Brian Tobin is vice-chair and Aaron Engen is managing director and co-head of power and utilities for BMO Capital Markets.
The natural gas deal of the century is done – finally. After years of negotiations, Russian natural gas giant OAO Gazprom and China National Petroleum Corporation reached a 30-year agreement under which the Russian company will reportedly supply CNPC with 3.7 billion cubic feet a day of natural gas.
As that news broke, many people began wondering whether the giant Sino-Russian deal signals an end to Canada's hopes for liquefied natural gas (LNG).
The simple answer is no. The deal was a natural fit and it was expected that the two countries would eventually reach agreement. China is close to reserves in eastern Russia, reserves that are too far from European markets. Both countries needed diversification and China's economic growth demands significant increases in natural gas supply. The economic laws of nature demanded it be done.
But as large as it is, the deal does not mean Canadian LNG opportunities are going to disappear. There is no cause for panic. Canada still represents an attractive source of natural gas for China at competitive prices. Although Russia will become an important source of gas for China, it will not be the only new source. The Chinese are comfortable with Russian-sourced gas as part of their global supply portfolio, but wary of relying too heavily on one source. They continue to develop additional sources of supply that include LNG from Canada. Frankly, China understands the need for energy supply/market diversification in a way that Canadians never concerned themselves over, at least until U.S. procrastination over the Keystone XL pipeline.
As we consider the impact of the deal on Canada's LNG projects, we must remember that context is everything. CNPC is just one of many Chinese companies that acquire or are looking to acquire LNG globally. Almost all are considering Canadian LNG projects and several have already made LNG-oriented investments here. Chinese interest in Canadian LNG stretches across numerous industries, including oil and gas, power generation, gas distribution, chemical production and manufacturing.
As evidenced at last week's 2014 International LNG in B.C. Conference held in Vancouver, the deal has not affected Malaysian, Japanese, South Korean or Indian interest in Canadian natural gas. In discussion after discussion, representatives from such countries were interested, and unfazed by the Sino-Russian deal.
But none of this means Canadians can go back to sleep comfortable in the knowledge that a Canadian LNG industry will be developed. Given time, the deal and others like it could shut us out of the global market. Canada must move quickly to assist in the development of a robust LNG industry. Getting there requires government and industry to deal with critical issues facing development.
Not surprisingly, the first, and currently the most important issue, is taxes – direct and hidden. Provincial and federal tax regimes must be clearly delineated and set at levels that will allow LNG sponsors and investors to earn appropriate returns on capital. Project developers are not bluffing when they say that if Canada gets the tax equation wrong, LNG projects will not proceed. Capital moves freely around the globe and is attracted to projects with the highest risk-adjusted returns. Canada is a low-risk country, and for that, developers will accept modestly lower returns on Canadian LNG projects. But here is a limit to the cost pressures projects can bear before they move elsewhere.
Second, Canada needs to develop and implement a feasible and workable framework for dealing with non-project concerns. Obtaining "social licence" in this country is a bewildering and challenging experience for both Canadians and foreigners. At its heart, the need demonstrates lost confidence in Canada's regulatory institutions, which should be ensuring that the public interest, widely defined, is protected when infrastructure projects are reviewed. When stakeholders come to believe that regulatory policies, procedures and institutions are unable or unwilling to protect their interests, they naturally turn to extrajudicial alternatives for protection and support. This needs to change.
And then there are the new rules for investing in Canada. They are seen as unclear and discriminatory and have fuelled Chinese mistrust. Chinese firms historically interested in significant energy-sector acquisitions have put a hold on such strategies, believing they are the target of Canada's new foreign investment rules. Luo Zhaohui, China's new ambassador to Canada, pointed out to The Globe and Mail earlier this month that his country does not fully trust Canada. At issue was Canada's new "negative" foreign investment rules.
China can be hardly blamed for such views. The new rules are confusing and subjective enough that it is difficult for foreigners or Canadians to know how they will be treated with any reasonable measure of certainty. So for now, the Chinese prefer to watch someone else take the first run through the new rules. The outcome will give the Chinese a benchmark against which they can measure how they should be treated if they venture into new, major investments in Canada.
To support Canada's global LNG aspirations, Canada's foreign investment rules need to be clarified. Only then can they support attracting capital to an LNG industry that will require tens, if not hundreds of billions of dollars in investment. And through that, Canadians will benefit from a growing and stronger economy and a better standard of living.
The Sino-Russia deal is not a death knell to Canada's LNG prospects. It is a wake-up call to improve the environment in which we hope to see the LNG industry flourish and compete globally.