NATURAL GAS IN NORTH AMERICA:

UNCLAS SECTION 01 OF 05 OTTAWA 000503

SIPDIS

SENSITIVE

STATE FOR EB/TPP/BTA EB/ESC/ISC (MCMANUS AND ERVITI),
WHA/CAN (MASON AND RUNNING),OES/EGC (MIOTKE AND
DEROSA)

WHITE HOUSE FOR NSC (SAMMIS AND BROCK),OPD (MCNALLY) AND
OVP (KNUTSON)

DOE FOR INT'L AND POLICY (A/S BAILEY) AND IE-141 (DEUTSCH)

STATE PASS FERC FOR CHAIRMAN WOOD AND DONALD LEKANG

COMMERCE FOR 4320/MAC/WH/ON/OIA/BENDER

E.O. 12958: N/A
TAGS: ECON EPET ETRD CA
SUBJECT: NATURAL GAS IN NORTH AMERICA:
CANADIAN PERSPECTIVE

REF: (A) 02 OTTAWA 2098 (GOC AGAINST ALASKA "SUBSIDIES")

(B) 02 OTTAWA 1689 (ENERGY CONSULTATIVE MECHANISM)
(C) 02 OTTAWA 2474 (ELECTRIC POWER OPPORTUNITIES)
(D) 01 OTTAWA 2857 (NORTHWEST READY FOR GAS DEV'T)

SENSITIVE, BUT UNCLASSIFIED - NOT FOR DISTRIBUTION
OUTSIDE USG CHANNELS.

SUMMARY/INTRODUCTION
--------------


1. (U) Although Canada's energy exports to the United
States have grown at impressive rates in recent decades,
making Canada our largest total energy supplier, Canada's
conventional natural gas resources are maturing and
production from current areas could peak within a decade.
GOC forecasters expect that Canada's exports of natural
gas will peak in 10-15 years and their share of U.S.
demand will decline from about 18 percent at the peak, to
perhaps 13 percent by 2025. Yet, like other countries,
both the U.S. and Canada continue to build gas-burning
infrastructure at high rates. There is a risk that
future tight gas supplies and high prices could "strand"
some of this investment (i.e. make it uneconomic before
the end of its intended lifespan).


2. (SBU) Gas industry observers are increasingly focused
on what is required in order for yet-to-be-developed
northern gas resources - in Alaska and in Canada's
northern territories - to take the place of these
"maturing" conventional supplies. Because Canada is a
net energy exporter, it is much more willing to accept
high energy prices, and thus its economic interests with
respect to northern gas development differ significantly
from those of the U.S.


3. (SBU) An outcome attractive to key Canadian interests
would likely entail (1) ensuring that two pipelines
(Mackenzie Valley and Alaska Highway) are constructed,
and (2) locating industrial benefits - perhaps a gas-
liquids separation facility - in Canada. Observers argue
that, while such a "big political deal" could be
relatively straightforward and low-risk, only the USG has
an overwhelming interest in brokering it.


4. (U) This message is based on conversations with
contacts in Ottawa, Calgary and Edmonton and was prepared
with assistance from Amconsul Calgary.
END SUMMARY/INTRODUCTION


GAS DEMAND GROWTH CONCENTRATED IN POWER SECTOR
-------------- -


5. (U) Recent rapid growth in overall demand for natural
gas has been driven by this fuel's low cost and
availability, and its low emissions relative to oil and
coal. In electric power generation, another important
factor is at work: gas-burning plants can be located
very close to power markets, avoiding the need to
construct additional power transmission lines, which has
become very difficult politically (ref C).


6. (U) As a result, ExxonMobil forecasts that while total
world energy demand will grow at an average 1.8 percent
annual rate through 2020, gas demand will grow faster -
2.6 percent overall, and 3.6 percent in the power
industry. By ExxonMobil's projection, gas will fuel 29
percent of the world's electricity by 2020 (versus 21
percent today).

CONVENTIONAL GAS SUPPLIES MATURING
--------------


7. (U) Most of Canada's natural gas production so far has
come from the Western Canada Sedimentary Basin (WCSB)
(ref B),where conventional production is expected to
peak in 2008-2013. Symptoms of this maturation include
simultaneous high drilling rates and declining new
discoveries; steeply rising drilling/discovery costs; and
a withdrawal from gas drilling activity by major energy
firms.


8. (U) Coal-bed methane and other nonconventional gas
sources, while they are promising, might not be large
enough to fully offset the decline in conventional
production. It appears unlikely that they will be
sufficient to cause overall Canadian gas production to
grow beyond the period 2015-2020 (see figure 5.6 of the
National Energy Board study, "Canadian Energy Supply and
Demand to 2025," at neb-one.gc.ca). As a result, the NEB
expects Canada's natural gas exports to peak in the
period 2013-2018. Canadian exports' share of total U.S.
gas demand is projected to fall from 18 percent at the
peak, to 13 percent by 2025.

THE NORTH IS WILD
--------------


9. (U) The "wild card" in this supply-demand projection
is the development of gas resources from Alaska and
northwestern Canada. Canada's northern territories
(roughly north of 60 degrees latitude) contain
significant oil and gas resources, notably gas in the
Beaufort Sea and near the mouth of the Mackenzie River, a
few hundred miles east of Alaska's Prudhoe Bay. National
Energy Board (NEB) projections guesstimate that this gas
will start coming to market in the period 2009-2017, and
contribute modestly to supply - perhaps 1.5 to 2 billion
cubic feet per day (Bcf/d) by 2025, on the order of one-
tenth of Canada's total production. This GOC forecast
limits itself to Canada, and is silent on Alaskan
developments. Also, over longer time periods,
development could extend to far larger reserves further
north, in Canada's Arctic Islands.


10. (U) IN RECENT DECADES, THE OBSTACLES TO OIL AND GAS
DEVELOPMENT IN THE TERRITORIES HAVE SHRUNK DUE TO A
NUMBER OF TRENDS - INCLUDING TECHNOLOGICAL ADVANCES,
INCREASED DEMAND FOR NATURAL GAS AS OPPOSED TO OIL (GAS
BEING EASIER TO TRANSPORT IN COLD CONDITIONS),PROGRESS
ON ABORIGINAL LAND CLAIMS SETTLEMENTS, AND GREATER
RECEPTIVENESS TO RESOURCE DEVELOPMENT AMONG ABORIGINAL
GROUPS (SEE REF D FOR DETAILS). THE GOC HAS HELD
REGULAR AUCTIONS OF EXPLORATION RIGHTS IN THE NORTHERN
TERRITORIES SINCE THE LATE 1990'S (SEE WEBSITE
INAC.GC.CA/OIL FOR DETAILS). NEVERTHELESS, GREAT
UNCERTAINTY REMAINS ABOUT THE LENGTH OF THE POLITICAL-
REGULATORY TIME LAG FROM PROPOSAL TO THE START OF
CONSTRUCTION.

PIPELINE PLANS TO ACCELERATE THIS YEAR
--------------


11. (U) With rising energy prices in 2000-2001 and the
release of the USG's National Energy Policy Report in May
2001, interest in northern pipeline developments revived.
Various stakeholder groups formed alliances to promote
one prospective route or another. The two most
frequently suggested options are:

-- A relatively short, flat "all-Canadian" line from the
Mackenzie Delta southward up the river valley and into
northern Alberta. (In an ambitious, one-pipeline
solution known as the "over the top" route, the north end
of this line could conceivably extend westward to Prudhoe
Bay - but this would greatly expand both the project's
scale, and the political/environmental/aboriginal
barriers to approval).

-- A more mountainous "Alaska Highway" line from Alaska's
North Slope southward to Fairbanks, thence more or less
along the highway route through the Yukon Territory and
northern British Columbia to northern Alberta.


12. (U) The stakeholder alliance in support of the "all-
Canadian" Mackenzie Valley line involves the Government
of the Northwest Territories (NWT),the Aboriginal
Pipeline Group (APG),and likely either or both of the
largest pipeline operators -- TransCanada Pipelines
(transcanada.com) and/or Enbridge (enbridge.com).
Insiders expect the NEB to receive a formal application
regarding this line during 2003. Supporters have lobbied
the GOC for fiscal incentives, but so far without
success, as the GOC (like the USG) remains officially
"route-neutral."


13. (U) Backers of the "Alaska Highway" line include the
Governments of Alaska and the Yukon Territory, as well as
Foothills Pipelines (foothillspipe.com). Foothills holds
permits dating from the 1970's (and now of undefined
value) to build a gas line on this route. Supporters and
opponents are intensely interested in the final version
of forthcoming U.S. energy legislation, since it may
include various fiscal measures ("subsidies," pricing
mechanisms, tax credits) which would affect the project's
economics.

A MACKENZIE LINE ALONE WON'T BE ENOUGH
--------------


14. (U) While the "Canada-only" pipeline proposal may seem
at this point to be moving toward realization, even if it
were built first, it is not projected to offset either the
decline in gas production from the WCSB, or the need to
bring Alaska's North Slope gas to market. A "Canada-only"
line would only deliver perhaps one-third as much gas as a
line from Alaska. Moreover, Mackenzie gas is expected to be
mostly or entirely consumed in Northern Alberta, since gas
will be the main energy input to the production of crude oil
from Alberta's oil sands. (This energy-intensive, heat-
driven process will see immense capital investment over the
coming decade as conventional oil production declines in
Western Canada).


15. (SBU) If, as now seems quite possible, the "Canada-only"
line begins construction first, this is considered unlikely
to make much difference to the economic case for building a
larger line from Alaska's North Slope soon afterward. On
the other hand, if an Alaska line were to begin construction
first, this could well put off the construction of a
Mackenzie Valley line for at least several years. For one
thing, the demand generated by the larger Alaska project
would drive up prices for already scarce skilled labor,
pipe, and other inputs; for another, the resulting gas
supply would undercut the economic case for the smaller
line.

ALASKA GAS: U.S. HOLDS THE BIGGEST INTEREST BY FAR
-------------- --------------


16. (U) Obviously, Alaska natural gas development must
answer many questions and clear many hurdles in order to
become reality. How much would it really cost to build?
What are the environmental consequences? How can aboriginal
groups best participate? Might liquefied natural gas (LNG)
facilities make more sense as a transportation option?


17. (SBU) But those discussing these questions should be
cognizant of Canadian factors which are too easily
underestimated in a "lower 48" perspective:

-- If a pipeline (rather than LNG) is to be the means of
transport, Alaskan gas must cross Canadian territory in
order to reach major markets. That territory is at least
1,500 miles wide and is under four or more jurisdictions.

-- The usual close alignment of national economic interests
will not necessarily hold in this case. Indeed, Canadian
economic and regional interests could work against this
development - at least, without some major political deal-
making. And Canada, as an energy exporter, can tolerate the
higher natural gas prices that might result if Alaskan gas
remains undeveloped. Simply put, an Alaska gas pipeline is
much more clearly in the U.S. national interest than it is
in Canada's national interest. This is particularly true as
a Canada-only Mackenzie Valley pipeline moves toward the
proposal stage.
MAKING THE CASE TO CANADIANS
--------------


18. (SBU) Construction of a natural gas pipeline from Alaska
would have positive economic spin-offs in western Canada,
but Canadians in that region understand well that such
effects are small and brief, because construction tends to
employ "flown-in" skilled trades and lasts only a few
seasons. The key sustained payoff for Canadian interests
would be in hosting "gas stripping" facilities to separate
liquids from the relatively "wet" Alaska gas. These liquids
provide inputs for petrochemicals and plastics industries
that are already established in Alberta, and which the
provincial government is determined to expand in the long-
term.


19. (SBU) On the downside, there are two major "negative
risks" for Canadian interests. First, subsidies or other
incentives granted to Alaskan gas could take market-
distorting forms that would be inconsistent with both
countries' expressed energy policies. Second, both
construction and the resulting gas flows could undercut the
economics of a Mackenzie Valley pipeline. Regional and some
national leaders very much want the latter pipeline for its
wider regional development effects - including all-season
roads and stimulus to hydrocarbon and mineral exploration
(see ref D).


20. (SBU) It bears noting that these concerns could be easy
for U.S. interests to address. Alberta (or northeastern
British Columbia) may well be the most economic location in
North America for gas-liquids separation, given northern
Alberta's already massive gas processing capacity. Market-
distorting subsidies are, after all, not in either country's
true interest. And as noted above (para. 15),the Mackenzie
Valley line, which may have a head start anyhow, is not
expected to change the fundamental economic case for Alaskan
gas development.

COMMENT: THE BOTTOM LINE
--------------


21. (SBU) COMMENT: North America will need to have its
"north of sixty" natural gas developed during the next two
decades. We can discern features of a possible low-cost,
low-risk political bargain that could pave the road to
developing this gas - by assuring key jurisdictions that
they will benefit, without imposing gross distortions on
energy markets.


22. (SBU) The USG and GOC are already committed to "route-
neutrality" and in most parties' opinions - as well as from
an economic standpoint - they should remain so. If fiscal
regimes must be tilted in favor of developments preferred by
the State of Alaska, it is clearly in the broader U.S.
national interest (economically and diplomatically) to
minimize the bias.


23. (SBU) Most stakeholders will be satisfied if two
pipelines - both the Mackenzie Valley (probably first) and
the Alaska line -- eventually get constructed. This would
satisfy top concerns of the sub-federal governments and
other groups in both the Yukon and Northwest Territories.
This outcome is also positive for northern Alberta oil-sand
interests and for the Government of Canada - as well as for
North America's continental energy security. Finally, a
"politically ideal" compromise would deliver some industrial
benefits to British Columbia as well as to Alaska and
Alberta.

CELLUCCI