For Ottawa and Alberta, the hardest part of agreeing on a pipeline plan is just beginning

Open this photo in gallery:

Governments and oil sands producers are clashing on whether building a massive carbon-capture plant in Alberta is economically viable, setting up difficult talks that could make or break a landmark deal aimed at easing the way for a new oil export pipeline.

Prime Minister Mark Carney and Alberta Premier Danielle Smith trumpeted the completion of crucial terms of their memorandum of understanding last week, including a carbon-pricing deal and support for a million-barrel-a-day pipeline to the West Coast on the condition that the energy companies move forward with the multibillion-dollar Pathways carbon capture and storage, or CCS, project.

West Coast pipeline is conditional on carbon-capture project, Carney says

That’s the sticking point. Energy producers collectively known as the Oil Sands Alliance have been planning Pathways for several years, but in a new era of energy-security fears and competition in world oil markets, they bristle at the notion of layering costs onto their production that other global suppliers do not have to bear.

“If you can’t get the conditions for growth, then there’s no point in building a pipeline or doing Pathways,” Kendall Dilling, the alliance’s president, said in an interview. “Once we get that piece done, then we can try to say whether this work is going to be supportive of the growth that we’re all hoping for.”

The alliance members are Canadian Natural Resources Ltd., Cenovus Energy Inc., ConocoPhillips Canada, Imperial Oil Ltd. and Suncor Energy Inc., which produce the lion’s share of oil sands-derived crude.

Cenovus chief executive officer Jon McKenzie told a conference hosted by The Globe and Mail last week that carbon pricing is just one burden on the industry. When added to the effects of other federal policies – including a ban on tanker loadings on the northern B.C. coast and regulations to cut methane emissions – it presents “an incredibly complicated policy framework that makes investments in Canada difficult and non-competitive with other countries, like the U.S. and countries in Asia,” he said.

Carbon pricing would not spur oil and gas sector to reduce emissions, Cenovus CEO says

Trilateral talks between the alliance, Ottawa and Alberta are under way. They were supposed to be completed by April 1, but the process has dragged on with no new deadline announced.

Federal Environment Minister Julie Dabrusin’s office said in a statement to The Globe this week that Ottawa is confident the deal with Alberta will give industry certainty and unlock the Pathways project.

At stake for Ms. Smith is her aim of doubling Alberta’s oil production to eight million barrels a day in the next decade, a goal that can only be realized by vastly increasing pipeline capacity for exports to Asian markets.

The conduit remains a concept, still requiring a defined route and private-sector backers to build and operate it.

The MOU’s success hinges on all sides agreeing to an economic structure fraught with risks. The Prime Minister has insisted that it can only proceed if Pathways does, though the MOU now includes relaxed terms that make the CCS project easier for the industry to stomach, to the point of reducing the carbon-reduction benefits it initially promised.

Former prime minister Justin Trudeau’s Liberal government had mandated the carbon price to hit $170 a tonne by 2030. Now, the price paid by the market will be $130 per tonne by 2040. The floor price, which is the fee enforced by the government, will be set at only $110 per tonne for 2040.

Producers would be offered carbon contracts for difference, or CfDs, essentially an insurance policy that guarantees covering the gap between the carbon cost and the market price, which has been consistently lower. Federal and provincial investment tax credits are also expected to cover much of the capital costs of the Pathways project.

Open this photo in gallery:

Indigenous loan guarantees could also cover part of the cost. Federal Natural Resources Minister Tim Hodgson said in an interview that, much like the West Coast oil pipeline, the government expects “significant Indigenous ownership” of the Pathways line that would carry captured carbon from the oil sands to Cold Lake, Alta., where it is set to be sequestered underground.

“If those Indigenous groups wanted access to the Canada Indigenous Loan Guarantee Program, we would certainly honour their desire to tap that program,” he said.

In addition, Pathways itself would be scaled down from the original design of capturing 22 million tonnes of CO2 per year at a cost of $16-billion. Its capacity is now pegged at 16 million tonnes, constructed in stages - six million tonnes by 2035, and two increments of five million by 2040 and 2045, respectively.

Speaking in Calgary on Thursday, Ms. Smith said she believes that the increased access to world markets will shrink the discount that Canada is currently saddled with. That should more than make up for the estimated cost of 80 cents to $1.10 a barrel for carbon capture, she said, quoting figures from Royal Bank of Canada.

“Now, I understand every increment is an increment that comes out of the amount of revenues that get earned and dividends that go to shareholders, and that matters to shareholder decisions,” she told a Calgary Chamber audience.

“However, one of the other things that we discovered is that by going west and creating more competition for our barrels, it could also reduce the differential on Western Canada Select [heavy oil] by $2 to $3. So if we have to pay a buck-ten to be able to permanently get an additional $3 on all our barrels, I think those economics are beginning to make sense.”

Opinion: Mr. Positive says yes to all the premiers’ projects

Dennis McConaghy, an author and former executive with TC Energy Corp., said he believes the governments are underestimating the operating costs for Pathways as well as the capital needed to expand oil sands production. So, without the oil sands companies’ support, the deal remains incomplete. Ottawa could be forced to lower its expectations for CCS even more than it already has to get them to back the deal, he said.

“I believe Mark Carney has got more blinking to do – yes, I do – if he wants this to actually happen,” Mr. McConaghy said.

Mr. Dilling said a strategy developed in the 1990s to accelerate development of the oil sands presents a useful guide for attracting private-sector investment. Its marquee policy was keeping production royalties low until capital costs for projects were recouped. That kick-started massive development of the northern Alberta resource, albeit at a time when climate-related costs were not a major factor.

“You’ve got to convince investors to give you billions and billions of dollars and that you think you’re going to have a return for them in about 10 years,” he said. “That’s a tough proposition in this world, so those kind of [policies] shorten up that period from spend to capital recovery.”

Still, the terms announced last week provide much stronger incentives for decarbonizing the oil industry than are available in any other sector, said Michael Bernstein, chief executive officer of Clean Prosperity, a think tank focused on climate and economy. Those include new rules around the clean fuel standard and the prospect of higher prices for Canadian crude in international markets.

“In the case of the Pathways project, we now have a situation where I think they need to show that they’re willing to step up and be part of a deal that clearly benefits them overall,” Mr. Bernstein said.

The industry could benefit from future policy decisions that recognize its commitment to reducing carbon emissions, especially as climate considerations rise again on political agendas, said Robert Johnston, director of energy and natural resources policy at the University of Calgary’s School of Public Policy and former CEO of Eurasia Group.

In terms of that value, he used the experience of the ill-fated Keystone XL pipeline; Washington rejected, approved, then rejected the project again as U.S. priorities see-sawed on the impact of the oil sands on climate change, based on who occupied the White House.

The downside for oil producers is higher costs of CCS amid rising carbon prices, and that’s weighed against the prospect of more lucrative returns from oil exports, Mr. Johnston said. “The problem, of course, is that the former is quite specific and measurable and the latter is subject to a lot of uncertainties.”

Carbon contracts for difference are another incentive. The MOU spells out that Canada and Alberta are responsible for funding up to $600-million each for the contracts, representing 75 million tonnes of emissions reductions.

Tyson Dyck, a partner in the environmental group of the law firm Torys, said the fact that the governments could come to agreement on such terms provides reason for optimism that Pathways can get built.

“This was a significant compromise. There were a lot of hard negotiations that went on behind the scenes to get this deal done. I think it’s a marked improvement on the carbon-pricing front relative to what we had a couple of weeks ago,” Mr. Dyck said.

Opinion: Ottawa sacrifices climate goals for a pipeline nobody needs

Mr. Dilling said it’s too early to say whether the CfDs in the MOU are large enough, but he said it is encouraging that Alberta and Canada recognize their importance. The $600-million each is “a very significant contribution,” he said, but it will be shared across various industries, so there is some uncertainty about what Pathways will get.

Policy uncertainty aside, though, he said the sector remains committed to getting Pathways built – in part, because the Prime Minister has repeatedly made clear that there will be no pipeline without it.

“There’s significant value in a new pipeline to the West Coast, and if we can figure out how to provide a million barrels a day of production to fill it, that offsets the cost of the carbon policy,” he said. “That’s the concept of the grand bargain, but you need the whole thing to work. Every piece is dependent on one another.”

Despite differing on details now, the economic opportunity of such a huge increase in oil exports is so significant that any sticking points with Pathways can be negotiated, said Adam Waterous, executive chair of Calgary-based oil producer Strathcona Resources Ltd. He believes Canada could produce as much as 10 million barrels a day in a decade if all goes according to plan, putting it in league with Saudi Arabia.

The key target audience for last week’s MOU announcement was foreign investors, especially those on Wall Street, who have been loath to invest capital in Canadian energy projects because of the regulatory and court snarls of the past. Attracting them now is key to getting the necessary private capital for the entire exercise, Mr. Waterous said. “That’s the title fight – that’s the main event.”

With a file from Matthew Scace