KINDER MORGAN WATCH

Oct 2008
Source: Oilweek Magazine

Opening the door

Pipelines are lining up again to satisfy Asia's growing thirst for Canadian crude oil

by Andrea W. Lorenz

http://www.oilweek.com/articles.asp?ID=606

For Canadian oilsands producers, the door to the Far East is still closed. If one of two pipeline giants succeeds in building a line to Canada´s West Coast, that door will swing wide, opening Canadians to a new world of customers.

Enbridge Inc. and Kinder Morgan, are vying for the opportunity to build a line that would transport heavy oil produced from Canada´s oilsands across rugged, often mountainous terrain to the British Columbia port of Kitimat.

One reason producers are eager to access Asian markets is the discount that they are forced to take because they can only sell to one customer: the United States. Tanker vessels, on the other hand, can travel to ports across the seven seas, allowing companies to sell for competitive prices.

Oilsands producers with Asian owners, such as Husky Energy and Japan Canada Oil Sands (JACOS), are particularly interested in backing a West Coast pipeline.

Majority-owned by Hong Kong-based billionaire Li Ka-shing, Husky would like to diversify its customer base, and company president John Lau has indicated full support for the idea of a West Coast pipeline. "The project is very important from a Canadian oil producers´ point of view," he told Oilweek. "It can help by providing an additional export outlet. Then you won´t be subject to the U.S. as the one buyer."

Given the spiralling cost of steel, labour, and construction, only one such pipeline can be built in the time frame proposed (starting in about 2015), and each company´s proposal has advantages the other lacks.

Their first challenge is to secure the commitment of a sufficient number of shippers. Recently, Enbridge´s confidence was buoyed by confirmation from a group of Canadian producers and Asian refiners that they want such a pipeline to be built.

Like Enbridge, Kinder Morgan wants to secure backing for its proposal, and in his presentation to the TD Newhouse Oil Sands Forum in July, Kinder Morgan Canada president Ian Anderson made his company´s case forcefully: "Asia is the new focus for energy producers worldwide. Canadian crude must access new markets or face massive discounts and lower production targets."

Making the case
Given the limited pool of shippers, the two companies are competing for support for their proposals. Enbridge, for its part, has waged a sophisticated public relations campaign that has planted its 400,000 barrel per day Northern Gateway Pipeline concept in the imaginations of both shippers and investors. In the past year, the company has secured an unequivocal indication of interest from heavyweight backers, surprising even optimistic supporters.

At the end of July, Enbridge CEO Patrick Daniel informed investors that "belief in the project is so strong that we have obtained $100 million of funding from a group of western Canadian producers and East Asian refiners to get the project to regulatory approval. The support from Asia for Gateway is broad based and now includes refinery support from Singapore to Japan."

Despite Enbridge´s success in securing interest in its proposal, there is no guarantee that it will be the one to open the door to the Far East. It faces strong competition from its rival. "We´ve always had the vision of increasing capacity to the West Coast," Kinder Morgan´s Anderson told Oilweek. It is an opportunity begging to be seized. Consumption by Asian countries is projected to grow by 550,000 barrels per day over the next eight years, he said.

Several heavy oil producers are already shipping limited amounts via Kinder Morgan´s Trans Mountain Pipeline to Vancouver port facilities, with a goal of "encouraging Asian markets to develop a taste for Canadian crude," said Anderson. Last year, these included ten tanker loads, two of which travelled to Japan while the rest sailed to China.

Until recently, Kinder Morgan has been relatively quiet about its plans and seems to have just woken up to the fact that it needs to give them more air time. The fact that Kinder Morgan already has pipe in the ground has allowed it to sit on its heels a bit, while Enbridge has worked hard for the past year to secure the interest of shippers.

"Kinder Morgan is very conservative," observes JACOS executive vice-president Yukio Kishigami. "They have a wait and see approach. Enbridge has been much more aggressive in inviting shippers."

Its project involves increasing capacity on its existing Trans Mountain line and adding a new portion, known as the Northern Leg, that would deliver 400,000 barrels per day to the port of Kitimat.

Competing behind the scenes
A year ago, Enbridge´s $4.2-billion Northern Gateway project suffered a body blow when the Chinese national company PetroChina announced that it was cancelling its support because progress was too slow.

Since then, according to an informed source, the Chinese government has reversed its position and is once again backing Enbridge´s proposal. This was revealed, he said, by the competition amongst buyers for "founder shipper" status on the Gateway line.

The process by which Enbridge secured the $100-million commitment from shippers and refiners was to sell ten units, or "founder-shipper" placeholders, for $10 million each. Companies that purchased the units would be charged lower tariffs and offered priority in booking capacity on the line.

Kishigami says his company, which is 88 per cent owned by a Japanese government corporation, did not have the chance to buy a unit because they were all gone by the time he was given approval from Tokyo to buy one. "I misjudged how popular those units would be," he admits.

"I thought we could buy at any time, but when I called Enbridge, they said, ‘I´m sorry, Yukio; we´re all sold out.´"

JACOS´s disappointment at not acting in time to ensure it received founder shipper status points to behind the scenes competition between China and Japan to secure a long-term source of Canadian oil. "We don´t see any Chinese name on the surface. However, it is behind the scenes," says Kishigami. Since Chinese pride was singed by U.S. Congressional refusal to allow CNOOC to purchase Unocal in 2005, Chinese national companies have been careful to work discreetly in North America.

The Japanese, for their part, depend on Middle Eastern suppliers for 90 per cent of their oil, a position their government is keen to change. A Canadian pipeline that would provide a corridor for shipment of heavy oil from JACOS´ 10,000 barrel per day Hangingstone SAGD (steam assisted gravity drainage) operation would give the country a supply of oil from a new source.

Yet although the Japanese government realizes that the composition of future shipments of oil will be increasingly heavy, they have converted only a handful of their refineries to enable them to process heavier grades. Fewer than five Japanese refineries-out of a total of over 50-are capable of doing so. Be that as it may, the government now recognizes that it must prepare for a heavy oil future and is offering tax incentives to encourage refineries to re-engineer.

All is not lost, and JACOS may still have the chance to become a founder shipper on Gateway. Enbridge vice-president of Public and Government Affairs Steve Greenaway told Oilweek the company is considering selling more units. "We´re looking at ways to accommodate other third parties who are showing interest."

Kinder Morgan tests the market
As for Kinder Morgan, when it tested the commitment of potential shippers in 2006, it met with less positive results. Through the process of a "forward binding open season" the company offered shippers take-or-pay contracts for terms ranging from 5 to 25 years.

It proposes increasing capacity on its Trans Mountain line between Edmonton and Vancouver/Washington State to 380,000 barrels per day from 300,000 barrels per and adding a 760 kilometre northern leg to Kitimat. The Northern Leg would traverse an existing utility corridor traveling part of the same right-of-way as Gateway, and the end result would be total capacity of 400,000 barrels per day.

The 2006 offer met with only lukewarm approval, however. "While we did receive a significant amount of support," says spokesman Norm Rinne, "for numerous market reasons we failed to meet a minimum volume threshold that would have allowed us to justify the expansion cost."

So far, Kinder Morgan has kept interest in its project alive through informal talks with shippers, said Anderson. "A year and a half ago, when Chinese national oil companies were here looking to line up supply, we were in discussions with them regarding the scope, timing, permitting, and cost." However, he added, "We don´t have agreements with any Chinese interests, although we have had MOUs [memorandums of understanding] with Chinese groups with respect to sharing information and plans."

Although it may have lagged behind Enbridge in presenting its plans to the public, Kinder Morgan has an important advantage over its competitor. Trans Mountain is the only pipeline currently transporting heavy oil from Alberta to the West Coast. Built in 1953, the 1,150-kilometre line now has the capacity to carry 300,000 barrels per day, between 20 and 25 per cent of which is heavy crude.

Among the challenges both companies face is winning the approval of more than 40 First Nations along the route. Kinder Morgan claims to be ahead of Enbridge on this front. "The advantage for us," says public affairs officer Philippe Reicher, "is that we´ve been in B.C. for 50 years."

For JACOS, alternative proposals to build heavy oil pipelines to the U.S. Midwest and Gulf Coast are less attractive than a West Coast-bound line, says Kishigami, because they will still mean accepting a discount. Echoing Husky´s Lau, he says, "Tanker vessels can go anywhere, but a pipeline goes to a fixed market. You have no choice but to sell to that market." Unless they swing open the door to Asia, Canadian suppliers will continue to be trapped in what he calls a "very fragile marketing situation." With a wry glint in his eye he points out the ironic fact that while Canada takes a discount on the oil it exports because it can only sell to one customer, Japan pays a premium on the oil it imports because it can only buy from one source.