Natural Gas Pipeline Regulation: Costs and Benefits of the Canadian Approach Glenn Booth Chief Economist National Energy Board Gold Coast, July 2004

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1 Natural Gas Pipeline Regulation: Costs and Benefits of the Canadian Approach Glenn Booth Chief Economist National Energy Board Gold Coast, July (title)

2 Outline 1. Mandate and Goals of the NEB 2. Canadian natural gas market 3. Economic objectives of pipeline regulation: framework for assessing costs and benefits 4. An assessment of the Canadian experience 5. Conclusions Note: All views expressed in this talk are mine and do not necessarily express those of NEB Board Members 2

3 Mandate of the National Energy Board Regulate interprovincial and international pipelines: construction, tolls, terms of service, environmental & safety considerations Regulation of gas, oil & electricity exports Monitoring of Canadian energy markets Created in 1959 Located in Calgary, Alberta 3

4 Rocky Mountains from Calgary 4

5 National Energy Board Goals 1) NEB-regulated pipeline facilities are safe and perceived to be safe 2) NEB-regulated pipelines are built and operated in a manner that protects the environment and respects the rights of those affected 3) Canadians derive the benefits of economic efficiency (from pipeline regulation) 4) The NEB meets the needs of the public to engage in NEB matters 5

6 Worldwide Natural Gas Reserves 6 Canada U.S. W. Europe Algeria Nigeria Iran Qatar Far East China Malaysia Australia Tcf

7 Worldwide Gas Production U.S. Netherlands Norway U.K. Russia Other FSU Algeria Iran Saudi Arabia Australia China Indonesia Malaysia Bcf/d Percent of Total World Production Argentina Canada Mexico

8 Top Gas Producers, MMcf/d Percent of Total Canadian Production CNRL BP Talisman ExxonMobil Petro-Can Shell Husky Imperial Rio Alto Conoco Anadarko PennWest Apache Paramount Chevron Murphy Enerplus EnCana Burlington Devon

9 Major Natural Gas Pipelines in Canada 9

10 Early Development of the Gas Industry Large finds of oil in western Canada in 1947 and 1950s: gas found in solution Natural gas was largely a by-product of oil production or an accident of oil exploration With no pipeline out of Alberta, gas was trapped Producers were willing to sell gas very cheaply 10

11 Challenge: Bring Gas to the Market! All you need is a pipeline So what s the problem? Where s the market failure? It s the hold-up problem Once a specific large capital investment is made, each party has an incentive to renegotiate the terms of the contract Shippers can threaten by-pass, search for alternatives Pipeline can try to extract monopoly profits Result: high risk and uncertainty 11

12 Primary Purpose of Regulation Regulation reduces the uncertainty and risk associated with a huge capital outlay: Restricts entry and thereby protects the original investor Reduces costs associated with contract negotiation Reduces risk and thereby reduces overall cost of financing Creates an incentive to invest and provide the desired service 12

13 Secondary Purpose of Regulation Granting monopoly franchise creates need to: Protect shippers against monopoly abuses Ensure right to be served Regulate prices All of these activities will result in second best outcomes (but are they also second level objectives?) 13

14 NEB Economic Regulation Objectives 1) Ensure adequate pipeline capacity is in place 2) Ensure that pipeline system provides shippers with desired services at reasonable cost 3) Ensure that pipelines are financially viable (are able to raise adequate capital to maintain system and finance expansion) 14

15 Adequate Capacity Belief that a little too much capacity is much better than too little Key measures of adequate capacity: Basis differential between markets Capacity utilization factors 15

16 Upstream Gas Spending and Export Revenues vs. Transmission Expenditures $C Billions Upstream Gas Drilling & Equip. Spending Canadian Gas Export Sales Revenues Transmission Facilities Spending 16

17 Gas Cost Components 1 ($/GJ) Field Gate Price TCPL Transportation to Dawn Intra-Alberta Transportation Distribution 1 Average cost components to Toronto industrial consumer in

18 Westcoast TransCanada Alberta (NGTL) North American Gas Pipeline Grid Sumas Northwest PG&E SoCal PGT ANG/ Foothills Northwest Kern River El Paso Foothills Transwestern Alliance AECO-C Northern Border Trailblazer NGPL El Paso TransCanada Transmission Mainline Great Lakes ANR Panhandle NGPL ANR Texas Eastern NYMEX Dawn CNG TQ&M Transcontinent al M&NE Iroquois PNGTS St. Stephen Algonquin Key Pricing Point for Canadian Gas

19 Importance of Adequate Capacity Basis Differential (Dawn- HH) ($US/M cf) Intra-AB Sales Volum e (Bcf) Basis Differential (Dawn - Henry Hub) Intra-AB Sales Volume (Bcf) 19

20 Example: Benefits of Adequate Capacity Difference in basis differential = roughly $0.40 Minimum: 800 Bcf (intra-alberta sales) x $0.40 = $320 million Maximum: 5.8 Tcf (all sales) x $0.40 = $2.3 billion/year $2.3 billion better estimate of deadweight losses 20

21 Cost of Transportation from Alberta to Ontario Competition and Canadian Gas Pipeline Tolls Start up of Alliance ($/Mcf Mcf) TransCanada Alliance Year 21

22 Cost of Competition and Excess Capacity Cost = extra cost of capacity as reflected in higher tolls Approximately $0.20/Mcf Cost = 5.0 Tcf (ex-alberta sales) x $0.20 = $1 billion/year 22

23 Costs of Too Much Capacity vs. Inadequate Capacity Annual Cost of Inadequate Capacity: $320 million to $2.3 billion/yr Annual Cost of Excess Capacity: 5.0 Tcf (ex-alberta sales) x $0.20 = $1 billion/yr Is it a wash?? We don t think so! 23

24 Full Costs & Benefits of Inadequate vs. Adequate Capacity Costs Foregone sales revenue Foregone royalties Inefficient allocation of supply Negative signal to upstream investors Benefits All gas/oil receives full market value Maximization of royalties Efficient allocation of supply Positive signal to upstream and downstream investors 24

25 Implicit Alberta to Ontario T-ValueT $US/Mcf Jan June 2004 (by month) (July daily) 0.0 TCPL FT & Fuel Daily Transport + Fuel Monthly Basis Daily Basis 25

26 Gas Pipeline Tolls and the CPI (Normalized to the Year 1991) Normalized level Year TransCanada PipeLines Westcoast Energy Inc. Consumer Price Index 26

27 Are Services Meeting Shippers Needs? Services on TransCanada: Long-term firm, short-term firm Biddable interruptible Parking and loans Multiple delivery points, multiple handshakes Firm and interruptible backhaul Active secondary market efficient allocation Services on Alliance NGL transportation in gas stream Authorized overrun service (free overrun) 27

28 What do Shippers Think? NEB is requiring pipelines to survey their shippers NEB has designed questions on: Satisfaction with service Satisfaction with value for service Satisfaction with NEB s role First results to be received for 2004 We also informally meet with shippers 28

29 Financial Integrity: DBRS Debt Ratings Enbridge Alliance TCPL WEI M&NP Terasen Superior Investment Grade Good Adequate A (high) A (low) A A (low) A A (low) Speculative Highly Speculative 29

30 Financial Viability of Cdn.. Pipelines Return on equity determined by formula Currently 9.56% Deemed equity components from 25 to 35% Low by international standards Possible due to stable regulatory framework Lower ROE and equity components translate into lower tolls 30

31 Conclusions (1) Regulation has placed emphasis on adequate infrastructure Canada has a strong natural gas & oil pipeline infrastructure enabling it to transport about $100 billion of product annually Large investment in upstream, putting Canada as 3 rd ranked gas producer in world Upstream investors have confidence in infrastructure 31

32 Conclusions (2) Tolls have increased with introduction of competition Satisfaction with services is under study Pipeline sector is financially viable 32

33 Conclusions - Final Bottom line is that you need to know your key objectives We believe we have met the key objectives Canada has an efficient pipeline infrastructure that is meeting the needs of Canadian producers and buyers 33

34 NEB website 34

35 TransCanada PipeLines Revenue Requirement Items 2003 Actual Return Depreciation Transmission by Others OM&A Costs Income Taxes Municipal and Other Taxes Gas Related and Electric Costs Other 35

36 Gas production from WCSB Bcfd

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