Canada’s Trans Mountain pipeline could cost government billions
The Trans Mountain pipeline generated a massive loss in the first four months that it was owned by the Canadian public – or a small profit, depending on which economist or accountant you talk to, and which financial report you read.
Annual financial statements by the Canada Development Investment Corp. (CDEV), the Crown corporation now responsible for Trans Mountain Corp., report that in the first four months that the pipeline was owned by the Canadian government (September to December 2018), it generated C$129 million in revenue and C$48 million in earnings before interest, taxes and depreciation.
When interest on debt is deducted, the pipeline had a net loss of $26 million in that time period, according to CDEV financials.
Robyn Allan, an independent economist who has questioned the economics of an expanded Trans Mountain pipeline, says CDEV’s financial statements show the existing pipeline suffered a C$58 million loss in the first four months that the government owned it.
That’s based on her calculation that Trans Mountain’s interest payments over four months would amount to C$83 million, which, if extrapolated, would total C$249 million for a full year.
“Trans Mountain is on track to book a loss of C$175 million in 2019,” she wrote in an email to Business in Vancouver.
Analysts for the Institute for Energy Economics and Financial Analysis (IEEFA) agree with Allan that the pipeline is losing money.
“The amount payable on the loan during the period covered by the audit is C$82.4 million,” said IEEFA analyst Tom Sanzillo. “I would conclude that the operating income did not cover the interest payable on the loan.”
Kin Lo, associate professor of accounting for the University of British Columbia’s (UBC) Sauder School of Business, disagrees.
He said Allan may be overestimating the interest payments and failing to account for a toll increase that will increase the existing pipeline’s revenue this year.
When Ottawa bought the pipeline and expansion project, it borrowed C$5 billion and paid Kinder Morgan Canada Ltd. (TSX:KML) C$4.4 billion. That included about C$1.1 billion for money spent or committed on the expansion before it was halted.
The interest on that borrowed money added up to C$83 million over four months, which, after revenues and expenses, totals a loss of C$58 million over four months, Allan said.
Lo said Allan appears to be including interest payments that may not be associated with the Trans Mountain pipeline. Lo said he calculates the interest attributable to Trans Mountain Corp. at C$49.7 million over four months, not C$83 million.
“Extrapolated over a year, that would mean an annual interest cost of $149 million, not C$249 million,” he said.
He added that the revenue for Trans Mountain should increase, following a toll hike of 30%.
“The interest is overstated, on the cost side, and then the revenue is understated because she’s using the 2018 figures to project out to what the 2019 figures are going to be,” Lo said.
“We already know that the tariff rates are different. They are about 30% higher. So starting now, May 1, until the end of the year, they’re 30% higher.”
Based on $128 million in pipeline revenue in the last four months of 2018, the revenues from May through August of this year are expected to be C$166.4 million, he said.
“This amount would be sufficient to cover interest cost (C$49.7 million), operations and administration (C$81.2 million), and depreciation (C$34.4 million) over that four-month period.”
The federal government is expected to make a decision by June 18 on whether to approve the pipeline’s expansion a second time.
The expansion – originally estimated to cost C$7.4 billion but now projected to cost as much as C$9.3 billion – was halted by the courts.
The government was forced back to the negotiating table to address flaws identified by the courts in the original recommendation by the National Energy Board and the order-in-council giving the expansion the green light.
Trevor Tombe, associate professor at the University of Calgary, suggests it’s irrelevant if the existing pipeline is currently losing money, since the government didn’t buy it with the intention of operating it as is. The whole idea was to expand it.
“One needs to distinguish the existing asset from the future one,” Tombe said. “The purchase price was for assets beyond just the current pipeline and reflects construction costs incurred and the value of the future option to expand.”
The Trudeau government has made it clear it has every intention of approving the expansion. But if, for some reason, the project is halted again, Canada would be stuck with an unexpanded pipeline and forced to write off close to C$2 billion.
Brad Bay, portfolio manager at Cypress Capital Management Ltd., agrees that without expansion of the pipeline, the Trans Mountain acquisition would be a “horrible” investment.
“If they don’t expand the project, it would be at a loss because they’d have to write down at least C$1.2 billion,” he said. “Absolutely it would be a tough project to hold if they weren’t going to expand it.”
The impairment would include the C$1.3 billion already spent on expansion work that was halted and a C$473 million goodwill payment.
The expansion project, which would twin the existing line to nearly triple its capacity – to 890,000 barrels per day from 300,000 – was last estimated by Kinder Morgan Canada to cost C$7.4 billion, of which C$1.1 billion had already been spent or committed.
Since the project was acquired in August 2018, Trans Mountain Corp. has spent another C$184 million just to “stand down” expansion activities.
If the project could still be built for C$7.4 billion, it means the government will need to spend at least C$6 billion more to complete the expansion.
But the federal government’s parliamentary budget officer (PBO) estimates delays could bring the capital cost up to C$9.3 billion, which means Ottawa may need to spend an additional C$8 billion, over and above the C$1.3 billion already spent, to finish the expansion.
It could ultimately cost Ottawa a total of C$10 billion to C$12 billion for the existing pipeline and the second line.
The question will then be: is that a reasonable price for a private company or consortium to pay for a 1,150-kilometre pipeline, with a capacity of 890,000 barrels per day and access to tidewater?
“That’s a pretty expensive pipeline, in our view,” said Michael Grande, S&P Global’s senior director for North American infrastructure.
“Even C$7.4 billion was quite an expensive pipeline.”
That doesn’t mean he thinks the Canadian government won’t be able to sell it, but he thinks it would more likely be a consortium of owners – private equity, sovereign wealth and pension funds – rather than a single buyer.
He dismisses the notion that it would be a stranded asset due to a lack of demand for Alberta oil.
“The crude needs to go somewhere, so I think that’s still very viable,” he said. “The fact is crude oil is not going away any time in the immediate future.”
According to a recent IHS Markit Ltd. study, the world is flush with light oil, whereas the supply of heavy crude is tightening.
Heavy crude production in Mexico has been declining for a decade, and production in Venezuela has dropped sharply in recent years – by 500,000 barrels per day since 2014.
IHS Markit analyst Kevin Birn said it’s a mistake to suggest Canadian shippers that have long-term contracts on the expanded Trans Mountain pipeline would focus only on China.
Once Alberta crude has access to tidewater, it can go wherever the best price is being offered.
“It will probably go to Korea and Japan and China, California, Malaysia, Singapore,” Birn said. “There’s a flexibility and a transportation cost savings that marine can do that pipelines can’t.”
(This article first appeared in Business in Vancouver)