Crude Observations

Hail Mary Time!

So here we are. Less than a week to go. The final word. The last hurrah. The big close. Bottom of the ninth, two out, nobody on. Fourth and 18 from the 37, one second on the clock. Hail Mary time. The final countdown. Game 7 – overtime. The whole enchilada. Time to get ‘er done. All or nothing. Go for broke. Last shot. The clock is about to strike midnight. The beams are about to cross. Henderson! The ball is tipped – it’s one shining moment! The last kick at the cat. Death or glory. Iginla – Crosby – Crosby Scores – The Golden Goal!! – The gold medal goes to Canada!


What am I talking about you may ask? Obviously I’m talking TransMountain Expansion and Kinder Morgan. Who isn’t? I mean in Canada. Well BC and Alberta actually. More so Alberta.


For the uninitiated, we are now less than a week away from the artificial May 31 deadline set by Kinder Morgan to get clarity and assurances on whether the BC government will get out of the way and allow a pipeline to be built. And to be quite frank, well, we’re still waiting. And rightfully thinking to ourselves that surely Mr. Trudeau, you’ve got something better than repeating that zippy catch-phrase “that pipeline will be built”. I mean, how can you sound so sure when no one has a clue what you’re up to?


Anyway, I was sitting around thinking about this and tallying up the wagers I’ve made saying that the “pipeline will be built” and I’m thinking as we get closer to this ridiculous May 31 deadline I may need a bailout or indemnification from Justin Trudeau and his pals, because if they don’t come through, I’m going to be buying lunches for the rest of 2018!


Not kidding in the least either. I am still very confident that the thing will be built and I have certainly not been shy in letting people know how I think it might happen.


One place I have been reticent about putting thoughts to paper has been here, in this fun little blog.


But that all ends today! Today I am going to lay out for all to see what I believe is the most direct and efficient way to do this. It will frustrate and annoy, but, for the record, consider this the one and only time that I will in good faith offer Justin Trudeau and his band of merry carbon crusaders a way out of this mess they created for themselves.


So herewith, heretofore and anon are my thoughts on what I see as the least horrible of the horrible options that are available to the Federal government to get this project moving once and for all. I do in fact believe I have alluded to it several times in jest, but have never really come out and explained it, flushed it out or rationalized it. I have instead bounced the idea off several individuals of differing political and philosophical stripes and the reaction I have received once I walk through my logic has been, while not over the top in favour, at least resigned to the outcome.


So here goes – and I can already feel my fellow fiscal conservatives coming off the top rope onto my head – the one, the only, the final answer… C’mon man – just say it!!!!




The Federal government needs to buy all of Kinder Morgan Canada, nationalize it, make it a Crown Corporation, build the pipeline and sell it. End of story. Assuming Kinder Morgan is done with Canada and this project (a fair assumption), no other option makes sense. And I think it is probably being discussed. Very seriously. And if it isn’t, it should.


Why? Because this project is now a symbol. A symbol of Canada getting major infrastructure projects done. It’s a signal to foreign investors about whether they should put their money here, or somewhere else. I’ve never believed TMX was the most economically important pipeline (that’s Keystone XL BTW – bot that’s for another day), but it is without a doubt the most optically important. It’s the investment virtue signal to the rest of the world.


Holy Carp! How did he get all the way to that conclusion?


I guess the first stop in all this is to go back to the first blog I wrote after the April bombshell from Kinder Morgan – the one where they said they were going to take their net and go home unless they got to be goalie.


In that blog, I suggested that the whole delay thing seemed to me more shakedown than showdown and I still kind of believe it.


At the time, I did some back of the envelope analysis on Kinder Morgan Canada’s finances and committed funding and concluded that at that point in time, Kinder Morgan Canada did not have the capital to finish the project. The basic math on this was based on the estimated project cost of $7.4 billion less the $1 billion already spent less $5.5 billion in committed bank financing leaving at least $1 billion to be financed either through cash flow, a secondary equity offering, additional debt financing, or, or, or… What I also pointed out was that with the corporate restructuring of Kinder Morgan Canada (IPO), that notional parent and evil Texas company Kinder Morgan was not likely to be stepping up to the plate for the additional capital, notwithstanding its 70% ownership. Kinder Morgan Canada, and thus the TransMountain Expansion, was on its own.


Another important point is that also left unfunded under the above scenario is the contingency fund required by the NEB ($1 billion I believe) and the absolutely guaranteed increase in costs to complete. Some industry people I know suggest we should be prepared for upwards of $5 billion in added costs, but I will conservatively say they are around $2.5 billion (i.e. halfway). Those increased costs and contingency fund are currently unfunded.


So for shi**s and giggles, let’s say that completing the TransMountain expansion project is going to require $10 billion.


Why so much escalation? I don’t know – it’s all anecdotal. What I have heard is that there have been some planning issues inside of Kinder Morgan Canada regarding the expansion, although I also hear that these have been effectively remedied by the company. And remember that the estimated cost has not been updated since before the NEB and Federal government issued approval. And costs NEVER go down. But KM’s been reluctant to quantify it before it gets substantially into construction likely because of the furor it will cause and that it is so hard to peg how much the delay will ultimately add. It’s just a giant gong show and the longer it goes on, the worse it gets.


So, cost escalation due to delay. Cost escalation due to poor planning and incompetent staff. Cost escalation due to added conditions. Cost escalation due to the political goat rodeo they are being forced to endure. Cost, cost, cost. Bottom line? $7.4 billion is a starting point. No one knows the end point.


And, as things stand now, Kinder Morgan Canada does not currently have the money in hand or access to additional capital to see the project through, and with the political uncertainty, no one is lining up with the paper bags of cash. Ironically enough, that capital would probably be a lot easier to raise if, say, actual construction was occurring and there was in place that certainty of completion. But it’s a chicken and egg thing. And only one party can provide that certainty. A level of government with well-established jurisdiction.


Hence all the talk about a Federal Government indemnity. But no amount of Federal government indemnity is going to pay for actual, physical cost over-runs or budget redos, or increased labour costs.


So with that said, here’s my rationale…


First off, no matter what Bill Morneau says to eager beaver BNN reporters, it makes zero sense to me to undertake an open ended indemnity risk of taxpayer money if that money is out of the control of the government. In that case, they really are just “writing a blank cheque to Texas” as the Fed NDP leader says and it doesn’t really address the BC delay issues head on.


But… if you are the federal government and you are confident or certain that you have the regulatory winning hand with the BC reference, the issues that might matter to Kinder Morgan Canada and its various shareholders don’t matter to you in the same way.


Kinder Morgan Canada can’t force the project through and has zero influence on the government of British Columbia – that’s for the NEB and Canada. Kinder Morgan Canada may or may not have access to enough money to finish this project regardless of where the current budget is. And Kinder Morgan the parent, as a public company and one of the largest pipeline operators in the world, for whom Canada shows up as “other” in the corporate pie chart, does not have the patience to wait for the Great Goat Rodeo in Canada to sort itself out.


But, what does the Federal Government have that Kinder Morgan does not? Three things specifically: Time, Money and Jurisdiction.


Given that, is it so much of a stretch to expect the Federal government to announce sometime on or around May 31 that they are buying Kinder Morgan Canada and creating a crown corporation that will oversee construction and completion of the Trans Mountain Expansion? With said construction to begin as soon as possible notwithstanding the BC reference because, hey, the Crown trumps the province, they know they are going to win and they don’t have shareholders breathing down their necks.


But wait you’ll say (and I don’t blame you), that’s a terrible idea. There is no way the federal government will do anything with this except make it a colossal boondoggle – they can’t control costs, where will they get the people etc. etc. etc.


Well let’s take a look at the alternatives again, the ones the media is so excited about:


Indemnity – as mentioned above, the indemnity for political risk and delay idea is open-ended, subject to massive interpretation as to how it is implemented, paid and applied and is basically an invitation for any project proponent to demand the federal government indemnify them for political risk and a green light for any special interest opposed to a project to protest as much as they want, all on the taxpayer dime. It’s foolish. Even if it never pays a cent, it’s bad policy.


Other investors – again, this is a bit of a pipedream. I have seen a lot of commentary and speculation on this by supposed “market experts” (at least the media tells me they are) but they talk about such ridiculous ideas it is hard to take them seriously. One article suggested Cenovus as a buyer – um, no, they are a producer, not a pipeline company. Work with me people. There is no one lined up to do this project. They all had the chance before the IPO to buy it and no one did – it ain’t a better deal now, I can assure you. Anyway, in all seriousness, there are four companies domiciled in Canada with the mainline experience to run this project and asset.

  • Enbridge has their hands full working on Line 3, selling assets to reduce debt and restructuring to keep shareholders happy. Not going to happen.
  • TransCanada is currently building gas pipelines all over North America and will, hopefully, soon issue an FID on Keystone XL for which they have almost all the required approvals. Why take on a TMX that is in direct competition with what you are trying to achieve with KXL?
  • Pembina and InterPipe. Two great companies with capable management teams, great cash positions and good assets. However, both are in the process of building petrochemical facilities and neither have the mainline experience the big transmission companies have. This type of project would be way too risky for them to take on.


Let Alberta buy the project. Well, Alberta can probably afford it and there is no doubt it’s in their interest to do so, but provincial ownership doesn’t address the BC issue.

Hope BC comes around – this is the preferred alternative but a lousy strategy. It’s not going to happen anytime soon. The government is 12 months into its mandate and 6 months away from the first recall opportunity so the coalition holds. There is NO WAY that Andrew Weaver and the Greens let Horgan go on this file. Which brings us back to Kinder Morgan pulling the pin without an alternative.


Conclusion? The Feds need to buy “it”. The only way to get BC onside is to give them no choice and no voice.


And by it, I mean all of it. All of Kinder Morgan Canada. They will own all the existing pipeline assets, storage assets, laterals, gathering facilities, people, knowhow, expansion projects – the whole kit and caboodle.


Aside from a lot, how much will it cost?


Hard to say how much it will cost. But we can guess at how much it should cost. Why? Because Kinder Morgan Canada is a publicly traded entity. The market cap for 30% is $1.75 billion implying an enterprise value of about $6 billion give or take a few hundred million.


There is no way Kinder Morgan goes easy into the sunset (see – even I’m calling them greedy now!), so there will need to be a premium. I’ve heard someone suggest that it would cost $7.4 billion to buy them but I’m not sure where that comes from, perhaps that’s applying the Kinder Morgan parent multiple to the Canadian company, but at the EBITDA levels reported that’s a premium valuation over TransCanada so not sure how much more makes sense.


No, the value of the company is its existing assets plus the goodwill of the permits granted with respect to the expansion and this is reflected in the share price. In my view, the value of that permit is debatable for a number of reasons, not least of which is that Kinder Morgan has indicated a willingness to walk away from it – so how much do they even think it’s worth? In addition, the value of that permit is either all or nothing depending on the whims of the Federal government, so there is no reasonable scenario where they (Feds) should pay a big premium for something whose value they created in the first place.


So, maybe a small but reasonable premium, to reflect the costs incurred to date (which have largely been paid already) and the goodwill. Let’s call it 10% and round the price up to $6.6 billion.


So, $6.6 billion plus the $10 billion costs to complete less the $5.5 billion in committed loans from Canadian banks that I am sure will be more than happy to lend to a Crown Corp less the $1 billion already spent and what you have is $10.0 billion in taxpayer money invested in an operating company that is building an expansion. An expansion that can now actually happen because you’re the Federal government dammit!


And you know what else? Since I’m the Federal government, I’m going to cut a bunch of these intransigent First Nations in on the action and set aside a healthy chunk of actual equity for affected bands to purchase – or maybe I’ll just hand it over.


And once the pipeline is built? What then? Well then you sell it. For how much? I don’t know, but the modelled EBITDA for the whole show is about $1.2 to $1.5 billion, so using the same multiple (because why not) you get an EV for the Pierre Trudeau Memorial Pipeline company of around $12 to $15 billion – at least. So a positive return. Maybe at this point it sells to one of TransCanada or Enbridge. Maybe Pembina or InterPipe steps up. Heck, you might even take a call from Kinder Morgan!


The point is that the federal government takes a lemon and makes slightly less sour lemon juice that can fake it as lemonade because the alternatives – a goofy indemnity, a permanent investment blackeye, no pipeline – are so completely unpalatable that this seems almost elegant in comparison.


Look, I get all the “taxpayer money” and “boondoggle” anti-nationalizing rhetoric. And I believe it. But I also believe that in order for “this pipeline will be built” to be anything more than a campaign slogan the Federal Government needs to boldly go where all governments want to go anyway and with finality exercize its power. Use the nuclear option.


Buy the whole thing. Nationalize it. Build it. Sell it.


I know there’s more detail, like excluded assets and all that jazz, but it really is that simple.


It’s a $10 billion boondoggle that will lose some Liberal seats in BC, is guaranteed to keep existing seats in Alberta, gain/preserve seats in Sask/Man and gain seats in Ontario. The Liberals will take it on the chin but will get their pipeline, their carbon tax, rehang the open for business sign and, most importantly for them, likely secure another term as majority government in Canada.


Trudeau? Morneau? Carr? Are you reading any of this? I actually have a lot of lunches at stake.


Prices as at May 25, 2018 (May 18, 2018)

  • The price of oil held rose during the week as Trump quit the NK summit, but fell at the end on potential OPEC supply increases
    • Storage posted an increase
    • Production was up marginally
    • The rig count in the US was mixed
  • After a larger than expected injection, natural gas gave up some ground then rallied thru the end of the week…


  • WTI Crude: $67.88 ($71.23)
  • Nymex Gas: $2.939 ($2.836)
  • US/Canadian Dollar: $0.7709 ($ 0.7769)


  • As at May 18, 2018, US crude oil supplies were at 438.1 million barrels, a decrease of 5.7 million barrels from the previous week and 78.2 million barrels below last year.
    • The number of days oil supply in storage was 26.4 behind last year’s 30.2.
    • Production was up for the week by 2,000 barrels a day at 10.725 million barrels per day. Production last year at the same time was 9.320 million barrels per day. The change in production this week came from a drop in Alaska deliveries and a increase in Lower 48 production.
    • Imports rose from 7.601 million barrels a day to 8.159 compared to 8.294 million barrels per day last year.
    • Exports from the US fell to 1.758 million barrels a day from 2.566 last week and 0.625 a year ago
    • Canadian exports to the US were 3.493 million barrels a day, up from 3.474
    • Refinery inputs were basically flat during the week at 16.628 million barrels a day
  • As at May 18, 2018, US natural gas in storage was 1.629 billion cubic feet (Bcf), which is 23% lower than the 5-year average and about 33% less than last year’s level, following an implied net injection of 91 Bcf during the report week
    • Overall U.S. natural gas consumption was down 1% during the report week
    • Production for the week was flat. Imports from Canada were up 3% compared to the week before. Exports to Mexico were down 1%.
    • LNG exports totalled 18.8 Bcf.
  • Can you say “Break-up”? As of May 21 the Canadian rig count was 85 – 67 Alberta, 2 BC, 15 Saskatchewan, 0 Manitoba and 1 elsewhere. Rig count for the same period last year was actually higher.
  • US Onshore Oil rig count at May 18, 2018 was at 859, up 15 from the week prior.
    • Peak rig count was October 10, 2014 at 1,609
  • Natural gas rigs drilling in the United States was down 2 at 198.
    • Peak rig count before the downturn was November 11, 2014 at 356 (note the actual peak gas rig count was 1,606 on August 29, 2008)
  • Offshore rig count was unchanged at 18
    • Offshore rig count at January 1, 2015 was 55
  • US split of Oil vs Gas rigs is 80%/20%, in Canada the split is 70%/30%



  • The BC Supreme Court struck down an appeal by the City of Vancouver and the Squamish First Nation to have the BC Environmental certificate for the TMX invalidated.
  • Keyera Corp.  that it has entered into an agreement to acquire a logistics and liquids blending terminal located near Tulsa, Oklahoma for $90 million.
  • TransCanada Corporation announced that the National Energy Board (NEB) has recommended the federal government approve a variance to the previously issued North Montney Mainline Project certificate, which would allow construction to start on the proposed $1.4 billion natural gas project in northeast British Columbia.
  • The British Columbia government filed a constitutional lawsuit Tuesday countering an Alberta government bill that would limit fuel being sent to the province
  • Maduro won the Venezuelan election
  • Trump Watch: North Korea! 25% tariffs on all foreign vehicles! Canada is “spoiled”. Oy.
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