A High-Powered Legal Team For Canada's Growing Energy Sector

Monday, October 1, 2007 - 01:00

Editor's Note: Canada's energy industry is booming. A sharp increase in demand is pushing governments and private industry to find new ways to generate more electricity fast. In this interview, we talk to two Heenan Blaikie partners about key developments in Canada's energy sector.

Editor: Gentlemen, would you tell us about your practices?

Abdel-Aziz : I'm a partner in Heenan Blaikie's Toronto office. My principal focus is in the energy and environment sectors, in which I have acted as counsel principally to clients in the petroleum and electrical generation areas, with a focus on nuclear.

Black : I'm a member of Heenan Blaikie's Executive Committee. With Calgary as my home base, I've worked exclusively in the energy field, both in private practice and as in-house counsel.

Editor: What is driving the dramatic increase in demand for energy generation capacity across Canada?

Abdel-Aziz: The most noticeable rise in demand is in Ontario, Alberta, and likely New Brunswick.

Ontario's electricity infrastructure deficit is looming large for government and industry. Province-wide consumption has grown substantially, but net generation capacity has been virtually frozen for over 10 years. There is significant pressure on the government to replace coal-fired generation, which supplies 20% of Ontario's power. The older portion of the nuclear fleet, which supplies half of Ontario's load, is nearing the end of design life. A serious gap of about 10,000 MW is forecast by 2025. Power generation projects ranging from green energy to nuclear power generation plants are underway. This is the beginning of a significant economic activity in Ontario's energy sector.

Alberta's established oil reserves are second only to Saudi Arabia. Oil sands bitumen and synthetic crude oil are projected at 80% of Alberta's production by 2013. Mining, extraction and upgrading activities necessary for the development of the oil sands resource require huge amounts of power. The next "big play"' will develop the relatively vast reserves found in Devonian carbonates, which is not commercially developed yet. It will require more energy-intensive technologies. Population growth in Alberta - driven by the success of the oil patch - is also straining the existing generation infrastructure. Plain and simple, more electricity is needed for the grid. Industry is pushing ahead with a proposal for nuclear power generation as an alternative to natural gas, which is regarded as unsustainable in the long run.

New Brunswick is looking beyond its own generation needs. Earlier this year, it signed a memorandum of understandingwith Maine to work toward common market rules and shared generation and transmission infrastructure. The government of New Brunswick regards this as the first step towards expanding the province's electricity exports to Maine and the rest of New England. New Brunswick is undertaking a feasibility study for new nuclear power generation capacity.

Editor: With the demand for increased power, what is the mood in Canada toward "greener" energy sources?

Abdel-Aziz: As a backdrop to what's happening in Canada, we have to look to the World Energy Council's statements on the ability of green energy (other than nuclear) to meet global energy demand. It is looking at a maximum best case scenario of just 2% to 3% of total demand being met by all forms of alternative energy combined. And some forms of alternative energy are more difficult to implement in Canada because of terrain and climate.

In the Clean Energy Standard Offer Program, the Ontario Power Authority recently announced preferential rates for small, clean energy generation projects (under 10 megawatts). And there has been substantial financial support from the federal government for clean energy technology. So there is a growing alternative power industry - and it is growing in both commercial and political importance in Canada.

Nevertheless, the national generation capacity gap will have to be met by more traditional power generation methods - principally fossil fuels and nuclear. The international and Canadian global warming policy agenda favor low emission technologies. This makes nuclear an important technology, to which governments in Canada are increasingly prepared to commit. In Canada, there is a reasonably broad-based acceptance of nuclear energy as a viable and environmentally safe alternative.

Editor: Are decisions made on generating energy and environmental concerns wrapped more tightly together in Canada than in the U.S.?

Abdel-Aziz: I think the answer is likely, yes. Public support for implementation of the Kyoto file has put the greenhouse related impacts of energy intensive technologies under closer scrutiny. It is not possible in Canada right now to consider electrical generation without environmental considerations being a significant part of the planning process.

Editor: How are new generating facilities being financed? Are public-private partnerships or P3s common?

Abdel-Aziz: Increasingly in Canada, P3 is an important and growing method by which governments address public infrastructure needs. For example, earlier in the summer, Infrastructure Canada announced a $33 billion "Building Canada" infrastructure plan and expressed a strong preference for public-private partnership vehicles to meet financing requirements. The benefits of P3s are that they enable private industry and the financial markets to do what they do best - manage financial and project risks. Government can then do what it does best - define policy priorities.

Both Alberta and Ontario have seen proposals from private entities to build and operate nuclear power generation capacity, as well as a public-private consortium comprising the principal vendor and project management team for domestic nuclear new build. The obvious public policy drivers for energy infrastructure, coupled with large capital requirements and the need for significant project risk management expertise, suggest that the P3 model will help close the power generation capacity gap.

Editor: Focusing on Alberta, what are the key issues facing the energy sector?

Black: The first - and most significant - issue is the tax on income trusts. An income trust is a similar vehicle to the master limited partnership used in the U.S. Last fall, Canada's federal government announced the elimination of the tax treatment on income trusts by 2011. That literally caused an overnight market cap reduction in the income trusts of say 15% to 20%. The market value has not been reclaimed, so there's been permanent unit value erosion to the energy trusts. It also resulted in a slowdown - essentially a freeze - in M&A activity in the energy business. The flip side is this is now presenting buying opportunities of arguably undervalued trusts for non-Canadian companies.

The trust issue has also severely slowed down the junior oil and gas companies and the start-up oil and gas market. Historically, their business plan was to grow up to a certain threshold - say the equivalent of 5,000 barrels of oil per day - and then look for an exit strategy to be bought out by a trust. That game plan is over. Without income trust buyers, these companies have to try to achieve sustainable growth as a "regular" company.

The second issue is that natural gas prices are at a two- or three-year low - just half of what they were 18 months ago. What's causing this significant erosion in gas prices? Weather is one explanation. The last two winters were significantly milder than average and this past summer was cooler. The heating and air conditioning markets in North America are typically big consumers of gas, so unseasonably warm/cool weather has decreased gas consumption demand. Second, gas production is up because of record gas drilling in the U.S. Rocky Mountains. Record gas storage levels have also dampened prices by fulfilling short-term demand with stored gas supplies. Finally, the growing LNG (liquefied natural gas) imports coming into North America are softening gas prices. Currently, about 1.6 billion ft3 of LNG is imported into the U.S. daily, but this will rise to up to 8 billion ft3 /day by 2010. That will have a huge impact on Canadian gas exports to the U.S.

Soft gas prices have also had a significant ripple effect on the oil and gas service business - companies who deliver drilling and completion services. That industry is getting hammered and since many of these service companies are also trusts, they're experiencing the double whammy of the effects of the tax on trusts plus the significant slowdowns from low gas prices.

Editor: But what about the Alberta boom we keep hearing about?

Black: For sure the Alberta boom is occurring with respect to the oil sands. There is massive capital investment - tens of billions of dollars - in the oil sands. The absolutely huge manpower requirements have resulted in dramatic labor shortages throughout the province in all sectors, particularly the construction and service industries. So contrary to this boom perception, the conventional sides of the non-oil sands industries are facing real challenges.

The non-oil sands sector - upstream oil and gas, the midstream business and the oil fields services sector - are all ripe for consolidation. A rule of thumb in the Western Canadian basin is the dollars paid per flowing barrel of oil equivalent (BOE). BOE prices are certainly down. Two years ago, deals were being done at say $100,000 per BOE but some recent transactions are happening at around $50,000 per BOE. Frankly there are numerous acquisition and consolidation opportunities in the Western Canadian basin.

Editor: Is Alberta still a good investment for American companies?

Black: Yes. Alberta's original oil boom in the 40s was effectively led by American companies. Over the years, there's been an ebb and flow of U.S. investment. Large American companies like Apache, Burlington, Anadarko, ConocoPhillips and Devon, have invested billions of dollars in the past decade. This investment has slowed down recently, but given the current state of the industry, this is likely becoming another reentry point for American companies.

The oil and gas business is global, so the opportunities in Alberta are not limited to Americans. Two huge, world-class oil and gas companies - Statoil (a Norwegian company) and Total (a French company) - have recently invested millions of dollars in the oil sands. The most current foreign investment is from the Abu Dhabi National Energy Company, referred to as TAQA, which is proving to be one of the most voracious acquirors of Canadian oil and gas assets. We acted as Canadian counsel for TAQA in its acquisition of Calgary-based North Rock Resources for US$2 billion in May and now we're closing the transaction for TAQA to acquire Pioneer Resources for US$540 million. TAQA has publicly stated its intention to spend billions more in Canada.

Editor: Any final thoughts?

Black: The recent TAQA acquisitions in Alberta are cutting-edge. This appears to be the first time that a major Middle East oil and gas company has begun significant buying in the Canadian oil patch. This is a fascinating global energy growth story.

Abdel-Aziz: I think the most interesting development is that the heart of oil production in Canada - based in Alberta - is actively seeking nuclear power plants. I see that as a historically significant development. Particularly because the end buyers of the electricity generated will be the oil companies. To my mind this development reflects the growing role of environmental considerations, the ever increasing importance of the oil sands and the carbonate zone, and the maturity of nuclear power generation technology on the world stage in general and Canada in particular.

Please email the interviewees at aabelaziz@heenan.ca or mblack@heenan.ca with questions about this interview.