The federal government is using profits from the Hibernia oil project to subsidize the Trans Mountain pipeline project, which is operating at a loss, according to an analysis by the Institute for Energy Economics and Analysis (IEEFA).
Or put another way, the federal government continues to finance the pipeline it owns and is expanding – as it promised to do – and it is using profits it earns from its share of the Hibernia offshore oil project to help cover some of the costs.
IEEFA appears to be stretching the definition of a subsidy, which is commonly understood to be a government benefit offered to a private company or sector. But the Trans Mountain Corporation is not a private company – it is owned by the government.
Kin Lo, associate professor of accounting and information systems at the University of BC’s Sauder School of Business, said the IEEFA analysis is “problematic,” especially the way it calculates indirect subsidies.
The IEEFA says some $320 million in “new subsidies” is going into the Trans Mountain pipeline and expansion project.
The IEEFA analysis appears to be intended to prove the federal government’s acquisition of the Trans Mountain pipeline and expansion project from Kinder Morgan Canada (TSX:KMI) was a bad investment, and public policy professor Marv Shaffer says that may be true, from strictly a stand-alone business perspective.
“Until the government sells the pipeline and a complete reconciliation of the sale price with overall costs is undertaken, we consider the outlays as dollars at risk since there is no guarantee that the eventual proceeds from the sale will cover all the actual costs,” IEEFA financial analyst and report co-author Kathy Hipple said in a press release.
“I think it is fair to characterize the government’s investment in TMX as financially risky but … it is misleading to characterize the money (government) is spending to support the investment and expansion project as a subsidy,” said Shaffer, an adjunct professor of public policy at Simon Fraser University.
“It may prove to be a poor investment from a private financial point of view, but that remains to be seen. And, in any case, that is not the point. The (federal government) didn’t make this investment to realize a financial rate of return. They did it to support Alberta in its efforts to realize full value for its oil resources.”
The federal government salvaged the pipeline twinning project by buying it, after Kinder Morgan announced it would pull the plug – after spending roughly $1 billion on the expansion – due to legal challenges and attempts by the John Horgan government to thwart the expansion project.
The Trudeau government borrowed $5 billion to buy the pipeline and expansion project, using a combination of debt and equity.
The federal government owns the pipeline project through the Canada Development Investment Corporation (CDEV), which also owns the Canada Hibernia Holding Corporation (CHHC). The CHHC owns 8.5% of the Hibernia offshore oil project in Newfoundland and earns profits on it.
In total, Trans Mountain and CHHA generated $322 million in revenue in the first six months of 2019, according to CDEV’s second quarter financials, and net income of $30 million.
Trans Mountain had net income of $43 million on revenue of $219 million in the first half of 2019.
But according to the IEEFA’s analysis, Trans Mountain had an operating loss of $10.9 million in the first six months of 2019, and that profits from CHHC were used to cover the loss.
According to the IEEFA, losses at Trans Mountain were covered by CDEV using “enterprise-wide” sources – i.e. the CHHC, which had a net profit of $38 million in the first six half of 2019.
“Operating and financing costs for the Trans Mountain pipeline will exceed revenues in the future,” the IEEFA report warns.
“CHHC is likely to be a continued source of operational subsidies, but is unlikely to produce sufficient revenues to also subsidize the project’s growing interest charges, as additional loans are needed to finance the pipeline’s expansion.”
But Lo says a $10.9 million loss (before taxes) showing on Trans Mountain’s books for the first six months of the year is “temporary.” He said the IEEFA analysis fails to take into account the fact that tariffs on Trans Mountain increased 30% in May.
By the end of the year, Lo estimates that Trans Mountain will show a profit, before taxes, of about $75 million at the end of 2019.
“Therefore, there are no losses that need to be subsidized on an ongoing basis,” Lo said.
According to the IEEFA, it’s not just the federal government that is subsidizing Trans Mountain. It also counts a corporate tax cut in Alberta as a subsidy too, one that amounts to $54 million deferred income tax recovery for Trans Mountain.
If that tax cut applied only to Trans Mountain, it might well indeed be called a subsidy. But it applies province-wide, in Alberta, not to any one company or sector, “so it is not a subsidy,” Lo said.
The IEEFA says the federal and Alberta governments provided a total of $320 million in direct and indirect subsidies to Trans Mountain.
Of that, it says $135 million are direct subsidies from CHHC, the Alberta government’s lower corporate tax rate, and $24.4 million in costs to Trans Mountain that resulted from changes in pension plan values, costs which were covered by CDEV.
As for the $183.8 million in indirect subsidies that it calculated, the IEEFA accomplished this with an apples-to-oranges comparison.
It used Kinder Morgan’s internal rate of return (12%) to calculate a commercial rate of interest, and compared it to the interest rate the federal government pays on its debt (4.7%). That internal rate of return is what a company would require for a return on equity, Lo said.
The IEEF took the interest payments Canada would pay on its debt at 4.7% for half a year – $118 million – subtracted it from the interest it estimated it would have had to pay at a commercial rate – $302 million – came up with a difference of $183 million, and called that difference a subsidy.
“It is simply incorrect to take the difference between the cost of equity and the cost of debt, and call that a subsidy,” Lo said. “The indirect subsidy of $183.8 (million) is non-existent.”
In response to the IEEFA report, the federal Ministry of Finance said in an email to Business in Vancouver that it is "normal" for a project like a pipeline expansion to incur expenses without generating revenue while it is being built.
"The board of TMC continues to consider the Trans Mountain Expansion Project to be a commercially viable project and the government is committed to divesting TMC," the ministry states. "The government expects to realize a positive financial return on its investment in TMC and the Trans Mountain Expansion Project."