SCENE-SETTER FOR TRI- AND BILATERAL ENERGY MEETINGS

UNCLAS SECTION 01 OF 05 OTTAWA 001924 SIPDIS STATE FOR EB/ESC/ISC (MCMANUS AND DUDLEY),WHA/CAN (RUNNING),OES/EGC (REIFSNYDER AND DEROSA) USDOC FOR ITA/MAC -- OFFICE OF NAFTA DOE FOR IA (A/S BAILEY, DAS DOBRIANSKY, PUMPHREY AND DEUTSCH) DEPT PASS USTR FOR MELLE AND CHANDLER DEPT PASS INTERIOR FOR INT'L AFFAIRS DEPT PASS FERC FOR KEVIN KELLY AND DONALD LEKANG SENSITIVE E.O. 12958: N/A TAGS: ENRG ETRD CA SUBJECT: SCENE-SETTER FOR TRI- AND BILATERAL ENERGY MEETINGS REF: (A) Ottawa 1812 (Uranium) (B) Ottawa 1721 (Hydrogen Economy Partnership) (C) Ottawa 1578 (NOAA Administrator's visit) (D) Ottawa 687 (GOC climate change measures) (E) Ottawa 566 (2002 energy trade data) (F) Ottawa 503 (Natural gas in North America) (G) Ottawa 334 (Protecting oil/gas pipelines) (H) Halifax 52 (Atlantic offshore outlook) (J) Calgary 44 (Alberta electric restructuring) (K) 02 Vancouver 1153 (BC energy policy) (L) 02 Calgary 473 (Alberta and Kyoto) (M) 02 Ottawa 3205 (Atlantic offshore overview) (N) 02 Ottawa 2474 (Power transmission barriers) SUBJECT PARAS CANADA ENERGY OVERVIEW 3 - 9 PARTNERSHIP FOR THE HYDROGEN ECONOMY 10 SHIFTING TO OILSANDS AND FRONTIERS 11 - 15 OILSANDS: CONTINUING EXPANSION 16 - 19 ARCTIC PIPELINES: APPROACHING REALITY 20 - 21 ELECTRICITY: ONTARIO RESTRUCTURING SKIDS 22 - 25 NUCLEAR: MOVING TOWARD LONG-TERM DISPOSAL 26 CLIMATE CHANGE 27 - 28 ¶1. THIS MESSAGE IS SENSITIVE, BUT UNCLASSIFIED. NOT FOR DISTRIBUTION OUTSIDE USG CHANNELS. ¶2. In preparation for the forthcoming meetings of the North American Energy Working Group (NAEWG) and U.S.- Canada Energy Consultative Mechanism (ECM) in Ottawa July 15-17, post provides the following updated overview of the very dynamic Canadian energy scene. CANADIAN ENERGY OVERVIEW -------------- ¶3. Since the early 1980's, Canada has been the single largest foreign supplier of energy to the United States; measured in total energy, it is our number one energy supplier by a wide margin. Canada is the world's fifth largest energy producer and a net exporter of all major energy products including oil and petroleum products, natural gas, electric power, uranium, and energy technology and services. The United States is virtually Canada's sole customer for crude oil and natural gas exports, which grew steeply over the past decade and a half, as well as its sole customer for exports of electric power. ¶4. Canadian and U.S. government efforts are coordinated across the full range of energy-related technologies including climate monitoring, carbon sequestration, clean coal, hydrogen and nuclear. Canada has been invited to participate in the Carbon Sequestration Leadership Forum (CSLF) and the International Partnership for the Hydrogen Economy (IPHE). ¶5. OIL: Canada supplies more oil and oil products to Americans than any other country, including Saudi Arabia. In 2002 Canada exported approximately 1.4 million barrels per day of crude oil, plus the equivalent of about 500,000 barrels per day in petroleum products and partially processed oil. In 2002, imports of Canadian oil and petroleum products accounted for about about 17 percent of U.S. oil imports and nearly 10 percent of total U.S. oil demand. ¶6. GAS: Natural gas makes up the largest part - more than one-third - of Canada's primary energy production. In 2002 Canada exported 3.74 trillion cubic feet of natural gas, making up 93 percent of U.S. gas imports and 18 percent of total U.S. gas demand. (See ref F for a Canadian perspective on North American gas supply issues). ¶7. ELECTRIC POWER: Canada exported about 35 terawatt- hours of electric power to the United States in 2002. Canada's total electricity exports peaked in 2000 and are now on a declining trend, due to changes in demand patterns, a lack of capital investment in both the U.S. and Canadian electric power industries and the difficulty of building new transmission capacity (see ref N for analysis). ¶8. NUCLEAR: Canada is the world's largest uranium producer (ref A),supplying about one-third of world production and 20 to 30 percent of U.S. demand. A Canadian Government-owned firm, AECL, is one of the world's most active vendors of nuclear reactors, having supplied units to China and South Korea in the past decade. ¶9. For further data on Canadian energy production and trade, refer to the EIA's Country Analysis Brief on Canada (www.eia.doe.gov/emeu/cabs/canada.html),or the GOC's National Energy Board website (www.neb.gc.ca). INTERNATIONAL PARTNERSHIP FOR THE HYDROGEN ECONOMY -------------- -------------- ¶10. Canada has been invited to participate in the IPHE. Working-level GOC officials appear to be cautiously interested, but have significant concerns about how IPHE will relate to the IEA's Hydrogen Coordination Group (ref B). They also have numerous questions about IPHE's possible structure and process. SHIFTING TO OILSANDS AND FRONTIERS -------------- ¶11. Canada's conventional oil and gas fields are mainly located in or adjacent to the western province of Alberta, which is north of Montana. While the cost of finding new reserves in this region has risen significantly in recent years, the industry continues to thrive, notably in the less-exploited northwestern portion of the Western Canada Sedimentary Basin which extends into the neighboring province of British Columbia. A relatively new energy/mining technology, the extraction of oil from oilsands (vast deposits of oily dirt) in northern Alberta, became profitable during the 1990's. Multi-billion-dollar investments are ongoing in that industry. See paragraphs 16-19 below for details. ¶12. The ability of supplies to keep up with North America's natural gas demand has been the subject of recent controversy in Canada, as it has in the United States. There is now broad, well-developed support among stakeholders to construct a pipeline down the Mackenzie River Valley, which would allow development of natural gas fields in the Mackenzie River Delta and Beaufort Sea areas (east of Alaska's North Slope). The first formal steps toward applying for regulatory approval for such a pipeline are expected to be taken in the second half of 2003. While the amount of gas which will be accessed by this pipeline is a fraction as large as that in Prudhoe Bay, the barriers to pipeline development are lower, and the gas could begin to reach southern markets around 2010. ¶13. Substantial oil and gas deposits under the continental shelf off Canada's Atlantic coast entered commercial production in the past decade, highlighted by the placement of a large fixed platform on the "Hibernia" oilfield (east of Newfoundland) in 1997, and the inauguration of natural gas exports from Nova Scotia to New England through the Maritimes and Northeast Pipeline early in 2000. ¶14. The Hibernia oilfield, which is being exploited by a consortium of private oil firms (Exxon/Mobil is the operator),is estimated to contain more than 600 million barrels of oil. Major oil firms are now beginning production from the nearby "Terra Nova" oilfield, which has reserves of about 300-400 million barrels. Conservative estimates put East Coast discovered reserves of oil in the two billion barrels range, with possible eventual production rates of up to one million barrels per day. ¶15. Offshore natural gas production from the Sable Island area, east of Nova Scotia, began early in 2000. Most of this gas is exported to New England - bringing large-scale natural gas service to these states for the first time, and helping to stabilize their winter heating costs. Gas reserves around Sable Island have been estimated at 3.5 trillion cubic feet, but more drilling is needed to complete this picture (ref H). There are much larger gas resources in Newfoundland and Labrador, but environmental and distance problems will slow these developments. OILSANDS: CONTINUING EXPANSION -------------- ¶16. The economically recoverable oil resources in Alberta's oilsands are many times larger than the sum of Canada's other oil reserves. Oilsands (aka "tarsands" or "heavy oil") are vast deposits of oily dirt which can be processed (economically at current oil prices) into "synthetic crude" which can then be refined in conventional oil refineries. Canadian authorities estimate reserves in the oilsands to be the equivalent of 175 billion barrels assuming current technology and economic conditions, and up to 315 billion barrels with technological advances and some price increases. Oilsands already account for more than half of Canada's crude oil output, and for most of the recent increases in Canada's production. ¶17. Crude bitumen production from oilsands increased by about 25 percent in 2002, due to large ongoing capital investments. The Canadian government has predicted that if currently planned projects are realized, by 2010 Canada will provide approximately 20.5 percent of U.S. oil imports and 14.1 percent of total U.S. oil supply. The Alberta Energy and Utilities Board projects that synthetic crude oil production from Alberta's oilsands will expand by 237 percent from 2002 to 2012. ¶18. During the past year, first Oil and Gas Journal and subsequently the U.S. Energy Information Administration began to recognize Canada's oil sands as "proven reserves" -- a decision which dramatically increases Canada's petroleum reserves on paper, to about 180 billion barrels, making Canada the world's second- largest reserve holder after Saudi Arabia. While the validity of counting the oilsands as "proven reserves" has been subject to some ongoing controversy (notably following a critical item by Jeff Gerth in the New York Times on June 18),their economic reality is affirmed by the many billions in actual capital investment which they are attracting and the resulting current increases in oil output. ¶19. COMMENT: There is growing confidence among Canadian stakeholders and analysts that this resource imposes an effective limit on the price which North America must pay for overseas oil in the long run, absent severe foreign supply disruptions. Embassy shares this view. END COMMENT. ARCTIC PIPELINES: MACKENZIE LINE CLOSER TO REALITY -------------- -------------- ¶20. IN RECENT MONTHS, STAKEHOLDERS IN AN ANTICIPATED NATURAL GAS PIPELINE DOWN THE MACKENZIE RIVER VALLEY IN NORTHWESTERN CANADA HAVE TAKEN FURTHER STEPS TO PAVE THE ROAD FOR A FORMAL DEVELOPMENT PROPOSAL. TRANSCANADA PIPELINES (TCPL), ONE OF THE WORLD'S LARGEST PIPELINE OPERATORS, SIGNED A DEAL IN JUNE TO PROVIDE FINANCING TO ABORIGINAL PIPELINE GROUP (APG),ENABLING APG TO TAKE A ONE-THIRD OWNERSHIP SHARE IN THE PIPELINE. THE MAIN PRODUCING PARTNER IS IMPERIAL OIL, THE CANADIAN SUBSIDIARY OF EXXON. AN INITIAL APPLICATION TO REGULATORS IS EXPECTED IN THE FALL OF 2003. ¶21. STAKEHOLDERS LESS AND LESS VIEW THE MACKENZIE LINE AND ANOTHER, LARGER PIPELINE TO ALASKA'S PRUDHOE BAY AS BEING INCOMPATIBLE. THIS IS BECAUSE IT APPEARS INCREASINGLY LIKELY THAT THE SMALLER AND SHORTER MACKENZIE LINE WILL BE CONSTRUCTED FIRST, AND BECAUSE THERE IS INCREASING CONCERN THAT NORTH AMERICA'S DEMAND FOR NATURAL GAS MAY OUTSTRIP SUPPLIES OVER THE COMING DECADE (REF F). CANADIAN OBJECTIONS TO POSSIBLE FISCAL INCENTIVES TO SUPPORT THE ALASKA PIPELINE FOCUS ON THE POSSIBLE MARKET-DISTORTING EFFECTS OF SUCH SUBSIDIES - PARTICULARLY IF THEY GO BEYOND THE SCOPE OF MEASURES TAKEN TO ENCOURAGE INVESTMENT IN OTHER GAS PRODUCING REGIONS. ELECTRICITY: RESTRUCTURING SKIDS IN ONTARIO -------------- ¶22. Electric power is primarily under provincial jurisdiction in Canada, and is traditionally dominated by provincial government-owned firms. Several provinces have taken steps to restructure their electricity sectors on competitive principles. Alberta has achieved a degree of competition at both wholesale and retail levels which has been characterized as a "messy success" (ref J). ¶23. In Ontario in recent years, the provincial monopoly utility was split up into generation, transmission and distribution components, and some competition was introduced at the retail level. However, in April 2002 a planned initial public offering of the provincial government-owned transmission grid operator, Hydro One, was blocked by a court ruling. Transmission grid issues quickly became politicized, particularly when power prices rose during the peak summer period. In November 2002, the Ontario government froze retail power rates at 4.3 cents/KWH for most customers until 2006. Since then, the government has struggled to increase generating capacity with little help from private investment. Re-starting mothballed nuclear plants is crucial to its survival strategy, but the first re- starts - expected this summer and fall - have been delayed. ¶24. Canada's National Energy Board (NEB) predicts that domestic electricity demand will grow slightly faster than supply through 2025, causing electricity exports to the United States to decline significantly from current levels in the long run. This is driven by the trend for generating facilities to be located closer to end users. One major reason for this is the difficulty of constructing new transmission capacity due to a range of concerns including environmental/agricultural opposition, regulatory hurdles, and uncertainty associated with the evolving market environment for electric power. Another is the growing availability of natural gas and the efficiency of gas-driven generating technology. ¶25. Canada still has abundant undeveloped hydroelectric potential, but these resources tend to be located far from densely populated markets. Provinces with large undeveloped sites include Newfoundland and Labrador (Churchill Falls II),Quebec (Great Whale) and Manitoba (Nelson River). There is significant potential for cogeneration of electric power in oilsands operations, but here as well, it will be difficult for the resulting power to reach major markets unless construction of long-distance power lines becomes easier. NUCLEAR: MOVING FORWARD ON LONG-TERM DISPOSAL -------------- - ¶26. Like the United States, Canada has no permanent disposal facility for its nuclear waste, which is currently stored at reactor sites. As in the U.S., proposals to move this waste to any other site(s) provoke strong local resistance. During 2002, Canada passed legislation which creates a Waste Management Organization, funded by nuclear energy firms, to develop a long-term approach to storing radioactive waste. The GOC plans to make a decision by 2006 in favor of one of the three major options (deep geological storage, centralized surface/subsurface, or continued storage at reactor sites). CLIMATE CHANGE -------------- ¶27. In the spring of 2002 the USG and GOC announced a more concerted effort to coordinate our climate change programs, with a particular focus on energy, especially energy efficiency, clean energy, clean coal, renewable and alternative energy and carbon sequestration. At Prime Minister Chretien's initiative, Canada formally ratified the Kyoto Accord at the end of 2002, despite vocal criticism from provincial governments and industries (with Alberta and the oil and gas sector leading the way - ref L). Critics were concerned that the burden of compliance would fall disproportionately on certain regions/industries and also that compliance would place Canada's economy at a lasting competitive disadvantage vis--vis the United States. ¶28. In its spring 2003 budget, the GOC committed C$1.5 billion (about US$1 billion) over five years directly to achieving greenhouse gas emission reductions, plus modest additional funds for research and long-term technology development. GOC officials are now engaged in determining what process will be used to allocate this spending. CELLUCCI