Canadian Arctic Gas Moves Forward

Abstract: Northern native people in Canada have inked a funding deal that should secure their ownership stake in the proposed Mackenzie Valley Pipeline. Winners under the tentative deal include the native population, the federal government, and TransCanada PipeLines Limited, while Alaska and its major gas reserve owners fall farther behind in the race to bring Arctic gas to southern consumers.

Analysis: Backers of a C$4 billion pipeline to tap gas reserves in Canada's Mackenzie Delta, after months of delay, are once again moving ahead in the race with Alaska to develop Arctic gas.

The Northern native population, seeking to secure a stake in the proposed Mackenzie Valley Pipeline, has arranged funding that should ensure their participation and ownership in the line.

It is widely expected that TransCanada PipeLines Limited (TransCanada), this country's largest pipeline operator, has agreed to come up with C$70 million in exchange for the right to build the line.

The money will be used by the Aboriginal Pipeline Group (APG), based in Inuvik, Northwest Territories (NWT), to pay for its share of project definition costs. The APG represents native communities whose members own much of the land needed for a pipeline right-of-way through the NWT.

Media reports, which TransCanada refused to confirm, have said the firm could provide up to C$300 million to the APG to help build the line in return for a small ownership interest in the pipeline. The 1,350-kilometer-long (810 miles) line is expected to flow between 1.2 billion and 1.9 billion cubic feet per day from the Mackenzie Delta to northern Alberta. The line is scheduled to be operational sometime between 2007 and 2010.

The financing deal is not quite as simple as a slam-dunk by Shaquille O'Neal. Under a historic agreement signed 16 months ago with Imperial Oil Limited, Shell Canada Limited, ConocoPhillips, and ExxonMobil Corporation, the APG had the opportunity to earn a one-third share in the pipeline as long as it could come up with its portion of the cost.

APG representatives say their interest in the pipeline will not be diluted by the deal with TransCanada, meaning the latter's bite would come out of pieces of the pie owned by producers. Before approving such a change, they are going to have to assess the impact of such a decision on their plans and the economic returns on one of the biggest energy projects on the horizon for the Canadian energy industry.

If the APG's tentative financing deal gets partner approval, a process which could take several weeks or even months, an application will be filed later this year with the National Energy Board (NEB), Canada's equivalent to the Federal Energy Regulatory Commission.

The NEB review will likely take two years, while construction could take another three or four years. It's as obvious as Mike Tyson’s fading boxing skills that Canada's Arctic gas is a long way from heating southern homes or fueling power stations, but this week's announcement is a milestone for several reasons.

The ability of the APG to find someone willing to put up the cash removes a significant hurdle, one that proved to be more of an obstacle than initially expected. The federal government, based in faraway Ottawa, Ontario, turned deaf ears to pleas for loan guarantees from natives and the government of the NWT.

The Liberal government's position was partially based on fears of getting into a subsidy war with the U.S., a losing proposition if there ever was one. Money for the Canadian line could have been an incentive to spur President George W. Bush and Congress to throw federal largesse at a much larger pipeline to bring Alaska's bigger proved gas reserves to southern consumers. Not only would the two pipelines compete for workers, equipment, and capital, gas prices could crash if both projects started deliveries within a short period and flooded the market.

Ottawa's refusal also reflected determination by politicians and senior civil servants that the project should stand on its own merits. They accurately assessed commercial prospects of the Mackenzie line would be strong enough to let business fundamentals, and not government intervention, drive the timing.

Besides Ottawa, other big winners include the northern native population, TransCanada, and the petroleum industry.

Gas was discovered in the Mackenzie Delta in the early 1970s, but rising costs and unsettled land claims led to a judicial inquiry and an eventual moratorium on any pipeline in the late 1970s. During the intervening decades, the indigenous population became determined to own part of the pipeline, thus enabling them to influence how the project is developed and the benefits are shared. This week's deal should generate jobs, taxes, and other spinoff benefits for residents of one of Canada's most impoverished regions.

The agreement also proved the APG was a tough negotiator. The petroleum companies have waited months to file preliminary information about the project with the NEB, but the APG's officials refused to give in to pressure. They made it clear no deal was better than a bad deal, and skyrocketing gas prices this winter gave the native population plenty of ammunition to defend their position.

Producers may not be thrilled at having TransCanada (which is not universally loved, to put it mildly) as a participant. However, declining conventional production across most of North America gave First Nations' members in Canada a very strong trump card. The ability to tap reserves estimated at up to 64 trillion cubic feet is a pretty good incentive for producers to hold their noses and start working with TransCanada on the project's long and arduous regulatory review.

For TransCanada, the deal gives employees and investors a better and more optimistic view of the company's future. With more than one billion cubic feet of spare capacity on parts of its system, additional volumes from the Arctic will boost utilization and hold down rates for other customers.

Petroleum companies operating in Canada benefit because this week's announcement proves innovative agreements and aboriginal land claims can go together as well as peanut butter and chocolate. Industry players had no choice about including the native population in their northern plans, since they were bluntly told their applications would not secure territorial approval otherwise. The deal arranged with APG back in October 2001 gave the NWT native people an incentive to be creative, which they used to their advantage as spot gas prices moved above $6 per million British thermal units and futures contracts for 2004 to 2008 exceeded $4 per million British thermal units.

The biggest losers out of this week's announcement are Alaska and its major gas reserve owners--BP, ExxonMobil, and ConocoPhillips. The proposed Alaska Highway Pipeline, expected to carry between four billion and six billion cubic feet per day, has been deemed too expensive by those producers because of its estimated cost of between $10 billion and $20 billion.

A combination of tax credits, loan guarantees, and other measures proposed for the Alaska Highway line were not included in last year's energy bill. With the Republicans controlling both houses, it's possible those incentives could be brought back. However, the expenses of a war with Iraq and tax cuts already putting the U.S. on a path to record deficits make it hard to see how President Bush will be able to afford an improved package.

Given the smaller size of the Mackenzie line, being first to secure market is the only way to ensure the race doesn't turn into a disaster for project proponents and their shareholders. With the APG securing preliminary funding, Canada's Arctic gas is another step down the track, while Alaska has yet to get out of the starting blocks.

Associate Editor: Robin Beckwith