Jul 13, 2015

Just how bad is BC’s LNG deal with Petronas?

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Last week, the BC government released the text of its Project Development Agreement with Pacific Northwest LNG (led by Malaysian state enterprise, Petronas), considered the front-runner in getting BC an LNG export industry. The agreement goes to the BC legislature this week in order to convince Petronas to make a “final investment decision.” There are still other barriers to this project going forward, due to First Nations rights and the province’s environmental assessment process. The project hit a major snag when the Lax Kw’alaams first nation balked at Petronas’ proposed site for its LNG terminal. Also, the Gitga’at first nation has just launched a legal challenge for not being consulted in the development process.

As far as the Project Development Agreement goes, much of the concern raised has been that the BC government is locking in the tax and regulatory regime for 25 years into the future. Changes made by subsequent governments – to the LNG tax, a special tax credit on corporate income tax, the BC carbon tax, and anything else that would affect project costs – would essentially have to pay compensation to Petronas. It is understandable why Petronas would seek such provisions, as this is a low-margin industry, and without them the company could not justify laying down tens of billions of dollars in capital investment.

However, what’s most disturbing is that this is a massive privatization of a public resource, for which the people of BC will get very little in return. Let’s look at the numbers:

Phase one of the project would produce 12 million tonnes of LNG per year for export, with a second phase that could raise that to 18 million tonnes. The actual amount of gas extracted, however, would be about 25% higher because of the huge amount of gas that would be used to extract, process, transport and liquefy the gas into exportable product.

For BC, there are two potential sources of gains: the revenues to the provincial government; and gains in employment.

Public revenues for BC depend on what price Petronas is able to get for LNG in Asia, but prices for LNG have crashed along with oil prices. It costs about $10 per mcf (thousand cubic feet) to land LNG in Asia due to the high costs of liquefaction and shipping, whereas current prices in Japan, Korea and China  are much lower ($7.45 to $7.85). So any company exporting BC LNG in the current market would be losing lots of money.

In spite of these horrible economics, it is possible that Petronas can justify paying a premium in order to secure supply over multiple decades, or its hope is that LNG prices will rise back to earlier highs. The initial hype for LNG was based on prices around $16, which seems completely unrealistic, especially given slowing demand for LNG worldwide, combined with lots of new (mostly Australian) LNG coming into the market.

So let’s assume landed price of $12, or about $2/mcf in profit, and 12 million tonnes (=576,000 mcf) of LNG exported per year. Based on that, over the 25 years of the agreement, the landed value of that LNG would be about $173 billion, and Petronas’ profit would be almost $29 billion.

BC lowered its corporate income tax rate for LNG to 8% so this would represent about $1.8 billion in corporate income tax over the 25 years. That said, this revenue may not be new money – the industry and government are now arguing that LNG exports are necessary to displace lost sales to the US.

BC also introduced a 3.5% LNG income tax, but allows companies to fully deduct capital costs before paying the full tax, a process that would take 8-10 years. This notably puts taxpayers on the hook for reduced revenues should there be cost over-runs (and this is an industry known for its cost over-runs). Over 25 years, BC would collect $600 to 700 million in LNG income tax assuming no cost over-runs.

Royalties are the other key revenue source. It is important to remember that royalties are not a tax, but the public’s share of the revenues for the exploitation of a public resource. In recent years, BC has been charging low royalties to keep production high, largely due to credits to companies for fracking operations. Those low royalties have averaged 7% per year, and assuming that rate over 25 years, this would amount to about $4 billion in royalties. A new royalty agreement with the proponents suggests these could be much lower, although it is hard to say how much.

Adding these together, BC would get about $6.5 billion in additional revenues over 25 years, or just over $200 million per year. Compare that to a provincial budget of $46 billion per year, and total provincial debt of $43 billion. There are also costs to the public sector associated with infrastructure, services and so forth, so we should really be looking at net revenues.

Revenues would go up if Petronas builds phase two, and its export capacity increases to 18 million tonnes per year. And prices in Asia could venture higher, thereby increasing corporate profits and BC’s share. On the other hand, I do not account for “transfer pricing,” whereby companies shift costs in order to minimize their global taxes payable.

What about jobs? The Petronas environmental assessment application estimates a peak of 3,500 temporary jobs during the 3-year construction phase of the project. After that, only 200 to 300 permanent jobs. There would likely be some additional employment upstream due to increased fracking as well, but in total the job creation is very small given the size of the venture. And that’s assuming all of these full time jobs hire people who would otherwise be unemployed; if they just shift from another part of the economy the benefits are much less. In comparison, BC has 2.4 million employed people.

For all of the hype about LNG creating jobs and eliminating our provincial debt, these real-world numbers are underwhelming to say the least. Having campaigned on that hype in the provincial election two years ago, it appears our provincial government is willing to accept a bad deal over no deal.

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