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Canada runs LNG marathon while gas world sprints

Canada is ruining its chances to build a world-class liquefied natural gas export industry (LNG) as markets and other suppliers sprint ahead.

Much ballyhooed from its inception, repeatedly celebrated as a sign of Canada’s arrival as an energy superpower, and feted by governments and communities from well head to port, the nascent industry is at risk of collapsing from sheer exhaustion trying to run Canada’s self-imposed marathon to capture sprinting new energy markets. The sad sight of yet another cancelled project should be a warning to our citizenry that we clearly don’t quite get the changing dynamics of global energy.

A promising future

For those of you not paying attention, Canada’s LNG industry was conceived at a pivotal time in Asian energy markets. In 2010, or thereabouts, Japanese gas and power utilities paid as much as 8 times more for natural gas than lucky North Americans, prompting American and Canadian energy companies to contemplate export possibilities.

There were several reasons for the Asian demand spike:

 

A shortage of gas supply

Qatar, the main LNG supplier to the world, pumped gas furiously, but had postponed development of its massive North Field which it shares with Iran in 2005. This was a policy decision, not just a geologic puzzle to be solved, and could therefore be reversed by a simple decision by the Kingdom. And it has.

 

A problem with the nukes

Japan’s nuclear industry had occasionally been viewed with suspicion by the population, but the events of the Great Tsunami of 2011 laid bare the failures of the industry to adequately safeguard its facilities. Fukushima’s reactors survived the earthquke, but the tsunami waves  overwhelmed the  standby power plant that provided important power to the reactor kit, leading to the meltdown of the reactors, the shutting in of the rest of the country’s nuke fleet, and a rapid rise in demand for natural gas (and coal). Japan’s annual trade deficit in energy grew to a Treasury-busting $90b.

Japan had many possible demand responses to prosecute. And they did.

The country embarked on deregulating its gas and power sectors with the expectation that deregulation would help lower prices. Tokyo raised the ambient building temperature to 80 F, which cut back power demand for air conditioning. Two big Japanese utilities (Chubu and Tepco) merged their energy buying groups to create a behemoth (Jera) that now buys 40% of global LNG. The government set out to find a way to declare the manner by which LNG is priced to be anti-competitive. Finally, with a hesitant government’s help, the utilities started to slowly bring the nuke fleet back on line.

 

A concern about carbon

Other big Asian markets (South Korea, China) awoke to the fact that their energy choices were either cooking the planet because of GHG emissions, or harming their people because of the particulate matter released by burning low grade coal for power. Like Japan, South Korea also set out to transform its energy markets, and filed an updated multiyear energy plan with more renewables and LNG in it. China agreed a major gas supply contract from Russia, but also set out to build the world’s largest renewables sector. And it has, installing one wind turbine and one soccer field of solar panels every hour.

 

Renewables not quite ready

When gas prices were spiking, the renewables industry was simply too small to respond. That has fundamentally changed. The renewables sector has been seizing more and more share from fossil fuel supplies. Rather than a 7-10 year program to build a big LNG supply, utilities can stand up windmills and solar plants with striking ease. And they are.

 

Canada’s immature approach to international energy

Sadly, Canada does not realize that the countries involved in global gas markets are sophisticated energy players. They get “energy security” as they have been the most impacted by energy market upheavals since the 1970s. They have multiple serious energy policy think tanks, deep market knowledge, superb data analysis, and well organized and funded energy ministries. Not surprisingly, their policy makers sprinted to make corrective choices for their market dynamics – deregulation, enabling renewables, negotiating supply with other nations. They had to.

It’s not clear to me that Canadian governments truly understand these global energy market dynamics. Energy security issues are of the highest national priority elsewhere, whereas Canada, rich in energy, treats energy as a social problem to be managed. Shortages of hydrocarbons in any free market will be quickly satisfied by any available hydrocarbons whose cost to produce and deliver matches the local market price. As much as the greenies don’t like it, hydrocarbons want to be set free from their geologic prison because the demand for them is so strong.

In global LNG markets, the Americans quickly sanctioned six export plants as soon as the costs of the Australian projects became clear. The Russians were quick to launch their LNG projects as well, and to negotiate new pipeline gas projects to feed Chinese demand. And the renewables industry stepped up its game.

US gas supply is now so strong that its new LNG export plants are exceptionally well positioned to capture any market expansion not otherwise taken by Qatar. Canada needs to ask “Why would investors spend north of $3000 per ton of LNG manufacturing in export-hostile Canada when it can spend as little as $900 per ton in export-friendly US?”

We see this dynamic playing out in global oil markets– as quickly as OPEC cuts supplies to try to create shortages in markets, the US shale industry ramps up to fill the supply gap. Meanwhile, Canada struggles to figure out how to export its oil bounty to Asian markets, despite a permanent proximity advantage.

 

The Canadian marathon fiasco

Canada has made several profound errors in judgement by forcing its new LNG industry into a marathon, when it should have been sprinting to capture these changing markets.

 

Taxation

Canadian government taxation policy takes way too long to formulate. Should the royalty rate be 6% or 7%? Canada’s first LNG project was announced in 2010, but it took three years before the BC  government announced a tax rate. Every day of delay removed a little bit of demand from markets and allowed a competitor to grab a little more market share.

 

Over promotion

Vigorous marketing of the long term benefits of LNG left the impression that there was no immediate urgency to make decisions. Every community, stakeholder and special interest group in BC promptly got into line with their hand out to extract their share of this seemingly limitless bounty.

Not surprising, negotiations dragged on, and on.

 

Buy high, sell low

Canada lost sight of that old trading adage to buy or invest low and sell high. Instead, we heard the promises of the billions of dollars of value that were available for the taking, with global gas markets at all-time highs. Our governments promoted investment at the very peak of the market, just when Adam Smith’s invisible hand reset prices.

 

Regulatory burden 

If there’s one domain where Canada aims for world leadership, it would have to be on imposing regulation and red tape. Canada levels all manner of complex regulations, conditions to be met, and complicated decision processes on its energy projects.  

What’s baffling is that the country has managed to deliver vast quantities of low cost energy to hungry North American markets, usually by stringing pipelines south. The country even has a hugely successful and bustling petroleum terminal in Saint John NB, which has been both importing crude oil cargos by ship and exporting refined products to the US since the 1940’s, largely without mishap. Canada knows how to move petroleum and gas around safely and economically.

But in the case of LNG – easily the cleanest of the fossil fuels – the regulatory burden crested new heights as Canadians insisted that the industry impose near zero impacts on the environment, be located in awkward, hard to reach and sensitive locations, and achieve technically challenging, world-beating performance hurdles. Admirable, but in the end, terminal for the projects.

In my view, global energy markets are now in permanent sprint mode. Nuclear plants take way too long. Same with hydro plants. Renewables are taking over global markets because they can move fast and cheaply. Energy investors now know that Canada will create a marathon of onerous project acceptance criteria, fiscal uncertainty, and regulatory hassle. 

For Canada to successfully prosecute its energy ambitions, it must rethink its entire approach to sanctioning energy projects in recognition that time is now more than ever of the essence.

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