Friday, 29 May 2015

BC and LNG: Better Late or Never

By Mark Jaccard and Tom Gunton
Originally appeared in the Vancouver Sun October 14, 2014

Our LNG discussion has certainly changed from 2013, when Christy Clark’s “Debt-Free B.C.” slogan promised voters huge tax revenues from exporting the “world’s cleanest LNG.” Industry calls the shots today, threatening to invest elsewhere unless government quickly delivers on tax breaks, minimalist royalties, and environmental deregulation. It’s a sobering time.

Increasingly, one hears our government has moved too slowly, just as a prospector arriving too late to a gold rush. But this argument reflects a fundamental misunderstanding of today’s natural gas market. It can have potentially harmful repercussions for our economy and environment. Here is why.

The demand for gas in East Asia (China, Japan, Korea, Taiwan) is certain to grow over the next two to three decades. China is key, as its rising energy demand will favour natural gas over coal, given its increasing concern for air quality and its vulnerability to international pressure as the world’s largest greenhouse gas emitter. But while this region’s gas demand rises, its natural gas prices will fall because of the emergence of many low-cost options. First, there are huge reserves of conventional natural gas in Asia. The recent pipeline deal between China and Russia is sure to be the first of many, eventually including countries such as Turkmenistan, Kazakhstan and Azerbaijan. Second, China has the greatest potential in the world to extract gas from its shale and coal. The country is keen to favour these domestic resources over imports, and production costs will be significantly lower than current LNG import prices. Third, there are many countries — such as Australia, the U.S., and in the Middle East — eager to supply LNG to East Asian ports, several with cost advantages over B.C.
Two years ago, the price of LNG in East Asia was unsustainably high because of the Japanese nuclear shutdown after Fukushima, gas prices pegged to high oil prices, and few LNG suppliers.

With so many options today, the behaviour of gas purchasers is predictable. They are encouraging the development of different supply sources, which strengthens their security of supply and price negotiating position. They are avoiding long-term, fixed price contracts, instead insisting on market-based price indices or timelines for price renegotiation to reflect evolving market conditions.

In this market, suppliers who get there first will not be able to indefinitely lock in high prices. Prices will be adjusted downward over time. What will matter is cost of production relative to competitors. Low-cost suppliers will stay in the game, albeit with reduced profits. Suppliers with high costs will lose money, perhaps eventually shutting down. Getting there early won’t matter much. Production cost will matter plenty. Moving too quickly increases the chances of a boom and bust outcome that leaves communities and the province worse off.

Government sets taxes and royalties close to zero in early years to improve the economics for several LNG projects racing to catch the ephemeral higher prices in Asia. Rapid development of one or more projects causes local inflation that leads to construction cost over-runs, worsening the economics for the projects and downloading more infrastructure costs to provincial and local governments. Then, when prices eventually are adjusted or renegotiated downward, the competitive benchmark is even lower, killing any hope of future government revenues and increasing pressure for industry subsidies just to keep operating.

Memories are short in politics and business. But B.C. had this very experience with the 1980s coal boom, during which unrealistic expectations fuelled excessive expansion that resulted in bankruptcies and losses threatening the viability of coal-dependent communities. Under pressure to minimize costs for what may be marginal projects, governments also downgrade or abandon environmental standards. Only one LNG project will be enough to kill any chance of B.C. hitting its climate target, not to mention the effect on local environments as siting, construction and operating regulations are weakened.

Given these risks of LNG development, caution is essential. Unfortunately, our politicians have been promoting a massive windfall, if we moved quickly.
We can only hope that British Columbians will demand better. It starts by rejecting the gold-rush metaphor, and recognizing that truly competitive projects will eventually find a niche in the growing Asian gas market, and uncompetitive projects will not. Moreover, by rushing development, exaggerating benefits and ignoring risks we increase the likelihood of costly mistakes that will only leave us worse off.

Mark Jaccard and Tom Gunton are professors in SFU’s School of Resource and Environmental Management.

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