The view from Taxpayer Mountain

June 20, 2018 - It has been a few weeks since the Canadian government’s stunning announcement that it would buy the embattled Trans Mountain pipeline and expansion project from

Kinder Morgan for C$4.5 billion. Since then, hundreds (if not thousands) of articles, news stories, analysis, satire and commentary pieces have been produced. In this blog post we try to

answer some of the most common questions we’ve received about the purchase, and what it means moving forward.

1. So, what the #$&% happened?

After Kinder Morgan announced on April 8, 2018 that it was suspending non-essential spending, and set the May 31 deadline to achieve political certainty, the Canadian government entered into negotiations with the company. When it became clear that Kinder Morgan was ready to abandon the project, because it no longer made economic sense, the discussion became about the nationalization of the pipeline and expansion project.

The announcement that Canada was bailing out Kinder Morgan is actually Plan B of the agreement reached behind closed doors in Houston and Toronto. Plan A is that Canada and Kinder Morgan will continue to look for a private sector buyer until July 22, 2018. If no buyer is found, then Canada will begin the process of buying the pipeline for $4.5 billion.

Analysts disagree on whether a buyer can be found, and at what price. One former oil industry insider stated: “It’s very difficult to imagine anyone else stepping up where Kinder Morgan feared to tread.”

Photo Credit: The Building of Trans Mountain: Canada's First Oil Pipeline Across the Rockies by Neill C. Wilson, Frank J. Taylor

2. What did Canada buy?

According to the Purchase Agreement, the deal includes:

• The existing 65-year-old Trans Mountain Pipeline system, including pipeline affiliated facilities like pump stations and storage tanks.
• The Trans Mountain Expansion Project (ie. The plans and existing approvals and permits to build the expansion).
• The Puget Sound Pipeline System, a 111-km pipeline that runs from Sumas to Anacortes in Washington state.

Kinder Morgan keeps:

• Leased merchant tanks within Edmonton Terminal
• North 40 Terminal
• Edmonton Rail Terminal
• Alberta Crude Terminal
• Base Line Terminal
• Vancouver Wharves
• Jet Fuel pipeline

Many of Kinder Morgan Canada’s employees will also transfer over to the new owners, expected to be a newly formed Crown Corporation.

3. What is the potential cost to taxpayers?

Canada has agreed to pay $4.5 billion for the assets listed above. That number could increase or decrease based on adjusted estimates closer to the closing date.

In addition to the purchase price, Canada has agreed to cover Kinder Morgan’s construction costs up until closing date, and will be responsible for future construction costs of the expansion.

According to economist Robyn Allan’s estimates, the total cost, including construction could be $15 to $20 billion – that includes the $4.5 billion purchase price; the cost of construction (likely north of $9 billion); the $2.1 billion liability fund required by pipeline owners under the National Energy Board Act as amended by the Pipeline Safety Act; and the $1.5 billion Oceans Protection Plan.

4. What did Kinder Morgan gain?

It appears that Canada paid a premium for the vintage pipeline, which Kinder Morgan valued at $550 million in 2007. Since then, some work has gone into the pipeline, including the Anchor Loop expansion.

Kinder Morgan stated that it was ‘very pleased’ with the deal, which will result in $1.5 million bonuses for Kinder Morgan Canada executives.

According to Kinder Morgan’s 8-K securities filings, its net of tax capital gain is $2.7 billion (ie. the amount the company expects to make from selling its properties for more than it paid for them). A Royal Bank analysis estimates that Canada overpaid by about $1.2 billion. It is impossible to know exactly how much Canada overpaid because we don’t know the full price of construction, and any future revenues are speculative.

5. What motivated the sale?

The official line has been that the Canadian government believes that the Trans Mountain project is in the national interest, and its completion is important to the Canadian economy and investor certainty. To justify the purchase, Federal Finance Minister Bill Morneau continues to reinforce the myth that Canada’s oil industry needs tidewater access to get a better price.But why would Canada pay such a premium for a project and assets that Kinder Morgan no longer wanted?

Some have speculated that the deal was motivated by the threat of a suit under NAFTA or the Canada China FIPA deals. Unfortunately, we may never know how those trade agreements influenced the Canadian government because of their secret (and frankly, anti-democratic) nature.

6. Does it change the legal challenges?

The 14 outstanding cases before the Federal Court of Appeal (FCA) aren’t changed by the nationalization of the pipeline. The appeals were always focused on the federal government’s decision to approve the project, so a change in ownership doesn’t change that. The primary difference is that Canada now bears the legal and financial risk if the FCA quashes the federal approvals.

As was the case before the nationalization, if the FCA overturns the project’s approval, the federal government will have the opportunity to try and correct the legal errors, and make a ‘fresh’ decision. That, at a minimum, would result in further delays and could result in new conditions or even a reversal of the approval.

In fact, it could be argued that having the Canadian government own the project increases the depth of its duty to consult affected First Nations – and this constitutional duty to consult is the basis of the ongoing FCA cases brought by Indigenous nations.

In addition to these existing cases, Canada will face many future decisions as the pipeline owner that could result in further legal challenges from First Nations. The Canadian Charter of Rights and Freedoms (which applies to government actors, but not directly to private corporations like Kinder Morgan) may also raise additional legal issues once the government owns the pipeline.

Similarly, the BC reference case – which asks the courts whether the province has the authority to regulate heavy oil shipments – will continue despite Canada’s purchase. The reference case question remains up in the air, despite Alberta Premier Rachel Notley’s assertion that crown immunitywould limit the power of provincial laws on a federal project.

Laws of general application still apply to Crown Corporations: for example, Canada Post still needs to comply with provincial motor vehicle laws. The jurisdictional issues around paramountcy and interjurisdictional immunitythat were always at play are not answered by who owns the pipeline. This is in part because BC’s proposed legislation would regulate the transportation of bitumen by any means, not just Trans Mountain.

7. What does it mean for regulatory permits and process?

The National Energy Board (NEB) may have to approve the sale of Trans Mountain, once it is finalized. The NEB also needs to approve the transfer of the regulatory certificates, including the 157 conditions that apply to the project’s approval. Prime Minister Trudeau repeatedly stated that these conditions were ‘legally binding’ when defending his approval.

Kinder Morgan has already tried to get out of some of the conditions, and violated multiple permit conditions. One would expect that at a minimum, Canada would meet the already inadequate NEB and permit conditions. But the government’s pipeline cheerleading also raises conflict of interest issues about the NEB and other bodies enforcing conditions and violations against the federal government, or Cabinet directing the NEB to relieve or weaken the 157 conditions.

In approving the transfer of the certificate, the NEB could change the conditions, and Living Oceans Society and Raincoast Conservation Foundation recently asked the NEB for clarity on process so that they could make submissions about further conditions.

In addition, the timeline for the pipeline’s completion could be pushed back by as much two years, with over 1,000 permits unresolved, no determined basic route and as many as 25 hearings yet to be conducted. Segment five of the pipeline, which crosses through Nlaka’pamux and Secwepemc territories (Hope to Kamloops, BC) remains under review. Kinder Morgan stated that two rerouting proposals put forward by the Stk’emlupsemc te Secwepemc, if accepted, would add two to four years to the construction schedule.

8. What other approvals are required to finalize the deal?

Kinder Morgan Canada Limited (KML)’s shareholders still need to approve the sale before it is finalized. It is expected that more details about the deal will be included in KML’s proxy statement, which the company will have to file with the Securities Exchange Commission before finalizing the deal.

You may have noticed that the Puget Sound pipeline is included in the deal, meaning that Canada may be the owner of a pipeline that is primarily in the US. The Purchase Agreement requires clearance from the Committee on Foreign Investment in the United States (CFIUS), which could require Presidential sign-off, which is an interesting twist given the recent characterization of Canada as a national security threat. How that plays into the ongoing trade war and NAFTA negotiations remains to be seen, as does the additional US or state regulatory processes that may be engaged by the purchase.

9. Can the Canadian government pull out of the deal?

Yes, in theory. There are seven ways to terminate the sale within the purchase agreement (see section 4.1).

First, Canada has the right to terminate the agreement if Kinder Morgan does not meet its obligations set out in the agreement by the closing date. These 17 conditions include Kinder Morgan meeting warranties and agreements, getting corporate proceedings and documents in order, attaining various federal (US and Canadian) approvals, and securing financial indemnity, as well as the absence of an injunction preventing the transaction.

Second, Kinder Morgan has the right to terminate the agreement if Canada does not meet or it is impossible for them to meet all of its obligations by the closing date. These 10 obligations include Canada meeting representations, warranties and agreements, payment of the $4.5 billion, a guarantee from Export Development Canada for a credit agreement, and approvals for the transaction.

In both of the scenarios above, either Canada or Kinder Morgan can waive the other party’s obligations if they see fit.

Third, Canada and Kinder Morgan can mutually agree to terminate the agreement.

Fourth, Kinder Morgan can terminate the agreement if they can find a better offer from someone else to buy the pipeline, although Canada will have the ability to match the new offer.

Fifth, unless they materially breach the agreement, either party can terminate the sale if it does not occur by December 31st, 2018.

Sixth, either party can initiate a process that could result in termination of the deal if the other party provides new information that breaches the agreement in a way that would make it impossible for them to meet certain specific conditions of the sale.

Lastly, Canada can terminate the purchase if, before closing the sale, any of the assets or parts of the business are damaged or destroyed in a way that causes a “material adverse change.” Notably, the agreement’s definition of a material adverse change excludes a long list of scenarios such as regulatory changes, public protest, sabotage, court delays, war, acts of god or permitting delays.

These seven options for termination are all set out in the purchase agreement, but don’t take into account potential implications of the trade agreements discussed in question 5 above, which could inform Canada’s decisions.

10. What is Canada’s spill liability if the government becomes the owner of the pipeline?

If no other buyer is found, and Canada becomes the owner of the existing vintage pipeline and the expansion, taxpayers will be on the hook one way or another for an oil spill. When the National Energy Board Act was amended by the Pipeline Safety Act in 2015, it placed up to $1 billion in “absolute liability” (ie. regardless of fault) on pipeline owners in case of a spill, and required them to have at least $500 million in cash on hand to deal with spills. This applies to both the vintage line and expansion, so that absolute liability would be up to $2 billion if the expansion is built. Kinder Morgan tried to get out of this requirement because it was inconsistent with its ‘pay nothing’ strategy. Further, the NEB Act places unlimited liability on pipeline owners should they be at fault for a spill.

It is theoretically possible for the Governor in Council (Cabinet) to direct the NEB to exempt them from these requirements, although that would be a massive conflict of interest, with all of the political fallout that would occur from both sides of the political spectrum. Even if that happened, the cost of a spill, its cleanup and long-term effects would still be borne by the public.

Conclusion

We have entered a new chapter in the Trans Mountain pipeline story that is destined to continue for years. The decision to nationalize the project is significant, and rather than dampening opposition, it has only deepened it on the ground – especially in BC.

The view from Taxpayer Mountain is not clear skies and sunny ways. It is a series of storms rolling in on the horizon with no end in sight.