ARCTIC GAS PIPELINES REACH KEY DECISION POINTS

UNCLAS SECTION 01 OF 04 OTTAWA 003349 SIPDIS SENSITIVE DEPT FOR WHA/CAN (HOLST, NELSON) AND INR (SALCEDO) USDOC FOR 4310/MAC/ONA DOE FOR INTERNATIONAL AFFAIRS: PUMPHREY, DEUTSCH DOI FOR OFFICE OF THE SECRETARY: PEARCE E.O. 12958: N/A TAGS: ECON ENRG EINV CA SUBJECT: ARCTIC GAS PIPELINES REACH KEY DECISION POINTS REF: OTTAWA 2951 SUMMARY/INTRODUCTION -------------- ¶1. (U) SENSITIVE, BUT UNCLASSIFIED. NOT FOR DISTRIBUTION OUTSIDE USG CHANNELS. ¶2. (U) Summary/Introduction: Both of North America's proposed major Arctic natural gas pipeline projects - Alaska and Mackenzie - are approaching key milestones: - On the Mackenzie project, Canada's National Energy Board has asked proponents to indicate by November 18 whether they are ready to proceed to public regulatory hearings early in ¶2006. This project would begin delivering about 1.2 billion cubic feet per day (BCF/D) around 2011. - On the Alaska project, the State of Alaska reached agreement on October 21 with ConocoPhillips on key fiscal issues and is near agreement with the two other big producers, ExxonMobil and BP. This line would begin delivering 4-5 BCF/D around 2016. ¶3. (U) Most players would like to see both projects proceed on these timelines, in part because Mackenzie would help create capacity for Alaska by training construction workers and ramping up pipe production. Constructing both projects at the same time, on the other hand, is not desirable because it would strain these inputs, increase costs, and could depress revenue after startup. ¶4. (SBU) According to various reports, the Government of Canada would prefer not to address key decisions on Alaska until Mackenzie is underway. However, the lead private sector player on Mackenzie - Exxon-controlled Imperial Oil - stopped work in April 2005, is frustrated by the difficulty of reaching agreements with native groups, and is said by some sources to be unenthusiastic about the project's economics. While an ExxonMobil VP told Ambassador Wilkins on October 24 that he is confident Mackenzie will go first, and ExxonMobil President Rex Tillingsley said the same in a speech on November 8, some other players now tell us that there is significant risk that Mackenzie's time line will slip further, to the point that it might not proceed before Alaska, meaning in effect that Mackenzie would be put off for ten to twenty years. We have not been able to evaluate the likelihood of this scenario. Its main consequence for U.S. interests might be that GOC decisions on Alaska would be held up in 2006-07 while the GOC struggles to rescue the Mackenzie project. END SUMMARY/INTRODUCTION. MACKENZIE PROJECT: BACKGROUND -------------- ¶5. (SBU) Exxon-controlled, Calgary-based Imperial Oil Limited is the lead player on the Mackenzie Natural Gas Pipeline project, which would bring gas from the Mackenzie River delta down the river's valley through the Northwest Territories and into Alberta. This is a relatively straightforward construction route with few natural obstacles and only three government jurisdictions involved (Canada, the NWT and Alberta). The proposed pipeline is a fraction the size of the Alaska project - it would carry 1.2 BCF/D of gas initially, expandable to 1.9 BCF/D. ¶6. (SBU) The main complication is the presence of several native groups along the route which have land claims in different stages of resolution with the GOC. These groups see the pipeline project as a unique opportunity to negotiate various economic benefits from governments and/or directly from industry. While the GOC's Indian and Northern Affairs Canada (INAC) is responsible for aboriginal "first nations" and for territorial governments, GOC policy is to "devolve" authority to these subordinate levels. ¶7. (SBU) Under cover of "devolution," the GOC has tended to minimize its on-the-ground involvement (i.e. other than injecting cash),and this has further encouraged native groups to demand that private firms provide quasi- governmental infrastructure such as schools and hospitals. Companies are understandably concerned that this trend may be going too far, and in particular that the GOC is not facing up to certain key issues (such as determining the native groups' jurisdiction to impose property taxes). ¶8. (SBU) In April 2005, Imperial Oil and the two other firms involved in the Mackenzie Valley Producers Group (Shell Canada and ConocoPhillips Canada),frustrated by native groups' demands and unenthusiastic about the project's economics, stopped much of their exploratory work in the Mackenzie River valley and delta. Nevertheless, Imperial continues to incur legal, negotiating and regulatory costs on the project. An industry insider estimated the current sum of these costs at around C$400 million (C$1 currently equals about 84 U.S. cents). ¶9. (SBU) Since then, gas prices have strengthened and the GOC has offered C$500 million over ten years to address "socio-economic concerns" along the pipeline route (distribution mechanism yet to be determined). On the other hand, it is not clear how much closer native groups are to final settlements on "benefits and access" agreements with the companies. As one company official told us, no native leader can afford to be perceived as not extracting the maximum possible from this once-in-a-lifetime negotiation, and with each group cutting a separate deal, none can appear to be getting less than another. This makes for difficult, never-quite-finished bargaining. A lesser problem, another said, was that government departments/agencies conduct their review of the project's regulatory application not through independent research, but by requesting further information from the companies ("getting the project to do their work for them"). This source said that while this problem is now under control, in early 2005, seventy percent of regulatory interventions originated with federal officials. STATUS: HOPING FOR HEARINGS IN 2006, FIRST GAS IN 2011 -------------- -------------- ¶10. (SBU) Currently, the optimistic timeframe for the Mackenzie project runs as follows: -- In coming weeks, companies and native groups achieve (and hopefully announce) further progress on "benefit and access agreements." -- By November 18, the companies (the Mackenzie Valley Producers Group, represented by Imperial Oil) notify the federal-territorial Joint Review Panel (JRP) that they are ready to proceed to public review hearings. -- The National Energy Board holds a Pre-hearing Planning Conference (Conference) in the Northwest Territories during the weeks of 5 and 12 December to inform residents of the NEB's role and to shape the public hearing process. If the companies do not indicate their readiness to the JRP, this conference will not take place. -- Public hearings would run approximately from January- July 2006. -- The GOC then adds its comments and the application proceeds to the National Energy Board in late 2006. -- Realistically, the first flow of gas would occur in 2011 "even if all goes well." MACKENZIE: GETTING CLOSER TO THE EDGE? -------------- ¶11. (SBU) Some of our pipeline industry contacts say that Imperial is already unenthusiastic about Mackenzie's economics, due to native groups' demands combined with parent firm ExxonMobil's relatively conservative outlook for natural gas pricing in North America five to ten years out. Mackenzie's expected delivery of 1-2 BCF/day is equivalent to one or two LNG terminals, meaning that Mackenzie's market opportunities could be "filled in" by a couple of the LNG projects now being contemplated. (The Alaska project, being larger, is less vulnerable to such displacement). On the other hand, ExxonMobil's Vice-President for the Americas assured Ambassador Wilkins on October 24 that Mackenzie will proceed before Alaska and that "as long as the parties remain in dialog then the project remains on track." Speaking in Calgary on November 8, ExxonMobil President Rex Tillerson told the Canadian American Business Council that "my expectation is that we'll ultimately get across the finish line" with Mackenzie. ¶12. (SBU) Despite these assurances, some well-placed interlocutors have told us that it is now entirely possible that the Mackenzie project will be delayed indefinitely, mainly due to its possible interplay with the Alaska pipeline. While public statements continue to say that Mackenzie will deliver gas "by the end of the decade," at least three or four years ahead of Alaska, pipeline industry sources say that nothing earlier than 2011 is realistic. This narrows the window over which the Mackenzie line can be expected to be serving a tight natural gas market. Moreover, the closer the two projects occur in time, the more they are likely to compete for scarce skilled workers, large- diameter steel pipe, and other inputs, thus rising inflation in construction costs. ¶13. (SBU) Because the Arctic construction season is short, if Mackenzie's timeline slips even by a few months, this might push construction and completion out by another year. The implication is that if JRP public hearings do not begin by February, the risk in terms of eventual market price for the gas, combined with an increased risk that the timeline will overlap with Alaska's, could incline Imperial to put off the Mackenzie project - at least until the continental market absorbs Alaskan (and possibly LNG) gas supplies, and promise to tighten again - which could take another ten to twenty years. ALASKA PROJECT: THE VIEW FROM OTTAWA -------------- ¶14. (SBU) The Alaska project will reportedly continue to be far down the GOC's list of priorities until Mackenzie appears to be well underway. Also, the GOC's Natural Resources ministry has suffered from a lack of leadership which is not fully resolved (reftel). Even were it to focus on the Alaska project, the GOC would not want to risk appearing to facilitate it at the expense of Mackenzie. To complicate matters, there is a growing possibility of an election campaign in mid- winter, and the government is already in campaign mode. ¶15. (SBU) We expected the State of Alaska's October 21 announcement of a "base fiscal contract agreement" with ConocoPhillips to renew pressure on the Mackenzie players to settle their differences and move toward public hearings. The subsequent controversy in Juneau (over whether the agreement protected the State's interests) may have had the opposite effect, encouraging native groups in the Mackenzie Valley to believe they have a further opportunity to hold out. ¶16. (SBU) Canadian energy patch observers continue to agree that the GOC is focused on ensuring that the Mackenzie project not only gets built, but gets built before Alaska. As the Alaska project draws closer to reality, the GOC will have increasing difficulty avoiding its fundamental dilemma. That dilemma is whether/how to choose between two regulatory regimes: the 1970's-era "National Pipeline Act" process (which TransCanada PipeLines asserts gives that company exclusive rights to develop the Canadian segment of the project),or the more modern and open "National Energy Board" process (which would allow proposals by other possible lead players, including TCPL arch-rival Enbridge Pipelines Inc.) Previous Prime Minister Jean Chretien went on record as having a preference for the NPA process. Various observers suggest that by remaining silent on this issue, the GOC is sending a signal that regulatory applications can be filed under either process - in effect, "letting the market decide." ExxonMobil's VP for the Americas told Ambassador Wilkins that he considers the GOC's silence to be acknowledgement that both processes remain available to project developers. WILKINS