Friday, June 20, 2014

Enbridge Clears Yet Another Hurdle

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In the past few weeks, we've focused on some of the challenges facing Canada's LNG export projects. Meanwhile, progress continues toward getting landlocked Canadian crude to fast-growing Asian markets. This week, the country's federal government finally approved Enbridge Inc's (TSX: ENB, NYSE: ENB) CAD7.9 billion Northern Gateway project.

The company's nearly 1,200 kilometer pipeline will have the capacity to move as much as 525,000 barrels of oil per day from the resource-rich province of Alberta to a deepwater port on Canada's west coast.

Northern Gateway is key to Canada's eventual diversification of its export markets. At present, the US absorbs 99 percent of the country's crude oil exports, often at discounted prices.

Indeed, the spread between the benchmark West Texas Intermediate crude and Western Canada Select is currently USD20.75, or a discount of 19.5 percent for Canadian crude. Over the past year, the differential between the two benchmarks has been as wide as USD42.00 and as narrow as USD12.00.

There are a number of factors contributing to the spread. The glut of production in Canada is competing with similarly abundant supplies from the prolific US shale plays. The result is that Canadian crude is being crowded out from crucial pipelines leading to various US markets. And the heavy, sour crude mined from Canada's oil sands is more costly to refine than the light, sweet crude produced from North Dakota's Bakken.

But the latest approval for Northern Gateway is just one hurdle in what continues to be a mind-numbingly complex approval process. We've previously detailed Enbridge's efforts to pacify various constituencies at the provincial level in British Columbia, including politicians, First Nations groups, environmentalists and labor unions.

Though the pipeline could commence operations by late 2018, Enbridge must still decide if the project will ult! imately prove economic.

That's because the company must fulfill 209 conditions set by the Joint Review Panel established by the government's National Energy Board. And 113 of those must be met before construction can even begin. This process is expected to take 12 to 15 months.

In addition to the numerous consultations required with First Nations groups and other communities along the pipeline's proposed route, Enbridge will also have to apply for regulatory permits and authorizations from federal and provincial governments.

Some Aboriginal groups have threatened legal action to further delay the pipeline's construction. To date, the company has signed 26 equity partnerships with these communities, representing about 60 percent of their population in British Columbia.

Of course, the cost of compliance, revenue sharing and taxation all add up. And Enbridge CEO Al Monaco has said the firm will have to recalculate the cost of the project before it can proceed with a final investment decision. "Obviously there's a lot of capital involved here to put to work, to execute a project like this, and that takes careful consideration," Mr. Monaco observed during the company's Tuesday conference call. The final cost estimate is expected later this year.

Still, Enbridge is hardly going it alone. This massive project has 10 funding partners, including oil sands giant Suncor Energy Inc (TSX: SU, NYSE: SU).

But even if Northern Gateway meets the aforementioned conditions and secures sufficient long-term commitments from energy shippers, it still faces competition from other projects, including TransCanada Corp's (TSX: TRP, NYSE: TRP) Keystone XL pipeline, which itself remains mired in endless political maneuvering.

While Northern Gateway is an important project for Enbridge that has cost the company and its partners CAD400 million thus far, it's just one of an estimated CAD36 billion worth of projects that the company considers commercially secure through 201! 7, with a! nother CAD5 billion worth of projects under development.

As such, some analysts believe that the project won't move the needle all that much for the company's near- to medium-term earnings. Management has targeted earnings per share growth of 10 percent to 12 percent annually through 2017.

But while Enbridge can endure without Northern Gateway, Canada can't remain dependent on the US as its sole energy export market forever. Although environmentalists and other groups have stymied progress in building necessary infrastructure, when there's demand, at least some output will always find a way to reach the market, as the crude-by-rail phenomenon has demonstrated.

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