Alberta’s bid to add value to its bitumen took a big hit last week when the operator of a new refinery reported a 50% increase in capital costs. At the same time, it was quietly announced that the province has put almost $2 billion more in financial commitments behind the project. Alberta’s new Energy Minster, Diana McQueen, will have more than a few difficult files on her desk but the Sturgeon Refinery (previously known as the North West Upgrader) may be one of the toughest. Will the government’s value added strategy pay off, or are we on the road to another government-backed upgrader boondoggle?
The Sturgeon Refinery, the first refinery to be built in decades in North America, is expected to take bitumen supplied by the Government of Alberta as well as from oil sands heavyweight Canadian Natural, and process it to produce diesel fuel, naptha diluent for use in transporting oil sands bitumen and other refined products.
Sounds simple, right? The province collects bitumen in lieu of cash for royalties and, in turn, guarantees a stable supply of bitumen to a new refinery in Alberta. The refinery’s similar deal with Canadian Natural, a major player in the industry, shows the venture makes business sense. And the Alberta government benefits from increased demand for bitumen, a more stable supply of diesel fuel, and from value-added jobs.
Not so fast. The province is likely taking far more risk than you think—risk that will likely only pay off only if the bitumen bubble lasts for decades.
This is not a simple, staple supply relationship. The Sturgeon Refinery will operate under an agreement (PDF) which includes commitments from the province and Canadian Natural to pay the refinery through a toll for bitumen processing. The toll would adjust to allow the operator of the refinery to recover its initial capital costs, to repay debt, and to earn a rate of return on equity. It would also see the Province and Canadian Natural pay for the refinery’s operating costs, as long as those operating costs don’t fall out of step with other refineries in Alberta. The contract provided a 10% return on the equity share of the first $5 billion spent, and then a pro-rated return on additional spending up to $6.5 billion in total project costs. In other words, as long as the project was built on-time, close to on-budget, and operated well, the owners would make money regardless of whether the price difference between bitumen and diesel made the investment profitable—the province, as well as Canadian Natural, were taking the risk on the commodity prices, not the operator. To make matters still more complex, Canadian Natural is also a 50% owner of the refinery itself, through the North West Redwater Partnership.
On September 20th, 2013 (yes, all of 11 weeks ago), Premier Redford attended a sod turning for the then-estimated-to-be $6 billion dollar refinery. On Thursday of last week, it was revealed that costs had jumped to $8.5 billion for the 50,000 barrel per day plant. On Thursday, North West Redwater Partnership, the parent company of the Sturgeon Refinery also announced it had re-negotiated the terms of its agreement with the toll-payers, the Alberta government and Canadian Natural, to cover these new costs. The text of the renegotiated contract is not yet public, but here’s what we know:
- The contract now includes a lower rate of return on equity of 5%, and the equity share of the project remains at 20%, with the remainder financed through debt. Over 30 years, the 5% rate of return on the $2 billion equity share will amount to toll payments of about $3.9 billion;
- The Alberta Government and Canadian Natural each agreed to loan $300 million (in subordinated debt) to the North West Redwater Partnership, to be repaid through the toll. Basically, if you can follow this, the Alberta government and Canadian Natural are loaning part of the capital for the project to its owners, and then allowing the owners to pay them back through the tolls paid by the Alberta government. Think of this like someone loaning you money to make the down-payment on a building which they’ve also agreed to rent from you under the condition that you pay them back over 10 years using some of the money they pay you in rent. The rate of return on this debt will be prime plus 6%, according to releases;
- According to North West, “if additional financing is required, the toll payers (again, the Alberta-government and Canadian Natural) have agreed to advance the additional funds as required to complete the project.” So, the Alberta government has committed to this refinery being built, no matter how much it costs, at least according to the project proponent.
In an emailed statement, the Minister of Energy stated that, “The strategic reasons that led us into this partnership are as valid today as they were when the Government of Alberta committed to it three years ago,” and that, “the project remains a good deal for taxpayers.”
The Government of Alberta agreed to cover the costs of servicing an additional $1.5 billion in debt (the Alberta government’s share of the new debt costs) which will be covered by the toll, and to loan the project proponent an additional $300 million which the proponent will use to finance their own investment in their own project. Further, they’ve agreed to do this all again if the refinery gets even more expensive.
Given what the Government agreed to, the explanation offered by Ken Hughes, the previous energy minister, for both the circumstances surrounding these changes and the impact this will have on the Government is lacking. With this in mind, I have 5 questions which I believe the new Minister of Energy needs to answer in her first week on the job:
1. What is the Alberta Government’s estimate, given these new costs, of the tolls to be paid per barrel of bitumen processed, and thus the necessary price differential between bitumen and the products produced in order for the province to come out ahead?
2. Was the Premier aware that costs were likely to increase significantly when she participated in the ground-breaking on September 20th, 2013? And if not, why not? Certainly, the potential for significant cost over-runs must have been known 12 weeks ago. Who knew what and when?
3. Why did the government choose to loan money to the North West Redwater Partnership—a loan which will be used to invest in the project? What were the advantages to the people of Alberta in structuring the transaction in this way?
4. The previous Minister of Energy stated that this remains a good investment for Alberta, in part, because it would, “create thousands of jobs.” At the same time, we hear daily about a labour shortage in the oil sands sector. Has the Alberta Government estimated the degree to which financing this project will exacerbate the labour shortage, drive cost inflation, and further erode oil sands royalties?
5. Did the Alberta government consider purchasing the refinery from North West as part of these negotiations? To use the analogy from above, rather than loaning North West the money to buy the building which it would then rent to you, why not buy the building yourself?
Over to you, Minister.