$2 billion oil industry subsidy in the making as Trans Mountain files toll application

Somehow, Trans Mountain thinks it’s acceptable to negotiate excessively favourable toll rate terms for its shippers as if Ottawa paid $1 billion for the old pipeline when Ottawa paid $3 billion. If Trans Mountain’s shippers don’t pay for the purchase of the legacy line in tolls charged to them, then Canadian taxpayers will.

This $2 billion industry subsidy comes in addition to the recent revelation by the Parliamentary Budget Office that Ottawa overpaid for the expansion project by $1 billion — and counting.

The toll settlement for the existing pipeline is a negotiated agreement entered into between Trans Mountain and its shippers. Discussions are held behind closed doors and when an agreement is reached, it’s submitted to the NEB for approval. If an agreement isn’t reached the Board would typically hold a hearing. The application Trans Mountain filed early last month includes detailed financial schedules that determine the tolls to transport products on the existing system and, if approved, would be retroactive to January 1, 2019 and continue for three years.

The toll schedules Trans Mountain has filed make it possible for the first time to examine the financial implications of Ottawa buying a 65-year-old pipeline under a scenario that incorporates the price paid for the aging assets and the ongoing financing expense for borrowing the funds needed to undertake the purchase. If the NEB approves the sweetheart deal, not only will Trans Mountain continue to operate at a huge loss, none of the principal on its debt to purchase the assets will be recovered.

The NEB has the authority to approve or reject the application for the toll, or ask Trans Mountain more questions. The Board also has the authority to hold a hearing.

The NEB must reject Trans Mountain’s application and tell Trans Mountain to go back and negotiate a toll agreement with shippers that reflects the terms Finance Minister Bill Morneau promised Canadians — terms that deliver on the promise that buying an aging pipeline was a good deal.

Morneau has the authority and responsibility to protect the treasury and Canadian taxpayers. He could ensure that his officials take steps to direct Trans Mountain to withdraw its industry-biased application because it ignores the Finance Minister’s clear direction that Trans Mountain be managed on commercial terms.

Putting taxpayers on the hook

When the loan principal to purchase the existing system and the ongoing interest expense to carry the debt are considered, it becomes apparent there is a shortfall in revenue from regulated tolls of $2 billion over the three-year term. This is because Ottawa agreed to pay approximately $3 billion for the regulated assets and the commercially negotiated five-year loan securing the funds — which Ottawa borrowed because it runs an annual deficit — carries an annual interest rate of 4.7 per cent or $141 million a year in interest expense.

Amortizing the loan over five years — which is reasonable given the age of the pipeline and the term of the loan — principal recovery required in shipper tolls is $600 million a year. Annual interest expense is $141 million a year. This means a total recovery required of $741 million a year.

Trans Mountain’s agreement with shippers, however, will deliver a return on capital of only $68 million a year (ITS-3). This leaves an annual shortfall in revenue required to cover the purchase of the existing pipeline of $673 million a year, leading to a subsidy of $2 billion over three years. Within five years, the taxpayer-funded toll subsidy on the existing line will reach $3.4 billion.

Trans Mountain has negotiated a deal with its shippers that secures tolls charged to them that are, on average, $6 per barrel less than the tolls required to repay principal and cover interest expense Trans Mountain has agree to cover in its Credit Agreement with Her Majesty in Right of Canada.

When Minister Morneau announced that Ottawa had agreed to buy Trans Mountain’s existing pipeline he called it an “exceptional deal.” He promised taxpayers that the “investment represents a fair price for Canadians” with a “real return on investment.” Morneau stressed that ownership would be temporary and that the terms were reflective of “a commercial deal.”

When a private company buys a regulated pipeline, it will not negotiate a purchase price that delivers a negative return on investment for its shareholders. It will pay a price for operating assets it knows can be recovered in tolls approved through regulatory proceedings. Kinder Morgan behaved this way when it owned Trans Mountain, and this is what Morneau led taxpayers to believe would continue to be the case when he announced the public purchase of private assets with borrowed funds.

Morneau said the “$4.5 billion investment,” of which approximately $3 billion was for the regulated assets, represented a fair price, but it is only a fair price if the shippers who use the existing pipeline (not taxpayers) pay for the assets. If the principal repayment and interest charges related to the purchase of the regulated assets are not passed on in the new toll agreement with shippers, Trans Mountain’s existing system will continue to book significant losses and earn a negative rate of return — hardly consistent with Morneau’s statements.

The opportunity for Morneau to make good on his promise to Canadians is now, before the Board gives the oil sector a $2 billion subsidy in the form of a huge toll discount on the backs of working Canadians. If shippers on Trans Mountain don’t repay the commercially negotiated purchase price for the existing system — as Finance Minister Morneau led Canadians to believe they would — then Canadian taxpayers do.

Why has Trans Mountain ignored its duty to negotiate tolls that cover its cost?

The shippers must have expected to bear the cost of the purchase when Morneau announced it. His assurances to Canadians that Trans Mountain would not only pay for itself but would generate exceptional return would have been understood by these sophisticated oil companies that regularly engage in toll rate hearings.

If oil producers who nominate for capacity on Trans Mountain were concerned about the purchase cost being passed on in their regulated tolls, they could have registered their concern with the NEB and asked the Board to review the purchase price implications before the deal closed.

Why has Trans Mountain ignored Morneau’s directions and designed an agreement that delivers its shippers such a subsidy?

The NEB was aware of Morneau’s promise to Canadians that the purchase of Trans Mountain’s existing system was entered into at a price that represented a “real return on investment” which he characterized as “exceptional.” If the Board had any reason to believe Morneau was misinformed, it was the Board’s duty to advise the Minister.

The Board could have looked into the terms of the deal if the NEB had any reason to believe that the price Canada paid for the existing assets could not be passed on to shippers as Morneau promised would occur. The NEB must have expected that, when Trans Mountain submitted its toll application, it would result in tolls to shippers that honoured Morneau’s assurances to Canadians about the commercial soundness of the deal.

In response to Trans Mountain’s Application filed January 4, the NEB released a letter on January 11 asking interested persons to file comments on it, and to state their position regarding whether it should be approved and reasons for that position.

On behalf of the public interest, I filed a detailed brief on January 14, explaining to the NEB why Trans Mountain’s Application results in a huge taxpayer subsidy that the federal government promised would never take place.

I also informed the Board that approving Trans Mountain’s Application means the private sector will be unwilling to pay much beyond $1 billion for the regulated pipeline assets — not the approximately $3 billion Ottawa ended up paying for them, triggering an immediate $2 billion loss upon sale plus any interest expense Trans Mountain incurred but was unable to recover prior to a sale. This is because the locked-in tolls generate a revenue stream that reflect a value for the assets of $1 billion, not $3 billion.

A toll agreement that reflects Morneau's promise to Canadians

I urged the Board to deny Trans Mountain’s Application and send Trans Mountain back to negotiate a toll settlement agreement with its shippers that reflects not only the commercial terms Ottawa promised Canadians, but terms that reflect the obligations entered into between Trans Mountain and Her Majesty in Right of Canada as detailed in the $6.5 billion Credit Agreement.

A whopping subsidy to oil producers through artificially low toll rates is not commercially prudent — not for other private sector pipeline operators that must compete on commercial terms, not for Canadian taxpayers and not for the Canadian economy.

Trans Mountain, meanwhile, responded to my letter by ignoring the substantive issues raised in it. Instead, Trans Mountain urged the NEB to facilitate this looming taxpayer-funded subsidy by approving its application. Trans Mountain even went as far as to tell the Board that "no further information or process is required" on their part.

This matter should have all been worked out before Canada bought a 65-year-old pipeline, but Morneau and his officials rushed the due diligence on Trans Mountain and were out-negotiated by a Texas pipeline company.

However, this doesn’t mean that every opportunity to protect Canadian taxpayers has to be squandered. There is an immediate and real opportunity for Trans Mountain to negotiate commercial toll rate terms for its existing pipeline that reflect the costs for the purchase and set up the financials on a go forward basis where a private sector buyer might be interested in them.

The federal government has a duty to make sure Canadian taxpayers are getting a fair deal.

If Morneau fails to act immediately and decisively, he is deliberately and willingly exposing Canadian taxpayers to a $2 billion subsidy over the next three-years, mounting to a $3.4 billion subsidy in five years. That’s not fair.