National Energy Board
Hearing Order MH-2-2002
Application of the Province of New Brunswick
Closing Argument
Atlantic Institute for Market Studies
1. AIMS has a very strong interest in this hearing not only because natural gas is emerging as perhaps the single largest economic opportunity in living memory for both Nova Scotia and New Brunswick, but because this industry is so greatly affected by government policies and regulations. AIMS shares the concern that if we don’t get things right now, we could squander this unprecedented opportunity. I am here to lend my voice to those you have already heard and urge the Board to continue with a policy framework and approach to regulation, which I submit, has been shown to benefit all Canadians. We can see the results in Atlantic Canada with the development of offshore natural gas and oil.
2. Because of the importance of the industry, I would like to take this opportunity to address both the evidence submitted by New Brunswick, as well as comment on the potential economic impact of the suggested changes to the Short-term Export Order Procedures. With respect to the evidence, I will focus my comments on the questions of benefits and markets, more specifically to the written evidence of: 1. John W. Stevens on Benefits of Gas Supply to Northern New Brunswick, (Volume 2, Tab 2); and 2. Mitchell Rothman on Market Tests of the Maritime Market, (Volume 2, Tab 3).
3. With respect to the potential economic impact, my focus is on the likely reaction of the industry as well as the availability of gas supplies and the overall benefits, which the region can reasonably expect, if the Board rules in favour of the Applicant.
4. Before beginning my comments on the evidence, I would like to say something about the public interest. The Applicant is seen by some as championing a Canada First Policy, and thereby as a protector of the public interest, while those opposed to their application are seen as primarily driven by self interest and who would take advantage of the public. I submit we should be absolutely clear – as the evidence in this case is clear – that if a protectionist policy (Canada First) had been in place during the last 10 years, the Sable gas project would not have been launched and this hearing would be moot, because we would have no gas to be concerned about. If we had had to wait until the Atlantic Canadian market was built up, as a protectionist policy would dictate, before exporting surplus gas to the U.S, offshore gas would never have been developed. Atlantic Canada is not a big enough energy market to be the driver for offshore development. Now that we have our first gas development, introducing a change in the ‘rules’ to a protectionist policy would only serve to choke off future exploration and development. Therefore, without the export market, gas would never have been developed in Atlantic Canada. And without continued access to that market new developments are unlikely.
Benefits:
5. Now turning to the evidence provided by the Applicant on benefits, I submit the Province has made two fundamental and fatal errors. First, they erroneously count costs as ‘benefits’. Table 3.1 of Mr. Stevens’ written evidence (Volume 2, Tab 2) counts construction costs of a gas transportation and distribution system in Northern New Brunswick ($97.9 million) and the operating costs of that system ($71.8 million) as ‘benefits’. The latter includes over $46.8 million in labour costs (salaries). As any first year student of economics or for that matter any project manager knows the capital cost of a project is the cost of constructing the project. The benefits are cheaper energy, profits and increased economic growth, not construction costs. We all would like to see benefits maximised, but at what cost? Since, according to New Brunswick, wages and salaries are a benefit, then all we need to do to maximise benefits is simply to require the use of only hand tools in pipeline construction. That would certainly drive up benefits, i.e., drive up labour costs. The pure absurdity of their logic would be humorous, if it were not for the gravity of the issues under consideration.
6. Transforming costs into benefits is not the only serious error. Mr Stevens’ second fatal error is treating the so-called future benefits the same as current benefits. Comparing a cost or benefit stream that occurs over time requires both to be discounted to the present, something Mr. Stevens neglects to do. He treats a dollar twenty years hence the same as a dollar today. Perhaps New Brunswick would like to loan us all a $1,000 today on the promise that we pay them back a $1,000 twenty years from now?
7. The evidence regarding benefits is not only misleading but ignores the real issue, net benefits. We need to compare both benefits and costs in order to determine whether society is better off or not. Mr. Stevens would apparently like you to focus only on his grossly inflated and distorted benefit estimates, while ignoring costs. In fact he has magically created the economic version of the perpetual motion machine by transforming all the costs into benefits – economic benefits are created free (at no cost). We have recently seen this kind of economic alchemy, when WorldCom magically transformed operating costs into investments.
8. The real question should be; is the spread between the economic costs and benefits in today’s dollars sufficient to justify investing in gas transportation and distribution infrastructure in Northern New Brunswick? An undistorted market answers this question in the most efficient manner, without the need for government intervention or the aid of regulations. Therefore, whether the market is distorted is a relevant question. Let’s look at the evidence.
Markets:
9. In that regard the focus of my submissions is the evidence presented by Mr. Mitchell Rothman (Volume 2, Tab 3). The Applicant contends that the gas market is indeed concentrated and thereby distorted or dysfunctional in Atlantic Canada. Mr. Rothman concentrates solely on measuring the structure of the industry in Atlantic Canada, as if it were isolated from the North American market, and he only looks at natural gas as if it does not compete with other fuels for market share. Mr. Rothman fails to recognise, or perhaps ignores, that we are connected to the North American continental gas grid and as such are part of the continental market for gas. He also does not recognise that the critical market is not the gas market, but rather the energy market, in which gas is simply one competing fuel.
10. We would not have gas without the U.S. market and by virtue of our connection to the continental gas grid, ExxonMobile, EnCana, Maritimes and Northeast Pipeline and other companies operating in Canada, face the discipline of the North American market, where prices are determined by the interaction of hundreds of buyers and sellers. Gas going to New England is priced in competition with gas produced and sold by numerous buyers and sellers, as well as in competition with other fuels. Therefore, contrary to the evidence presented by New Brunswick, the market is, when looked at in this broader context, extremely liquid. There is, of course, not yet a great amount of liquidity at certain specific locations, such as the Goldboro gas plant. However, restricting exports will decrease not increase liquidity, and it will increase, not decrease distortions to prices and supply. This is addressed in the evidence of Mr. Johnston for the Province of Nova Scotia.
11. Before natural gas became available in Atlantic Canada, the energy market was a mix of fuel oil, electricity, propane, wood and coal. The price of energy per thermal unit in this market is competitively determined by market factors involving the supply and demand interaction of all of these fuels. The entry of gas into this market only adds another fuel to this competitive mix. Adding gas to the energy mix does not distort the market but on the contrary increases choice and competition.
12. With only a handful of gas customers in New Brunswick and only large industrial customers like Nova Scotia Power and StoraEnso in Nova Scotia, the natural gas industry (transporters, local distribution companies and gas marketers) does not have a large captive market and can hardly be seen as having market power. Natural gas currently has nearly a zero market share. Therefore, in a greenfield gas market like Atlantic Canada, natural gas is in a head-to-head competition with large well-entrenched fuel oil refiners and distributors as well as electrical utilities to win market share. Yet the Applicant would have you believe that the market is concentrated and dysfunctional, thereby leading to the conclusion that government intervention in the form of restraining gas exports is needed. This is addressed in the evidence of Mr. Johnston for the Province of Nova Scotia.
13. For these two critical pieces of evidence (benefits and markets), the Applicant has greatly inflated the benefits by transforming costs into benefits, ignoring costs, and presenting a narrow distorted and misleading picture of the energy market in Atlantic Canada. For these reasons alone the Board should reject New Brunswick’s application.
Impact/Implications:
15. Nonetheless, I submit the Board should also consider the overall economic impact of adopting the changes proposed by New Brunswick. Contrary to New Brunswick’s expressed desire to increase the availability of natural gas in the province, a change in the short-term export regulation as requested will in fact do just the opposite. It would restrict or reduce gas availability over time. Changing the market-based procedures as proposed by New Brunswick would likely result in producers being forced to sell a portion of their output at below market prices for delivery into uneconomic domestic markets. This will create, by regulation, a gas bubble or shut-in gas, i.e., a quantity of gas that can not be sold outside Canada. Restricting to whom producers may sell their gas to will create a government-driven market distortion. It will most likely result in a two-price system for gas (market prices for export gas and below-market prices for domestic gas) with results similar to the distortions caused by the National Energy Program.
16. The results of selling energy below market prices can readily be seen by looking at the development of the electrical power industry in Newfoundland. Because the province is forced to sell electricity at below market prices to Quebec, this has choked the development of the industry in Newfoundland, transferred a massive amount of wealth outside the province and capital investment in electrical generation has fled the province. We can expect similar disastrous results in the gas industry, if the market-based procedures are abandoned.
17. Restraining trade through regulation will not provide the maximum amount of gas to Atlantic Canadians at the lowest price, but will initially force artificially lower prices, reduce the return on invested capital and cause capital to migrate to those areas where market forces prevail, i.e., ultimately reduce supply. In short, adopting New Brunswick’s proposed changes would not only put at risk current developments like the Deep Panuke project, but the future of the industry on the East Coast as well. A policy that restrains gas exports will make large capital investments in Atlantic Canada difficult to justify especially when weighed against other areas of gas exploration worldwide. Such a policy would also cause many large volume buyers in the US Northeast market, the major driver of Nova Scotia’s gas developments, to seek alternative sources of gas supplies. Recent threats by New Brunswick to hold up the Deep Panuke project until EnCana guarantees that some of its gas will be made available to New Brunswick, illustrates how the Applicant intends to use the NEB to put at risk the future of the industry.
Summary:
18. AIMS strongly recommends that the Board reject New Brunswick’s application. The evidence is not only seriously flawed, but what the Applicant proposes would restrain trade, reduce investment, lower the availability of gas, and choke off the benefits that could come from the industry. It would create the very dysfunctional market that New Brunswick claims they are concerned about. In short it would not be in the best interests of the public, the industry or present and future energy consumers in the Maritimes.
