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LNG Promises Steeped in Forecast Risk

Courtesy of Pacifica Partners

The government of BC staked a great deal of the province's future prosperity on its ability to work with the energy industry to harness BC's natural gas reserves for export to the energy hungry nations of Asia. To further underline the future potential, the government has stated that it would follow in the footsteps of Alberta and Norway by establishing a legacy fund from the forecasted tax revenues that the LNG (liquefied natural gas) industry would generate. The government estimates that the fund would total about $100 billion in the next thirty years for the benefit of future generations and make BC debt free.

The vision is appealing for obvious reasons and the goal of managing the wealth for future generations is laudable on many facets. What is not so praiseworthy is the fact that this forecast of LNG based wealth & prosperity is based on far too many assumptions that are prone to forecasting risk. This risk is being downplayed and it is worth highlighting where the risks could come from. BC's own history shows but one example when we look back at the 1961 Columbia River Treaty signed between Canada and the US. The signing of the treaty was one of the last Presidential acts of Dwight Eisenhower and it promised both nations great benefits from dam construction and hydroelectric power generation. However, as a sign of how complicated these things can be -- to this day, critics say the Canadian side gave away too much while at the time of negotiation some members of the US Senate were open in their admiration for Canada's negotiation skills. Critics of this treaty forget the fact that forecasting is often a murky exercise and both sides tried the best they could to get the best deal possible.

This is close to where BC stands today as it tries to negotiate the best deal it can with the energy industry. What the future will bring for LNG is most anybody's guess. Looking back over the last ten years at the rush of investment into the Canadian oil sands might serve to provide a more contemporary example of what can happen in energy markets. France's Total SA invested billions of dollars in Canadian oil sands assets during the previous decade. However, by last year the company had written down the value of those investments by taking nearly $2 billion in asset writedowns on its investments. Writedowns have also been taken in the US shale gas industry by companies who invested in shale gas acquisitions only to find them uneconomic with the collapse in North American natural gas prices.

It is this price weakness that has focused North American energy interests on Asian demand for natural gas since Asian natural gas prices are currently 3 to 4 times higher than those in North America. The Asian nations are wise to this price difference and have been toughening their negotiating stance with natural gas exporters.

They know that while Canada and the US would like to try to establish an LNG export industry, countries such as Australia have already begun to ramp up their export capabilities. Australia's $58 billion Gorgon project (originally budgeted at $37 billion) operated by Chevron and its partners will begin delivering LNG cargo to Asia within the next year. This cost overrun has reduced estimated returns from this project's original forecasts. This has not gone unnoticed by the companies that are in the process of deciding on whether to proceed with LNG investments in BC. Given the lack of infrastructure already in place in BC, the cost curve is going to be steep and the likelihood of cost overruns is high. That will lead to a strong pushback from the industry on the taxation proposals that the BC government has put forward.