Investors have started to call Alberta’s stagnant oil and gas industry "uninvestable," says famed independent energy analyst Martin King, because when they look at Canada and Alberta they see a regulatory mess involving too many interest groups and an incoherent transportation framework.
The big exception, admits King and dozens of other industry experts, is the expansion of the province’s petrochemical industry. Thanks to the Alberta government’s Petrochemical Diversification Program (PDP) and cheap world class natural gas reserves, companies are tapping into billions of dollars in royalty credits to build manufacturing facilities here that will turn propane into plastics and methane into methanol.
The PDP program, announced in October 2018, plans to provide up to $1.1 billion in royalty credits to encourage companies to build or upgrade manufacturing facilities that make valuable products, such as plastics, fabrics and fertilizers. While petrochemical facilities do not pay royalties - because they pay taxes - they can trade royalty credits with oil and natural gas producers who do. The producers can apply these credits to reduce their royalty payments to offset production costs. Another part of the program offers incentives, including loan guarantees, to support investments that increase the feedstock supply.
Phase I (PDP1) of the program attracted 16 proposals worth $20 billion. Some $500 million was awarded in royalty credits to Calgary-based Inter Pipeline and a joint venture of Pembina and the Petrochemicals Industry Company of Kuwait to build two world-class petrochemical plants with a combined worth of $8 billion in Alberta’s Heartland. Altogether the two plants will produce 1.5 million tonnes of polypropylene plastic pellets annually for easy shipment by rail to the U.S. and overseas. Completion dates range from 2021 to 2023. Another $80 million was awarded to Nauticol Energy in February under Phase II of the program to construct a $2 billion project by 2026 that will turn methane into 3 million tonnes of methanol per year.
Alberta’s oil patch is becoming more investable not only because of petrochemical royalty credits that help offset higher capitol costs, but by the province’s cheap Montney and Duvernay shale-like natural gas reserves and reduced labour costs driven by a weak Canadian dollar. David Chappell, senior vice president of petrochemical development for the Inter Pipeline project, says it also helps that the approval process for petrochemical plants by Alberta environmental authorities are relatively efficient. Chappell, who has worked on the project since inception, says it only took 12 months to gain the necessary approvals because Inter Pipeline’s was the only Alberta petrochemical project underway at the time.
The rewards of expanding the Alberta petrochemical industry could be immense. Kevin Jagger, Pembina’s vice president of petrochemicals, predicts Pembina alone will net $275 to $350 million a year from their plant. And there appears to be no limit to the amount of natural gas liquids (NGLs) available to feed the petrochemical industry’s appetite. In fact, the industry has been suffering from an oversupply of NGLs, from which products such as propane, ethane and methane are extracted, ever since the Cochin pipeline to Chicago was reversed leaving few pipeline options to ship Alberta NGLs to Eastern Canada. The resultant oversupply and depressed prices have prompted many propane producers to leave propane as part of an NGL mix for export. Jagger says the Pembina plant will remove about 23,000 bpd of propane from natural gas liquids (NGLs), which is only 10 per cent of what Alberta produces.
Assuming the Alberta petrochemical industry takes off, some of this glut will be reduced, but the real NGL opportunities lie in exports to the U.S. and overseas. An in-depth analysis released by the Canadian Energy Research Institute (CERI) in November 2018 says if propane recovery continues at the current rate, the amount of product available for export will decline from 90 million bpd to 20 million bpd. But if all the propane were extracted from western natural gas there could be as much as 191 million bpd of propane available for export.
The big hope behind the Alberta PDP is for more jobs. Inter Pipeline will create up to 13,000 jobs over the four-year construction period and 180 full time jobs after the project is complete. Pembina/Kuwait will peak at 3,000 jobs during construction and have over 200 full time employees on site when the project is operational. At the time the Nauticol Energy project was announced in February of this year, Premier Rachel Notley said it would create another 3,000 jobs, most likely while being built. Altogether, the province expects the PDP to create more than 26,000 jobs. Statistics Canada figures show that for every petrochemical job there are five jobs created in industries like manufacturing.
Alberta’s petrochemical industry is gambling that the decade-long strong global demand for petrochemical products will continue. Its confidence is well placed says Bob Masterson, president and CEO of the Chemistry Industry Association of Canada (CIAC). Although global chemical industry growth weakened in 2018 due to slowing economic growth, trade disputes and Brexit, he says the world-wide chemistry sector is still growing in excess of global GDP. “It’s a growth story for another 20 years,” says Masterson, “because an increased focus on energy-efficient products has increased demand for plastics.” He’s hoping that the progression of Alberta projects, with more to come from the PDP2, will help push our annual chemical industry growth rate ahead of the global GDP in a few years’ time.
King, the former director of GMP FirstEnergy’s institutional oil and gas research, believes the province’s diversification program will make the economics of Alberta’s oil and gas wells more attractive. But he has his doubts about whether an expanded petrochemical industry will have much effect on oil and gas prices. King expects a gradual improvement in oil prices to $60 a barrel by the third quarter of this year. So much depends on how wide the price differential will be between Western Canadian Select (WCS) and West Texas Intermediate (WTI) and how quickly Alberta products can be shipped out of the country. He predicts natural gas prices will grow more sideways, with much depending on discussions around market structure and internal Alberta pipeline issues.
Mark Plamondon, executive director of the Alberta Industrial Heartland Association, where most of the projects are being built, believes producing NGLs from feedstock at home will make our plastic products more competitive. He explains, “Due to some of the most cost-advantaged feedstock in the world, plastic production in Alberta’s industrial heartland can be very competitive globally, despite the additional transportation costs to get the products to overseas markets.”
Many believe Alberta’s cheap input costs will make its polypropylene products competitive enough to replace the $1 billion in chemicals the province imports from the U.S. per year and ramp up its U.S. exports. Out of the $6.8 billion in chemicals the province ships worldwide each year, some $5.4 billion are exported to the U.S. But King is wary of depending too much on U.S. markets. “The biggest issue for the petrochemical, oil and gas industries is that we’ve been too dependent on the U.S. market and that avenue is getting smaller and smaller because they’re building more and more of their own facilities.”
Cameron Gingrich, director of strategic energy advisory services for the energy consulting company Solomon and Associates says competition from American NGLs in the Midwest and Northwest United States is what has driven Canadian NGL exports down. “There’s a big push to build export facilities for Alberta NGLs because the U.S. market is swamped,” he says. “Our plastics are more likely bound for Asian markets.”
A CERI 2017 market review shows Canada has a 6.3 percent or an .84 million bbl/d share of the 13.3 million bbl/d global NGL market. The U.S. has almost 30 percent, or 3.7 million bbl/d and Saudi Arabia, Qatar and Iran altogether turn out 4 million bbl/d or almost 31 percent of the world’s NGLs. The CIAC’s 2018 year-end survey of industrial chemical business conditions showed a drop in Canadian chemical exports to the U.S., valued at $14.5 billion in 2016. “There continues to be concern that the rise of protectionism in parts of the world could limit the ability of export-intensive economies like Canada to access those foreign markets,” says Masterson.
Masterson claims increased U.S. petrochemical investment has been driven by government investment supports offering tax breaks, including $1.6 billion in incentives for Shell in Pennsylvania. The U.S. Gulf Coast and states like Pennsylvania are more willing to partner with industry on long term, high value investments. He estimates the U.S. chemical industry has invested over $250 billion in Gulf Coast facilities over the last five to seven years, which is more than half of all U.S. manufacturing investments.
Yet Alberta producers have a huge advantage in overseas markets. They offer a higher quality feedstock, which is cheaper than the coal and naphtha light oil used in Asian and European countries. Masterson says using Alberta petrochemical feedstock is not only cheaper but emits eight times less greenhouse gases than coal feedstock used to make the same chemicals.
Despite the ambitious petrochemical forecasts for the province, there are challenging changes on the horizon that may impact its full-speed-ahead growth. A report issued in November 2018 by the global management consulting firm McKinsey and Company claims world petrochemical industry growth will slow to 2 to 3 per cent through 2030. With the increased ethylene cracking capacity and export opportunities and subsequent increased demand for ethane and propane, the report predicts, there will be a jump in feedstock prices. The cost increase could further erode petrochemical profit margins and substantially constrain investments based on advantaged feedstocks by 2020.
Achieving an effective, efficient and competitive rail service will be essential to growing Canada’s chemical and petrochemical industries. The CIAC report refers to weather and labour issues that disrupted services last year and recommends greater investments in rail infrastructure to keep pace, especially in Western Canada.
Yet Alberta investors don’t seem to be worried about rail capacity or rising feedstock price forecasts. Says Plamondon, “Even if feedstock prices go up they will still be drastically less than oil or coal-based feedstocks and will be lower than anywhere else.” Jagger says the petrochemical industry's switch from propane pressure cars to hoppers for shipping polypropylene in an inert form will actually reduce rail costs. “For almost every two rail cars of propane we only use one car for plastics,” he says.
Internationally renowned economist Christof Rühl wrote in Bloomburg News in February that the anti-plastic movement may reduce petrochemical margins in the future. The Crystol Energy specialist in oil and gas said the campaign has every indication of global success and that the oil and gas industry is underestimating the impact of the war against plastics.
“Public perceptions are important,” adds King, “the petrochemical industry needs to take threats like this seriously.
Fortunately, the newly approved Alberta plants will produce wholly recyclable plastics. Chappell says Inter Pipeline wants to be part of the solution and is encouraged by more industry groups contributing to funds to investigate different technologies that can be used to manufacture products from used plastics and ways of burning plastic safely to recover energy. For example, in January of this year the Global Alliance to End Plastic Waste pooled $1.5US billion in funds to create infrastructure that will improve recycling plastic waste. Masterson says the Canadian chemical industry has made a commitment to a circular economy in line with that of California, to make plastic packaging designed to be recycled by 2030.
Challenges aside, Alberta’s petrochemical industry continues to attract investment. The second phase of the Petrochemical Diversification Program (PDP2), announced in June 2018, has offered another $500 million royalty credit Petrochemical Diversification Program (PDP), with the figure spread across four years, beginning in 2020-21. So far it has attracted significant interest.
On March 8, Inter Pipeline announced plans to construct another $600 million petrochemical plant that will cash in on $70 million in royalty credits. Located near Edmonton, the plant will use a propane derivative to make acrylic acid used in paints and diapers. This will bring the total value of projects aided by the PDP up to $12.6 billion. The province is hoping to gain another $28 billion in private investment under the program through a possible refinery project and facilities that would process ethane to make materials like ethylene. At the time of the Inter Pipeline announcement the Premier said the province is only one third of the way through its PDP program.
Plamondon thinks there is as much as $30 billion of potential petrochemical investments on the Heartland’s 2030 horizon but expects some of that growth will come from investment in the manufacture of other products.
With a huge supply of world-class feedstock, Jagger sees room for another world scale ethane cracker, but says the industry has a long way to go to rightsize petrochemical demand and production to get top dollar for Alberta’s feedstock.
If the petrochemical industry is going to thrive, King agrees, there will be a need for more diversification and endless cost controls. But the long-time critic of government oil and gas industry intervention still believes the only way to create a large amount of value-added for the oil and natural gas industry is to tackle the need for more rail and pipelines to transport Alberta products to the West Coast.