Future of TransCanada?s Mainline could spur Canada?s next great energy debate

Claudia Cattaneo? May 25, 2012 ? 6:03 PM ET | Last Updated: May 25, 2012 9:13 PM ET

As if the great debates over proposed pipelines to export oil to the United States and Asia weren?t convulsing Canada enough, a new one is about to divide the country. It involves the future of TransCanada Corp.?s historic Mainline.

For more than half a century, the Mainline has been a reliable workhorse that over winter peaks moved as much as seven billion cubic feet a day (bcf/d) of natural gas from Western Canada ? roughly half of its total production today ? to warm up homes and energize factories in Eastern Canada.

But its use has fallen off sharply during the rest of the year because of the emergence of alternative supplies nearby, pushing pipeline tolls and tempers at both ends of the system through the roof. Indeed, tolls are so high they exceed the price of the natural gas it transports.

While recent oil sands pipeline debates have pitted the oil producing community against the environmental movement, the restructuring of the Mainline is rubbing many old wounds between the energy-producing West and the consuming East.

Indeed, when Canada?s energy regulator, the National Energy Board, kicks off four months of hearings on June 4 in Calgary that will include extended stops in Toronto and Montreal, many of the issues debated during the Mainline?s inception six decades ago will resurface.

Some of the same stakeholder groups will also re-appear ? Western Canadian producers, Eastern Canadian utilities and TransCanada itself ? all with the goal of getting stuck with as little as possible of the $6-billion pipeline?s untenable costs.

Then and now, at issue is whether it?s in the public interest to ship Western Canadian gas to Eastern markets despite high transportation costs as a way to ensure national energy security, when more economic north/south and other solutions are available.

The NEB?s three-member panel, headed by CEO and chairman Ga?tan Caron, will have to sort out how to make best use of the 14,101 kilometres of infrastructure, running from Alberta to Quebec, which it regulates. It will have to set new tolls, decide how to allocate risks and rewards among Mainline shippers and other stakeholders and decide whether the Western Canadian Sedimentary Basin should be linked to Eastern markets.

While not officially part of the hearing, there is a new twist to the debate: TransCanada is floating a plan to give the Mainline a new lease on life by converting part of the system to oil service. The multi-billion plan would create a new domestic market for oil sands oil in Eastern Canada at a time other plans are bogged down by environmental opposition, provide respite from high tolls for natural gas shippers and get TransCanada out of a jam. But this, too, is already stoking debate about whether shipping Western oil eastward is the way to go, when larger world oil markets beckon.

The first time Canadians had a Mainline debate was in the 1950s. TransCanada?s predecessor, TransCanada Pipelines Ltd., had just been created with the goal of building a 3,200-kilometre natural gas pipeline linking Alberta to Quebec. The project played into the day?s federal Liberal government political imperative that Canada needed to meet its energy needs before Alberta gas could to flow to the U.S., oil patch historian Earle Gray writes in The Great Canadian Oil Patch.

Producers had strong doubts that shipping gas over such a long distance would be economically feasible or preferable to market-favoured solutions ? such as piping Alberta gas to closer southern markets and nearby U.S. gas to Eastern Canadian markets. But the project went ahead and the first gas from Alberta arrived in Toronto on Oct. 27, 1958.

Still, it left deep political wounds ? a warning to today?s political elites that Canadians take their pipelines very seriously.

A complex plan involving generous government support for the uneconomic line became such a flashpoint that it contributed to the fall of the Liberal government in 1957 after 22 years in power.

?Not since the founding of the Canadian Pacific Railway nearly a century before had Canada seen such a political maelstrom involving a private corporation,? Mr. Gray writes. ?It reached its climax in the most bitter, tumultuous political debate that has ever rocked the Parliament of Canada and left in its wake shattered careers and broken lives ? So impassioned were the feelings that some men fainted, others were left fatigued and in broken health, and one member of Parliament died of a heart attack.?

Much like in the ?50s, there are now cheaper options for Eastern Canadian consumers, particularly with the discovery of massive shale gas deposits in the Eastern U.S. such as the Marcellus. Ample supplies have depressed prices to the point they hardly justify the cost of long-haul transportation.

Meanwhile, Western producers are looking to Asia to sell their gas, where prices are higher and the market hungrier, and don?t see the point of continuing to pay for an asset that doesn?t fit into their strategies for the future.

After years of unsuccessful negotiations, TransCanada presented a restructuring proposal to the NEB in the fall it says achieves ?the greatest good for the greatest number? ? but that doesn?t seem to make anyone happy. It?s the reason the proposal has landed before the NEB for a ruling.

?You have competing interests ? producers on one side, utilities on the other and marketers in between, and there has been no real compromise by anybody,? said Cameron Gingrich, senior manager of gas services at the Calgary-based consultancy, Ziff Energy Group. ?It?s definitely going to be a contentious hearing.?

The cornerstone of the Calgary-based company?s restructuring proposal is to cut tolls on the Mainline and increase tolls on short-haul pipelines, primarily the massive Alberta-based Nova Gas Transmission Ltd. (NGTL) system it also owns.

?For many years, our system has been a base-load, Empress (Alta.) to Eastern Canada/NortheasternU.S. system,? said TransCanada senior-vice president Karl Johannson, who will be one of the hearing?s top witnesses. ?Now it?s more short-hauls in Eastern Canada region and we have less volumes come out from Empress. And our tolls have to change to reflect that. Our shorter hauls have to take on a bigger burden of our overall cost of service.?

In general terms, TransCanada is proposing to increase tolls on the Alberta/NGTL system by 5? to 21? per thousand cubic feet (mcf), about 25%, and to reduce the toll on the Mainline to $1.39 per gigajoule (the two lines use different units), from $2.09, about 40%.

The new tolls would keep the Mainline afloat until volumes return, which TransCanada is confident will happen as natural gas prices eventually recover and the restructured Mainline makes Western Canadian natural gas more competitive.

Like producers, the pipeline company has no doubt that the days of the Western Canadian Sedimentary Basin supplying six bcf/d of gas to eastern markets are over.

?There are too many alternatives,? Mr. Johansson conceded. ?But there is still a lot of load on that line. There are still going to be daily flows. It?s still one of the biggest pipeline systems in North America.?

TransCanada believes that after benefitting from the system, producers have an obligation to sustain it since it was built for them.

The company also believes it?s in the interest of Western Canadian producers to maintain the option of shipping to Eastern Canadian markets. While new supplies are indeed available close by, the Mainline is providing essential fuel to Eastern Canada during cold winter months that cannot be easily replaced. The pipeline is less than half full on an average basis, but during the home-heating season it still runs close to capacity.

Western Canadian gas producers find many of TransCanada?s arguments outrageous and its restructuring proposal a way of transferring Western Canadian wealth to the East.

By increasing tolls on the Alberta system, all Western Canadian consumers will pay higher prices for natural gas, while Eastern Canadian consumers and short haul users benefit from lower Mainline tolls, they argue.

A subsidy to the Mainline of $350-million a year will make it hard for the already-struggling producers to stay in business.

Unlike the Mainline, the Alberta system is healthy and transports 10 bcf/d of gas across the West, picking up supplies from growing shale deposits, feeding growing oil sand operations and population centres, connecting to other pipelines headed for the U.S.

?The one thing that is very offensive to Western Canada is this idea they have that they will cause their subsidiary company, NGTL, to sign a big healthy contract with the Mainline and provide them with a whole lot of revenue for service that simply is not something that NGTL should be doing and is going be harmful to Western Canadian producers, and in fact harmful to everyone in Western Canada,? said Nikol Schultz, vice-president for pipeline regulation and general counsel at the Canadian Association of Petroleum Producers, which will represent producer interests at the hearings.

Producers, who supply little gas to the Mainline system today, are proposing to ?levelize? or reduce tolls over a period of four or five years until volumes recover. While they don?t believe that will happen, they are relying on TransCanada?s own rosy forecast. Alternatively, they propose leaving the tolls the way they are and to let market forces prevail.

Other options have also been talked about, including taking the system out of service, or securitizing it so that becomes a separate asset, perhaps supported by government financial backing.

The oil conversion option has been floated for many years, but it seems to be gaining momentum. Russ Girling, TransCanada?s CEO, talked about it at the company?s annual meeting in April.

?We are going to actively pursue it and see if we can turn it into an opportunity for both, the oil-and-gas industry and TransCanada,? Mr. Girling said to the media, suggesting the line could carry between 300,000 and 800,000 barrels a day to Eastern markets and that the conversion was being encouraged by refiners in Eastern Canada and oil producers in Western Canada.

Mr. Gingrich said that with uncertainties around the proposed Northern Gateway, TransMountain and Keystone XL oil sands pipelines there is a need for new outlets for oil sands oil.

Mr. Johansson said TransCanada is doing ?significant due diligence? on the plan and talking to potential shippers, but is not prepared to go into details because it?s not developed enough.

CAPP said it would press the company for information during the NEB hearings.

A portion of the line has already been converted to oil service in recent years and became part of the Keystone oil pipeline to the U.S.

The more ambitious plan to move of Western Canadian oil to Eastern Canada would also need to make market sense, Mr. Schultz said.

He noted that in the past, long-haul oil transportation was so costly it didn?t pay, and today Eastern Canada imports nearly 800,000 barrels a day from overseas.

The idea is expected to advance in parallel with the hearings, and potentially result in a separate application if there is shipper support.

Whether it?s in the business of shipping oil or gas, producers believes it?s time for TransCanada, as the owner of the Mainline, to start bearing the risk of its choices, rather than keep shifting it to others.

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