Natural Gas Pipeline Regulation:Natural Gas Pipeline Regulation:Costs and Benefits of the Costs and Benefits of the

Canadian ApproachCanadian Approach

Glenn BoothChief Economist

National Energy BoardGold Coast, July 2004

1(title)

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OutlineOutline

1. Mandate and Goals of the NEB2. Canadian natural gas market3. Economic objectives of pipeline regulation:

framework for assessing costs and benefits4. An assessment of the Canadian experience5. Conclusions Note: All views expressed in this talk are mine and do not

necessarily express those of NEB Board Members

3

Mandate of the National Energy BoardMandate of the National Energy Board

Regulate interprovincial and international pipelines: construction, tolls, terms of service, environmental & safety considerationsRegulation of gas, oil & electricity exportsMonitoring of Canadian energy marketsCreated in 1959Located in Calgary, Alberta

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Rocky Mountains from CalgaryRocky Mountains from Calgary

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National Energy Board GoalsNational 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

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2001 Worldwide Natural Gas Reserves2001 Worldwide Natural Gas Reserves

0100200300400500600700800900

1000

Canad

a

U.S.W. E

urope

Algeria

Nigeria

Iran

Qatar

Far Eas

tChin

aMala

ysia

Austra

liaTc

f

7

2001 Worldwide Gas Production2001 Worldwide Gas Production

0

10

20

30

40

50

60

Argen

tina

Canad

aMex

icoU.S.Neth

erlan

dsNorw

ayU.K.

Russia

Other FSU

Algeria

Iran

Saudi A

rabia

Australi

aChina

Indonesia

Malays

ia

Bcf

/d

0

5

10

15

20

25

Perc

ent o

f Tot

al W

orld

Pro

duct

ion

8

Top Gas Producers, 2001Top Gas Producers, 2001

0

500

1000

1500

2000

2500

EnCan

aBur

lington

Devon

CNRL BPTali

sman

ExxonMobil

Petro-C

anShe

llHus

kyIm

peria

lRio A

ltoCon

ocoAna

darko

PennWes

tApa

che

Paramoun

tChe

vron

Murphy

Enerp

lus

MM

cf/d

0

2

4

6

8

10

12

14

16

Perc

ent o

f Tot

al C

anad

ian

Prod

uctio

n

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Major Natural Gas Pipelines in Canada

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Early Development of the Gas IndustryEarly Development of the Gas Industry

Large finds of oil in western Canada in 1947 and 1950s: gas found in solutionNatural gas was largely a by-product of oil production or an accident of oil explorationWith no pipeline out of Alberta, gas was “trapped”Producers were willing to sell gas very cheaply

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Challenge: Bring Gas to the Market!Challenge: Bring Gas to the Market!

All you need is a pipelineSo 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 contractShippers can threaten by-pass, search for alternativesPipeline can try to extract monopoly profits

Result: high risk and uncertainty

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Primary Purpose of RegulationPrimary Purpose of Regulation

Regulation reduces the uncertainty and risk associated with a huge capital outlay:

Restricts entry and thereby protects the original investorReduces costs associated with contract negotiationReduces risk and thereby reduces overall cost of financing

Creates an incentive to invest and provide the desired service

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Secondary Purpose of Regulation Secondary Purpose of Regulation

Granting monopoly franchise creates need to:

Protect shippers against monopoly abusesEnsure right to be servedRegulate prices

All of these activities will result in “second best” outcomes (but are they also second level objectives?)

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NEB Economic Regulation ObjectivesNEB Economic Regulation Objectives

1) Ensure adequate pipeline capacity is in place2) Ensure that pipeline system provides shippers

with desired services at reasonable cost3) Ensure that pipelines are financially viable

(are able to raise adequate capital to maintain system and finance expansion)

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Adequate CapacityAdequate Capacity

Belief that a little too much capacity is much better than too little

Key measures of adequate capacity:Basis differential between marketsCapacity utilization factors

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Upstream Gas Spending and Export RevenuesUpstream Gas Spending and Export Revenuesvs. Transmission Expendituresvs. Transmission Expenditures

0

10

20

1999 2000 2001 2002

$C B

illio

ns

Upstream Gas Drilling & Equip. SpendingCanadian Gas Export Sales Revenues Transmission Facilities Spending

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Gas Cost ComponentsGas Cost Components1 1 ($/GJ)($/GJ)

0 1 2 3 4 5 6 7

Field Gate Price Intra-Alberta Transportation

TCPL Transportation to Dawn Distribution

1 Average cost components to Toronto industrial consumer in 2003

TransCanada TransmissionMainline

TQ&M

Westcoast

KernRiver

Northwest NorthernBorder

TransCanadaAlberta(NGTL)

NGPL

ANR

ANREl Paso

PG&E

SoCal

PGT

TexasEastern

Panhandle

Algonquin

Transcontinental

ANG/Foothills

NGPL

NorthwestFoothills

El Paso

Transwestern

Trailblazer

M&NE

CNG

IroquoisPNGTS

Alliance

LakesGreat

North American North American Gas Pipeline GridGas Pipeline Grid

Key Pricing Point for Canadian Gas

NYMEX

AECO-CSumas

Dawn

St. Stephen

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Importance of Adequate CapacityImportance of Adequate Capacity

0.000.100.200.300.400.500.60

1995 1996 1997 1998 1999 2000

Bas

is D

iffer

entia

l (D

awn-

HH

) ($

US/

Mcf

)

020040060080010001200

Intra

-AB

Sal

es V

olum

e (B

cf)

Basis Differential (Dawn - Henry Hub) Intra-AB Sales Volume (Bcf)

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Example: Benefits of Adequate CapacityExample: 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

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Start up of Alliance

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1997 1998 1999 2000 2001 2002 2003 2004

TransCanada

Alliance

Competition and Canadian Gas Pipeline Tolls Competition and Canadian Gas Pipeline Tolls ($/($/McfMcf))

Year

Cos

t of T

rans

port

atio

nfr

omA

lber

tato

Ont

ario

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Cost of Competition and Excess CapacityCost 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

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Costs of Too Much Capacity Costs of Too Much Capacity vs. Inadequate Capacityvs. 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!

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Full Costs & Benefits of Full Costs & Benefits of Inadequate vs. Adequate CapacityInadequate vs. Adequate Capacity

Costs

Foregone sales revenueForegone royaltiesInefficient allocation of

supplyNegative signal to

upstream investors

Benefits

All gas/oil receives full market value

Maximization of royaltiesEfficient allocation of

supplyPositive signal to upstream

and downstream investors

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Implicit Alberta to Ontario TImplicit Alberta to Ontario T--ValueValue

0.00.20.40.60.81.01.21.41.6

7-1 7-3 7-5 7-7 7-97-11

$US/

Mcf

TCPL FT & Fuel Monthly Basis Daily Transport + Fuel Daily Basis

Jan 2002 - June 2004(by month)

(July daily)

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0.800

0.900

1.000

1.100

1.200

1.300

1.400

1.500

1.600

1.700

1.800

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Year

Nor

mal

ized

leve

l

TransCanada PipeLines Westcoast Energy Inc. Consumer Price Index

Gas Pipeline Tolls and the CPI Gas Pipeline Tolls and the CPI (Normalized to the Year 1991)(Normalized to the Year 1991)

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Are Services Meeting Shippers’ Needs?Are Services Meeting Shippers’ Needs?

Services on TransCanada:Long-term firm, short-term firmBiddable interruptibleParking and loansMultiple delivery points, multiple “handshakes”Firm and interruptible backhaulActive secondary market – efficient allocation

Services on AllianceNGL transportation in gas streamAuthorized overrun service (free overrun)

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What do Shippers Think?What do Shippers Think?

NEB is requiring pipelines to survey their shippersNEB has designed questions on:

Satisfaction with serviceSatisfaction with value for serviceSatisfaction with NEB’s role

First results to be received for 2004We also informally meet with shippers

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Financial Integrity: DBRS Debt RatingsFinancial Integrity: DBRS Debt Ratings

Superior

Good

Adequate

Speculative

HighlySpeculative

Inve

stm

ent

Gra

de

Enbridge Alliance TCPL WEI M&NP Terasen

A (high)

A (low)A

A (low)A

A (low)

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Financial Viability of Financial Viability of CdnCdn. Pipelines. Pipelines

Return on equity determined by formulaCurrently 9.56%

Deemed equity components from 25 to 35%Low by international standardsPossible due to stable regulatory frameworkLower ROE and equity components translate into lower tolls

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Conclusions (1)Conclusions (1)

Regulation has placed emphasis on adequate infrastructureCanada has a strong natural gas & oil pipeline infrastructure enabling it to transport about $100 billion of product annuallyLarge investment in upstream, putting Canada as 3rd ranked gas producer in worldUpstream investors have confidence in infrastructure

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Conclusions (2)Conclusions (2)

Tolls have increased with introduction of competition

Satisfaction with services is under study

Pipeline sector is financially viable

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Conclusions Conclusions -- FinalFinal

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

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NEB website

www.neb-one.gc.ca

gbooth@neb-one.gc.ca

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TransCanadaTransCanada PipeLinesPipeLinesRevenue Requirement ItemsRevenue Requirement Items

2003 Actual

Return

Depreciation

Transmission by Others

OM&A Costs

Income Taxes

Municipal and OtherTaxesGas Related and ElectricCostsOther

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0

5

10

15

20

1960 1970 1980 1990 2000 2010

Bcf

d

Gas production from WCSBGas production from WCSB