‘Borderline treasonous’: Oil executives sound alarm as foreign investors flee

CALGARY — Canadian energy executives are becoming increasingly vocal about the country losing its competitive edge relative to their peers in the United States, saying it’s “very, very worrisome” that investors are exiting the domestic energy sector.

“If the people of Canada think for one moment that we can only have Canadian investors and hope to drive any type of business going forward, they are absolutely, massively mistaken,” Grant Fagerheim. president and CEO of Whitecap Resources Inc., said in in an interview about the exodus of foreign investors in the domestic oil and gas industry.

Their concerns were echoed by a foreign institutional investor in a letter to Prime Minister Justin Trudeau that was shared with the Financial Post. The letter marks the second time in recent weeks a fund manager outside of Canada has directed their concerns to Trudeau.

“Moving forward, I hope your government will start to recognize the numerous issues that are affecting Canada’s energy sector, and do everything in its power to support an industry which has benefited Canadian prosperity for a long period of time,” Susan Johns, a U.K.-based fund manager, said in the letter, dated Nov. 7.

It follows a similar note last month by Darren Peers, an analyst and investor at Los Angeles-based Capital Research, a US$1.7-trillion fund, which criticized Ottawa for allowing Canadian energy competitiveness to lag.

Johns, who was previously with London-based Consulta, but is now running her own fund called Susan Johns LP, stated in her letter that she has invested in Canadian junior and intermediate companies for more than 30 years.

It is “hard for me to watch such a vibrant industry being strangled by regulation, carbon taxes and the inability of producers to get their product to world markets,” she said in the letter.

Fagerheim said Johns is a household name among junior and intermediate energy CEOs in Canada. Johns did not respond to a request for comment.

In his Oct. 19 letter, Peers said that while he recognizes that Ottawa “has done a lot to maintain Canada’s competitiveness as a country to invest in, when it comes to energy it has not done enough.”

Executives said the two letters should create a sense of urgency that Ottawa needs to take corrective action quickly.

“It is very, very worrisome what is happening to the energy industry in Canada from a competitiveness perspective. That worry for me is even more exacerbated when I look at what’s happening south of the border,” said Cenovus Energy Inc. president and CEO Alex Pourbaix.

Pourbaix said the U.S. government is working to streamline permit applications there and “Canada ignores these red flags at its peril.”

“No one is required to invest in Canada,” Pourbaix said.

Eric Nuttall, Toronto-based senior portfolio manager with Ninepoint Partners, who invests in Canadian oil and gas stocks, said “it’s not surprising” that other fund managers are coming forward with their concerns.

“It’s mystifying to me why there still doesn’t seem to be action taken,” Nuttall said. “It’s borderline treasonous.”

But energy executives say fund managers and investors don’t normally like to be in the limelight. Pourbaix said instuitional investors don’t normally embark on letter-writing campaigns, and other executives agreed.

“I don’t think investors like to be in the public eye with their investment risks and strategies. I don’t think it’s common behaviour,” said Precision Drilling Corp. president and CEO Kevin Neveu.

Neveu said all of the country’s investment banks track investment flows in and out of Canada, and the numbers show there’s very little flowing into the country’s oil and gas sector. That should be alarming to Ottawa, he said.

“Our government doesn’t need investor letters to show them what is going on — the data is there,” Neveu said.

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TransCanada ‘open minded’ about joint venture partner for $10-billion Keystone XL pipeline

CALGARY – TransCanada Corp. would consider all sources of funding to build its long-delayed Keystone XL pipeline, including a potential joint venture to de-risk the project that was hit by another legal setback last week.

“Should Keystone XL proceed, we will pursue an all-of-the-above funding model,” TransCanada executive vice-president and chief financial officer Don Marchand said Tuesday during the company’s investor day presentation.

The company is considering using debt, hybrid securities and issuing shares to pay for the $10-billion pipeline between Alberta and the U.S. Gulf Coast.

“We would also consider JV partners — we’re absolutely open minded on that front as well,” Marchand said.

The CFO’s comments come as TransCanada works on “getting back to living within our means,” and is taking a number of initiatives to reduce its debt burden. The Calgary-based pipeline giant was carrying $35 billion in long-term debt at the end of the third quarter.

Calgary-based TransCanada currently has a $36-billion backlog of growth projects even without Keystone XL and, “Realistically, they can’t fund it all,” said Jennifer Rowland, an analyst with Edward Jones in St. Louis.

She said she expects other midstream companies — such as Kinder Morgan Inc. — apart from private equity players could be interested in partnering on the Keystone XL pipeline.

However, the project will have to compete with the Ottawa-acquired Trans Mountain oil pipeline connecting Alberta to the West Coast, which is also seeking investors.

“There is quite a bit of private equity money out there,” Rowland said, adding there is a “high probability” private equity ends up playing a role if the company does pursue a joint venture.

Canaccord Genuity analyst David Galison argues that it makes sense for TransCanada to look for joint-venture partners to fund Keystone XL.

“They’ve got a massive capital budget and interest rates have been rising,” Galison said.

Still, there is a sense of urgency in getting Keystone XL built, or nearly complete, before the next U.S. presidential election as the pipeline was rejected by former president Barack Obama before current President Donald Trump approved it.

“With this project, there is an underlying level of risk in the U.S. if it’s not in the ground and flowing by the time there’s a new election in the U.S. at the executive level,” Galison said.

He noted that Obama had halted work on the Dakota Access Pipeline months before that project was completed and said the same thing could conceivably happen to Keystone XL if Democrats retake the White House.

A federal court judge in Montana told TransCanada to halt construction on the project until the U.S. State Department has conducted detailed studies on potential spills and cumulative emissions impacts from oilsands pipelines.

“We’re going through the decision,” said TransCanada president, liquids pipelines Paul Miller, adding that the judge’s demands were “manageable, however, at this point I believe it is too early to determine what impact it will have on our schedule.”

He added the U.S. State Department was “taking the lead” on the file.

Analysts, including at CIBC Capital Markets, have speculated the State Department will need to issue a supplemental environmental impact statement on the project, a process that could take six months.

Miller declined to provide a new cost figure for the 830,000-bpd Keystone XL until all the legal challenges had been cleared.

“There was a short window where people were hopeful (Keystone XL) was going to happen in 2019,” Rowland said, adding that timeline seems difficult now.

“It’s unfortunate for the Canadian producers more so than (TransCanada),” Rowland said, adding that the company has other projects it could pursue as it awaits a decision on the legality of its route through Nebraska and tries to address the deficiencies identified by the judge in Montana.

Canadian oil producers, meanwhile, are forced to accept record-setting discounts for heavy oil relative to the West Texas Intermediate benchmark – with the discount amounting to US$50 per barrel in October.

Miller called Keystone XL and the existing Keystone pipeline “two very effective bullet lines” that would allow TransCanada to ship 1.4 million barrels of oil per day between Alberta and the U.S. Gulf Coast, which is a premium market for heavy oil.

The discounts for Canadian oil, measured as Western Canada Select, are likely to persist until sufficient pipeline export capacity are built, Miller said.

TransCanada told investors it expects to raise its dividend at an average annual rate of eight to 10 per cent through 2021, an outlook supported by expected growth in earnings and cash flow. Comparable earnings before interest, taxes, depreciation and amortization are expected to grow to about $10 billion in 2021, a 35 per cent increase from the $7.4 billion in 2017, TransCanada said.

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With a file from Thomson Reuters

In EV era, Brookfield and Caisse place $13-billion bet on conventional car battery maker

The rapid growth of the electric vehicle industry may be drawing headlines, but when it comes to drawing major investments, the internal combustion engine remains on solid footing.

In a deal that highlights the breadth of the traditional automotive industry, two Canadian investment funds on Tuesday announced a US$13.2-billion deal to purchase the leading global manufacturer of lead-acid batteries.

Toronto-based asset manager Brookfield Business Partners and pension manager Caisse de dêpôt et Placement du Quebéc (CDPQ) along with other investors will jointly acquire 100 per cent of Ireland-based Johnson Controls’ automotive business — which shipped 154 million automotive lead-acid batteries in 2017.

Although the buyers described the asset as positioned to benefit from growth in electric vehicles, analysts said its business remains tied to vehicles with internal combustion engines.

“As positioned right now they’re not an electric vehicle type play,” said Brian Bernard, an analyst at Morningstar Research who covers Johnson Controls.

It is Brookfield Business Partners largest acquisition to date since the unit went public in 2016. The stock rose 2.3 per cent on the Toronto Stock Exchange to $50.03.

Johnson Controls has a leading share in the global market for the lead-acid batteries used in traditional vehicles, at about 36 per cent, and has also been growing its absorbent glass mat batteries segment, Bernard said.

The latter segment, known as AGM batteries, allow vehicle engines to shut off at red lights and other stop points, and then quickly restart. That function creates better fuel economy for vehicles, which automotive manufacturers are increasingly seeking, said Bernard.

“The growth in those things has been double-digits phenomenal,” said Bernard, adding, “A lot of their investment has been building capacity for that.”

Such batteries are also necessary to meet increased power demands as automakers add screens, computers and other functions inside cars, he said.

The deal is expected to close by June 30, 2019. It will be funded through a mix of US$3.2-billion equity and US$10.2-billion in long term debt financing, with Brookfield and CDPQ each putting up 30 per cent of the equity and the balance funded by other institutional investors who were not named.

Brookfield declined to make an executive available for comment, and CDPQ said no one was available to speak.

In announcing the deal, the investors stressed the strength of the Johnson Controls’ Power Solutions’ business: market leading position, stable cash flows, diverse customer base.

The buyers also emphasized that Johnson Controls’ Power Solutions “is well-positioned to benefit from growth in demand for advanced batteries in all vehicle powertrains including electric vehicles.”

Bernard said that although Johnson Controls’ has a lithium-ion battery facility in Michigan, it’s not a significant player in that market.

Indeed, the company has been moving away from its automotive roots after spinning out its car-seat unit in 2016. The latest sale completes its transformation to a “pure-play” provider of fire, security, climate control and building-management systems.

Chris Berry, of House Mountain, an adviser to companies that mine battery metals, said that the lithium-ion battery in electric vehicles is not comparable to the lead-acid batteries found in internal combustion vehicles.

“The lead acid battery — OK, it’s been around forever,” said Berry. “On the lithium-ion side, you have a number of different chemistries and there’s a tremendous amount of intellectual firepower that’s going into building a lithium-ion battery that will take you further on a single charge.”

In the battle to build the next great lithium ion battery, most of the major players are in Asia, in particular China, said Berry. It is investing billions of dollars every year to develop a supply chain for battery grade material such as lithium and cobalt, and then build facilities that can manufacture batteries.

“They know they’re not going to compete with the West, which has 100 years of internal combustion engine technology,” said Berry, “So they’re saying why not dominate the EV industry?”

Some analysts project electric vehicles could account for as much as 15 per cent of all vehicles in a decade or so, up from around one per cent now, said Berry. But even under that scenario, traditional vehicles would account for 85 per cent of the market.

Jose Lazuen, an analyst at Roskill who focuses on advanced transportation, said Johnson Controls has a strong clientbase and stable cash flows.

While growth in the electric vehicle market may excite people, Lazuen said Brookfield and CDPQ’s decision to purchase Johnson Controls’ Power Solutions likely came down to basic fundamentals.

“They saw an investment opportunity to make returns,” he said.

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Thermal power plants use a lot of water, but that’s slowly changing

nuclear cooling towers

It may come as a surprise that as of 2015, most of the water taken out of US ground- and surface-water sources was withdrawn by the electricity sector. Irrigation is a close second, and public supply is a distant third.

In 2015, thermal power generation—anything that burns fuel to create gas or steam that pushes a turbine—used 133 billion gallons of water per day. That water is mostly for cooling the equipment, but some of it is also used for emissions reduction and other processes essential to operating a power plant.

Those gallons are mostly freshwater, but some near-coast power generators do use saline or brackish water to operate. Much of the water is returned to the ecosystem, but some of it is also lost in evaporation. The water that is returned can often be thermally polluted, that is, it’s warmer than what’s ideal for the local ecosystem.

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Canada gets it right on cannabis, wrong on oil, GMP Capital CEO says

The roll-out of legal cannabis is a prime example of how Canada can get things right. Energy shows how the country sometimes gets it wrong.

That’s the view of GMP Capital Inc.’s Harris Fricker, who is seeing deal-making in marijuana and blockchain eclipsing the traditional industries of energy and mining that were once bread-and-butter businesses for the Toronto-based financial services firm.

Canada has become a world leader in cannabis, with initial support from Canadian investors giving way to capital inflows from the U.S., Europe and Asia thanks to a welcoming regulatory environment, according to Fricker. That’s a stark contrast to Canada’s oil-and-gas sector, where major pipeline projects have failed to get off the ground, leading to a record price discount for the nation’s oilsands crude.

“Cannabis is a poster child for how to do it,” GMP’s chief executive officer said Monday in an interview at Bloomberg’s Toronto office. “Oil-and-gas is a poster child of how not to do it.”

GMP is benefiting from interest in blockchain and cannabis, with two-thirds of its investment banking business coming from outside natural resources, Fricker said Friday after releasing third-quarter results. GMP had a 72 per cent surge in revenue in the quarter from a year earlier, led by strong investment-banking activity. Fricker said cannabis and blockchain “admirably” filled the void of a beleaguered commodities division.

Staggering Run

The cannabis sector provides the greatest immediate potential, with what Fricker describes as a “staggering” five-year run ahead of it. Canadian investment banks like GMP and Canaccord Genuity Group Inc. are benefiting from a surge in listings in Canada by domestic and U.S. pot companies while cannabis remains illegal at the federal level south of the border.

Opportunities in blockchain — the distributed digital ledger technology that underpins Bitcoin — will start to materialize in five to seven years, he said. Fricker predicted a year ago that as many as 50 blockchain-related companies would go public in Canada. The plunge in bitcoin prices this year has cooled that market for now, he said.

GMP Capital CEO Harris Fricker.

“Blockchain has more potential because you’re talking about changing the way value is transmitted,” Fricker said, calling that shift from a 200-year-old traditional accounting system the “Holy Grail.” “As it takes root, its ability to profoundly change society is greater.”

GMP, which is hosting a blockchain technology conference in Toronto Tuesday, is better positioned to provide investment-banking services to these emerging industries than the bank-owned investment banks and U.S. firms because his company is more agile and nimble, Fricker said.

No Salad

“If they’re a cruise ship, we’re a Viking ship,” Fricker said. “I tell my guys never, never get the two confused because there’s no salad bar on a Viking ship.”

As a part of the strategic shift, GMP now has 15 bankers working in the cannabis space, and another 10 on blockchain. Staffing in the energy sector, traditionally the bank’s focus along with mining, has been cut in half, he said.

Canada has become a world leader in cannabis, with initial support from Canadian investors giving way to capital inflows from the U.S., Europe and Asia.

Still, Fricker said Canada shouldn’t turn its back on resources, and efforts to move away entirely from oil-and-gas are misguided.

“We have been blessed with one of the great caches of resource wealth in the world and harvesting that responsibly — including the gold standard and environmental — should absolutely be the rule that governs,” Fricker said. “But harvest it we must.”

Advance Energy

Fricker expressed frustration at Canada’s inability to advance energy infrastructure, including pipelines to deliver oil and gas out of land-locked Alberta. The impasse has led to record discounts of more than US$50 a barrel for some Canadian crude relative to global benchmarks. The federal government was forced to take over the Trans Mountain pipeline expansion in May after Kinder Morgan Inc. halted work amid rising opposition from environmental groups and the British Columbia government.

“We are at an historic high in the differential and we can’t pipe oil product — which is our single largest revenue source in this country — to either coast.”

Canada’s energy woes haven’t helped GMP’s stock, as many investors link the company to that sector. GMP has dropped 40 per cent this year, more than six times the decline in Canada’s benchmark stock index, cutting its market value to about $150 million (US$113 million).

Beyond investment banking, Fricker said he wants to expand the Richardson GMP wealth-management division by attracting more advisers to its platform. He has a five-year goal of lifting assets under management to $50 billion from its current level of $30 billion.

“Given the changes the banks are making in their wealth-management businesses, we’re optimally positioned to attract large book investment advisers who want to be in the advice delivery game,” he said. “That’s where we’re seeing our growth come from.”

Bloomberg.com

How machine learning systems sometimes surprise us

This simple spreadsheet of machine learning foibles may not look like much but it’s a fascinating exploration of how machines “think.” The list, compiled by researcher Victoria Krakovna, describes various situations in which robots followed the spirit and the letter of the law at the same time.

For example, in the video below a machine learning algorithm learned that it could rack up points not by taking part in a boat race but by flipping around in a circle to get points. In another simulation “where survival required energy but giving birth had no energy cost, one species evolved a sedentary lifestyle that consisted mostly of mating in order to produce new children which could be eaten (or used as mates to produce more edible children).” This led to what Krakovna called “indolent cannibals.”

It’s obvious that these machines aren’t “thinking” in any real sense but when given parameters and a the ability to evolve an answer, it’s also obvious that these robots will come up with some fun ideas. In other test, a robot learned to move a block by smacking the table with its arm and still another “genetic algorithm [was] supposed to configure a circuit into an oscillator, but instead [made] a radio to pick up signals from neighboring computers.” Another cancer-detecting system found that pictures of malignant tumors usually contained rulers and so gave plenty of false positives.

Each of these examples shows the unintended consequences of trusting machines to learn. They will learn but they will also confound us. Machine learning is just that – learning that is understandable only by machines.

One final example: in a game of Tetris in which a robot was required to “not lose” the program pauses “the game indefinitely to avoid losing.” Now it just needs to throw a tantrum and we’d have a clever three-year-old on our hands.

Elon Musk on double-decker freeways, permitting, and building sewers

boring machine segments

Tesla, SpaceX, and Boring Company CEO Elon Musk is good at finding alternative markets for his products. He did this with the lithium-ion batteries he was building and sourcing for his Model S, X, and eventually Model 3 cars: by developing a line of stationary storage battery products, he tapped into another well of potential customers at little additional expense.

Similarly, Musk told mayors on Thursday that he wants The Boring Company to dig sewers, water transport, and electrical tunnels under cities, in addition to the transportation-focused tunnels he hopes to dig to house electric skate systems.

Musk mentioned this alternate use for his boring machines at the National League of Cities’ City Summit, during a “fireside chat” with Los Angeles mayor Eric Garcetti. According to Forbes, Musk told the audience, “The Boring Company is also going to do tunneling for, like, water transport, sewage, electrical. We’re not going to turn our noses up at sewage tunnels. We’re happy to do that too.”

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Oil price discounts could be costing Canadian economy as much as $100 billion a year

Imagine producing a bumper crop of a product in high demand around the globe, only to learn you must settle for a discounted price because there’s no easy way to get your product to market.

Canadian grain farmers experienced that situation in 2013 and again last winter when their harvest outstripped the transport capacity of Canada’s rail companies. Western Canada’s oil companies are now in the same boat thanks to production gains that have not been matched by export pipeline capacity gains.

Like those farmers, oil producers have filled storage to bursting while they wait for a solution to appear. The price discounts or “differentials” that had mainly affected heavy oil have spread to light oil and upgraded synthetic oilsands crude as pipeline space tightens.

Estimates on the cost to the economy vary wildly, but the Canadian Association of Petroleum Producers officially estimates the impact as at least $13 billion in the first 10 months of 2018.

It estimates the cost at about $50 million per day in October as discounts for Western Canadian Select bitumen-blend crude oil versus New York-traded West Texas Intermediate peaked at more than US$52 per barrel.

“The differential has blown out to such an extreme level for two reasons, the lack of access to markets and the fact we really have only one customer (the United States),” said Tim McMillan, CEO of CAPP.

Getting an exact number on how much discounts are costing Canada is all but impossible thanks to ingrained sector secrecy about transportation and marketing, he said, adding it’s entirely possible the real costs could be as high as $100 billion per year.

Producers’ exposure to WCS prices differ depending on what kind of oil they produce, where they sell it and how they transport it.

Calgary-based Imperial Oil Ltd., for instance, says about one-quarter of its output of 300,000 barrels of bitumen per day is influenced by WCS pricing — the rest is used in its Canadian refineries or shipped by pipe or rail to the U.S. Gulf Coast where it gets close to WTI prices.

The company announced last week it will build a 75,000-bpd oilsands project, going on faith that pipelines will be in place for when production begins in about four years (a prospect that took a hit Thursday when a U.S. judge put TransCanada Corp.’s Keystone XL pipeline on hold until more environmental study is done).

Meanwhile, it is ramping up rail shipments from its co-owned Edmonton terminal as fast as it can.

Other oilsands producers including Canadian Natural Resources Ltd. and Cenovus Energy Inc. are cutting production to avoid selling at current prices.

The industry’s problems receive little sympathy from environmentalists like Keith Stewart of Greenpeace.

“The root of the problem is that companies kept expanding production even when they knew there was no new transport,” he said.

But McMillan pointed out it takes years to plan, win regulatory approval and build projects.

For example, producers would have had no way of knowing ahead of time that the 525,000-barrel-per-day Northern Gateway pipeline project approved in 2014 by a Conservative government would then be rejected by a Liberal government in 2016, he said.

“If Northern Gateway had come on as planned, we wouldn’t be in this situation,” said McMillan.

In a report last February, Scotiabank analysts estimated the differential would shave $15.6 billion in revenue annually, with a quick ramp up in crude-by-rail expected to shrink the hit to $10.8 billion by the fall.

At that time, discounts had widened to about US$30 per barrel from an average of around US$13 in the previous two years.

Crude-by-rail shipments increased to a record 230,000 bpd in August but haven’t reduced the differential.

According to Calgary-based Net Energy, the WCS-WTI differential averaged US$45.48 per barrel in October and has averaged US$43.75 so far in November.

In an analysis last March, Kent Fellows, research associate at the School of Public Policy at the University of Calgary, estimated the differential would translate into a $13-billion economic loss if it persisted for a year — $7.2 billion to the Alberta government, $5.3 billion to industry and $800 million to the federal government.

The differential has gotten much worse, he said in an interview this week, which means the lost opportunity is proportionately worse.

Higher differentials hit provincial governments in the form of lower-than-expected royalties — their cut of every barrel produced from land where mineral rights are Crown owned — while the federal government will see lower corporate income taxes, Fellows said.

“If this keeps up and we start to see either a lack of growth or more shutting in some of this production … you’re losing jobs and even personal income tax as well,” he said.

The Alberta government estimates that every annual average $1 increase in the WCS-WTI differential above US$22.40 per barrel costs its treasury $210 million.

In Saskatchewan, Western Canada’s other major oil-producing province, each $1 change in the differential is equivalent to about $15 million in revenue, based on an assumed WTI price of US$58 per barrel, the government says.

Finance Minister Donna Harpauer said in an interview that if current discounts continued for a year, the Saskatchewan industry’s lost revenue would be about $7.4 billion.

Part of the reason WCS discounts were wider in October is that WTI, which opened the year at US$60.37 per barrel, jumped to more than US$76. Producers exposed to WCS didn’t get the benefit of the higher U.S. oil prices.

McMillan said the differentials are being noticed by potential energy investors — CAPP expects capital investment of $42 billion in the Canadian oilpatch in 2018, down from $81 billion in 2014.

“We’re losing hundreds of millions of dollars that’s going to subsidize drivers in the United States.”