlantic
Basin and Qatar
• LNG glut and price disparity in different basins has created spot
arbitrage opportunities
• Large growth in LNG fleet - allows industry to sustain the long-
haul parts of the spot market
• Decline in competitiveness of gas relative to other fuels
(including coal and shale gas) has freed up volumes to be re-
directed elsewhere
• Buyers such as JERA have emerged, which take huge volumes
and increasingly favour mid-term and short-term contracts or
spot purchases
6
7. Spot and Short-term Market
• Rapid rise in spot volumes traded:
• Threatens Canadian projects (most of the spot trade is from non-project financed
projects)
• Challenge for long term JCC oil-indexed supply agreements, allowing price offtakes
pursuant to formulas based on U.S. Henry Hub pipeline gas pricing
• Spot LNG (Japan) fell from U.S.$15.21 per MMBtu (July 2014) to U.S.$6.32 per
MMBtu as of Sept 2016)
7
8. Spot and Short-term Market
Source: Waterborne LNG Reports, U.S. DOE, PFC Energy Global service
Spot and Short-term Market Development - 1995-2014
8
9. The view from the United States
• The U.S. and Australia are Canada’s principal competitors
• U.S. ‘brownfield’ projects on the sites of existing import
facilities have significant timing and pricing advantage
9
15. PNW LNG
• Majority owned by Petronas with participation by Japex,
Sinopec, Indian Oil and Brunei Petroleum
• $36 billion, 19 million tonne/year facility
• Includes $11.4 billion export terminal, $5.2 billion upstream
acquisition, $12 billion of upstream development and $6.7
billion TCPL pipeline
• Located on Lelu Island in Prince Rupert Harbour in territory
subject to overlapping claims of five First Nations
15
16. PNW Project Timeline
• Feb, 2013: PNW submits its project description to CEAA
• Apr, 2013: Japan Petroleum Exploration Co. Ltd. agrees to buy 10 per cent of the offtake over
at least 20 years
• July, 2013: PNW applies to the NEB for a licence to export up to 19.68 million tonnes of LNG
annually for 25 years, beginning in 2019
• Dec, 2013: The NEB grants PNW a licence to export up to 22.2 million tonnes of LNG annually
for 25 years
• Feb, 2014: PNW submits its environmental impact statement to the Canadian Environmental
Assessment Agency
• Mar, 2014: The federal government approves PNW's export licence
• June, 2015: PNW announces conditional FID – it will proceed with the project as long as it
satisfies two conditions: approval of a project development agreement by the B.C. legislature
and clearing the federal environmental assessment review process
• July, 2015: The B.C. government passes legislation that ratifies a project development
agreement with PNW
• Mar, 2016: The federal government grants the CEAA more time to review the project
• Sept, 2016: The federal government gives conditional approval to the project
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18. LNG Canada
• Shell Canada, Kogas, Mitsubishi, PetroChina
• 24 million tonnes per year at full buildout
• Located in Kitimat on the Haisla First Nation Reserve
• 700 km pipeline owned and operated by TCPL
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20. Woodfibre LNG
• 2.1 million tonnes per annum
• Located on a brownfield pulp mill site near Squamish in
territory of Squamish First Nations
• Using pipeline gas as feedstock; electrically fuelled
20
21. Next Generation Projects
Project Proponents Capacity Status
WCC
Tuc Inlet,
Prince Rupert Harbour
Exxon/Imperial 30 MTPA 25 yr. Export
license, EA pre-
application stage
Aurora LNG
Digby Island
Prince Rupert Harbour
Nexen (60%),
Inpex and JGC (40%)
24MTPA 25 yr. Export
license, EA pre-
application stage
Woodside Petroleum LNG
Grassy Point,
North of Prince Rupert
Woodside 20MTPA 25 yr. Export
license, EA pre-
application stage
21
22. The Canadian advantages
• Abundant low cost resource base
• Climatic advantage
• Proximity to Market
• Stable fiscal/regulatory regime
• Strong local government support
• Diversity of supply
22
24. Canadian challenges
• High Capital Cost of Greenfield Projects
• Pipeline Infrastructure requirements
• Potential cost pressures
• Dynamics of International LNG Pricing
• Requirement for First Nations Support
24
26. Regulatory timeline
• Feb, 2012: LNG Strategy announced
• Oct, 2014: Greenhouse Gas Industrial Reporting & Control Act announced
• Oct, 2014: Liquefied Natural Gas Income Tax Act and a Natural Gas Tax
Credit under the Income Tax Act announced
• Feb, 2015: the Federal Port Development Act is introduced
• March, 2015: The administrative and enforcement components of the
Liquefied Natural Gas Income Tax Act are introduced
• May, 2015: British Columbia reaches a Project Development Agreement
(PDA) with PNW and a Long-Term Royalty Agreement (LTRA) with the
North Montney Joint Venture
• June, 2015: The Liquefied Natural Gas Income Tax Act Regulations are
deposited
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27. Export Permits
• 40 year export permits issued by National Energy Board
• Sole test is whether the quantity to be exported is surplus to
Canadian needs, taking into account trends in the discovery of
the resource
• Simplified process – recent applications approved without a
hearing
• Expert evidence utilized to determine excess
• Extensions of term to 40 years for projects which already have
25 year licenses are being readily granted
“Taking into consideration the significant investments required for liquefied natural gas projects, and their
significant anticipated economic benefits, the Government is taking additional steps to support the LNG
industry and other natural gas exporters by extending the maximum limit of natural gas export licences
from 25 to 40 years, to improve regulatory certainty,” (Canadian Federal Government Economic Action
Plan 2015)
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28. Environmental Assessment
• Liquefaction facilities are regulated under the Canadian
Environmental Assessment Act and the B.C. Environmental
Assessment Act
• MOU on the Substitution of Environmental Assessments
• 3 stage process:
– Application Information Requirements
– Application Review Stage
– Decision Stage
28
29. First Nations Consultation
• First Nations have a constitutional right to be consulted with
respect to all resource development projects within their
traditional territories
• Supreme Court of Canada historical cases which assert
Aboriginal Title to the land does exist:
1997: Delgamuukw
2014: Tsilhqot’in Decision
• UN Declaration on the Rights of Indigenous Peoples
29
30. Challenges to First Nations Engagement
• 600 Indigenous Nations in Canada: 203 are in B.C.
Treaty Nations vs. Unceded Territory
• Of the 50 First Nations in Northern B.C., more than 40 are
impacted by major LNG projects
• Hereditary Chiefs system vs. Elected system
• Revenue sharing and equity ownership
Needs to be fair and equitable: benefits must outweigh the
risks
• Every First Nation community will be different
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31. How to Engage with First Nations
• Consultation and accommodation must be fair, reasonable, respectful
and equitable
Start early in the life of the project – make a meaningful effort to
learn about the community, its culture and history
Fully inform the community about all aspects of the project
Maintain consistency in building and nurturing the relationship over
the life of the project
• Project must meet the highest environmental standards – this is a
prerequisite for First Nation support
• Share project benefits with First Nations
Financial benefits/equity ownership
Training and jobs
Contracting opportunities
31
32. United Nations Declaration on the Rights
of Indigenous Peoples
• Does the UN Declaration on the Rights of Indigenous Peoples
impose greater consultative obligations?
• According to the Office of the High Commissioner, in terms of
resource development, the Declaration:
outlaws discrimination against indigenous peoples and
promotes their full and effective participation in all
matters that concern them
It also ensures their right to remain distinct and to pursue
their own priorities in economic, social and cultural
development
• The Declaration explicitly encourages harmonious and
cooperative relations between States and indigenous peoples
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33. Compliance with International Standards
• The international banking community has established
standards to assess environmental and social issues
• IFC Performance Standards on Environmental and Social
Sustainability
• Various Multilateral and Export Credit Agency standards
• Equator Principles for commercial banks
33
34. Compliance with International Standards
(continued)
• Historically, compliance has only been required for large-scale
projects in developing countries
• Canadian projects are likely to require lending consortiums of
commercial lenders and agencies
• Australian LNG experience shows that IFC Performance
Standards are likely to be applied in Canada
• Early diligence is key for Canadian projects “Action Plans” to
ensure gaps between standards are identified
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35. Regulation of Construction/Operations
• Regulated by the B.C. Oil & Gas Commission under the Oil
and Gas Activities Act – Liquefied Natural Gas Facility
Regulation
• Incorporation by reference and delegation
Federal Port Development Act
Canada Marine Act Amendments
35
36. Carbon Tax
• British Columbia has had a revenue neutral carbon tax since
2008
• Currently $30/tonne
• Canada is a party to the Paris Climate Agreement – federal
phase in of a $50 tax
• Recent Climate Action Plan includes measures to reduce
upstream carbon impacts
36
37. Carbon Tax
• British Columbia has had a revenue neutral carbon tax since
2008
Source: “State and Trends of Carbon Pricing”, World Bank Group, 2015
37
38. Regulation of GHG Emissions
• Tough standard of 0.16 carbon dioxide equivalent tonnes per
tonne of LNG produced
• Flexibility in options to meet standard
Facility design
Purchase offsets in local market
Contributions to technology fund at a rate of $25/per
tonne of CO2e
• LNG Environmental Incentive Program
38
39. B.C. LNG Income Tax
• Tier One (1.5%) until initial operating losses and prescribed CAPEX
recouped; Tier Two (3.5%, increasing to 5% in 2037)
• Capital expenditure account includes costs of constructing LNG facility,
storage tanks and marine loading systems, but not feedstock pipeline
• Taxes “any person that engages in or has income derived from
liquefaction activities” - income derived from the liquefaction process
whether
by virtue of being the processor; or
having the right to acquire the product
• Novel transfer pricing rules
• Natural Gas Income Tax Credit
39
40. B.C. LNG Income Tax (continued)
• Discriminates against non-integrated projects
• Taxes offshore owners of gas where not resident in B.C. and
no permanent establishment in B.C.
• Transfer pricing rules do not recognize the complexity of
international LNG pricing
40
41. Project Development Agreements
• Built on the Australian model
• The Province contractually indemnifies the proponent and
partners against
Changes in the LNG Tax or the Natural Gas Tax Credit
Discriminatory changes in the Carbon Tax rate or the GHG
emissions benchmark
• Long Term Royalty Agreement – initially 6.06%, rising to
13.36% in 2038; minimum infrastructure investment
requirements
41
42. Project Development Agreements
(continued)
• Ratifying legislation requires that PDA be governed by B.C.
laws and that B.C. is venue for any proceeding
• PDA provides that all disputes be resolved exclusively by
arbitration under the Rules of the B.C. International
Commercial Arbitration Center
• Assignable as security – agreed form of Direct Agreement
gives lenders notice and cures rights
• Covenant not to challenge the LNG Tax
• MFN clause where appropriate to achieve equitable terms
and conditions
42
43. Investment Treaties
• Canada currently has 36 “Foreign Investment Promotion and
Protection Agreements” (FIPAs) and is progressing another 25
(e.g. Canada–China Foreign Investment Protection and
Promotion Agreement ratified in 2014)
• Canada is actually fifth in the world for treaty arbitrations
instituted against it
• Typically no “umbrella clause” protection in Canadian FIPAs,
but they do typically include expropriation protection as well
as rights to fair and equitable treatment, MFN national
treatment and access to justice and fair procedure
• A treaty claim allows international ICSID arbitration before the
International Center for Settlement of Investment Disputes
43
43
46. Tolling Model
Upstream/ Natural
Gas Owner(s)
Project Tolling
Company
Downstream/LNG
Buyer(s)
Liquefied Tolling
Agreement
(LTA)
Natural Gas
LNG
Common ownership/affiliation
LNG Sale and Purchase Agreement(s)
46
49. Project financing
• Ideally lender recourse is limited to SPV
• Risk allocation through turnkey EPC contract, tolling
agreement, long term offtake agreements
• Basel III may raise the cost of financing
• Example – $34 billion floating ICHTHYS project north of
Australia (Inpex and Total)
49
50. Internal sponsor funding
• Financing sourced from internal cash flow or balance sheet
borrowing
• Gives sponsors more exclusive control over project decision
making, transaction cost savings
• May be only alternative where Project deploys new or
untested technologies
• Example – The massive Gorgon Project in West Australia
funded directly by Chevron, Exxon Mobil and Royal Dutch
Shell
50
51. Export credit agencies
• Direct financing or credit support driven to assure supply or to
contracting opportunities
• Example – Exxon Mobil’s PNG LNG Project in Papua New
Guinea involved participation of 6 export credit agencies
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52. Are the Canadian projects financeable?
• Generally yes, if there is a return to long term JCC oil index based pricing
• Sponsored by large international players, with buyer equity participation
• Probable access to U.S. commercial bank and bond markets
• Interest of Export Credit Agencies yet to be determined
• Facilities using known technologies, but long distance large diameter
pipelines must be laid over rugged mountainous terrains
• Risk of labour material price inflation if projects proceed simultaneously
• Abundant secure gas reserves
• Continued challenges of Aboriginal consultative process where there are
territorial overlaps or linear projects transversing multiple territories
52
53. Overall Assessment – are the Canadian
Projects competitive internationally?
• Not right now – the Canadian projects are high cost,
particularly relative to the U.S. brown field projects
which have existing infrastructure and pipelines
• The Canadian Projects require a return to higher oil
prices and oil indexed pricing of LNG to become
competitive
• The leading Canadian projects are at or near shovel
ready; and are in a position to make a FID when
world pricing conditions improve
53
54. Industry wish list
• Continue to engineer costs out of the Projects
• Continue to work with governments to develop a labour strategy
• Lobby for relief on restrictions on the use of foreign workers
• Lobby against federal phase in of a $50 carbon tax
• Lobby for relaxation of the stringent 0.16 emissions limit and the right to purchase
offsets outside of the Province
• Consider powering liquefaction from the electrical grid rather than gas; implement
upstream improvements to reduce emissions
• Challenge the legality of the LNG tax
• Lobby for relief from Provincial sales tax on imported equipment and for relief
federally from excise tax
• Continue to work with First Nations to build support and strong working
relationships
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55. Contacts
Al Hudec
Cell: (778) 886-9356
Email: ahudec@farris.Com
Don Bell
Tel: (212) 880-6118
Email: Dbell@torys.Com
John Mackay
Tel: +65-6437-5407
Email: John.Mackay@lw.Com
Karen Ogen
Tel: (604) 612-5980
Email: Ceo@fnlngalliance.Com
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