Pipe Dreams: Canadian Government Bails Out Houston Billionaire

Despite fierce opposition from the provincial government of British Columbia, First Nations groups, among many others, Trudeau plans to move forward with building a second pipeline that would nearly triple flows of heavy tar sands oil to the BC coast.

In his continuing bid to earn his country the title of most corrupt petro-state, Canadian prime minister Justin Trudeau just committed his government—or, rather, all of the country’s citizens—to a Can$4.5 billion bailout for the Trans Mountain pipeline expansion project.

Trudeau’s government has agreed to buy the existing Trans Mountain Pipeline, along with associated assets, from the current owner, a subsidiary of Houston-based Kinder Morgan, Inc. And despite fierce opposition from the provincial government of British Columbia, First Nations groups, local municipalities, environmental activists, government watchdogs, and any sensible person concerned about the integrity of the Salish Sea, Trudeau plans to move forward with building a second pipeline that would nearly triple flows of heavy tar sands oil to the BC coast.

The big winner in all this is Houston’s richest billionaire, Richard Kinder—the executive chairman of Kinder Morgan, a multinational pipeline giant that rose from the ashes of Enron and succeeded in playing the Canadian government like a fiddle throughout the years-long Trans Mountain saga.

The losers? Well, just about everyone else, especially the First Nations whose homelands and waters will be threatened by an unwanted pipeline.

Financially, the Trans Mountain expansion was always a high-risk endeavor that struggled to attract investors. In the fall of 2016, Kinder Morgan, Inc. signaled that it was looking for joint-venture partners to share costs and risks, and the company continued to look for joint-venture partners through the following spring. Finding no takers, the company announced that it would raise equity through an Initial Public Offering (IPO) by bundling its Canadian assets, along with the Puget Sound Pipeline in Washington, into a shell company.

The IPO raised Can$1.75 billion, but Houston siphoned off virtually all of the money to pay back the parent company’s burgeoning debt. That left the Canadian subsidiary with virtually no capital to move forward with the pipeline expansion, forcing it to head back out into the markets to raise an additional Can$2 billion to complete the project. But they never found anyone deep-pocketed enough who was willing to plunk down equity to build the pipeline—at least, not until the Canadian government stepped in. Not even the major oil companies that had signed up to ship oil through the pipeline—most of whom were contractually obligated to say nice things about the project—were willing to put their money on the line to get the pipeline built.

Plenty of financial risk

In reality, the pipeline faced at least four major types of financial risk that made it difficult to attract investors.

First was the fierce and vocal public opposition to the project, which spawned all manner of legal, political, permitting, and reputational challenges. Any successful political or legal obstacle could add cost and delay—with a major adverse decision threatening to halt the project altogether.

Second was the likelihood of cost overruns, which are all too common with megaprojects, and seemed to be a particular problem for Trans Mountain. In 2013, Kinder Morgan pegged the cost of the Trans Mountain project at a “mere” Can$5.4 billion. In late 2015, the company boosted the cost estimate to Can$6.8 billion. In spring 2017, citing higher “compliance costs,” the company raised its estimate yet again to Can$7.4 billion. Since then, the company has declined to update its cost and schedule estimates, but some well-informed analysts believe that the final cost may rise to as high as $9 billion. Shippers who use the pipeline’s services would pay for a subset of cost overruns, but for 76 percent of the project’s spending (see slide 50, here), any cost escalation would have been borne by the pipeline company itself.

Third was the pipeline’s massive oil spill liabilities. Under Canadian law, the pipeline company would pay up to $1 billion for a major spill, even if someone else (say, a numbskull with a backhoe) actually triggers the spill. And if the pipeline company is at fault, the liability is literally limitless. On top of all of that, any pipeline company would have to deal with the expense of maintaining sufficient insurance and financial reserves to pay for a spill.

Fourth is the uncertain and volatile economics of the global oil industry—and the role of Canada’s tar sands within that industry. Tar sands operations are climate pariahs that will face harsh financial consequences in a carbon-constrained world. But even setting aside climate concerns, tar sands oil has racked up a dismal financial track record, with high costs, limited profits, and a mass exodus of major investors over the past several years. Major tar sands expansions now look unlikely—which means that the Trans Mountain’s capacity may prove unnecessary, even as the pipeline faces significant “counterparty risks” from shippers who may eventually have trouble paying their agreed-upon fees.

Easy for Kinder Morgan to walk away

Even though Kinder Morgan faced massive risks in moving forward with the pipeline, the company faced surprisingly little downside from walking away. As of early April, Kinder Morgan had paid out about Can$1.1 billion to move the expansion project forward, and that money would have been lost if the project folded. But the Trans Mountain shippers—the oil companies that bought space on the pipeline—were contractually responsible for 80 percent of those costs.

In addition, Canada’s National Energy Board gave Kinder Morgan a de facto slush fund of more than $200 million to keep the project alive, again paid for by shippers rather than the pipeline company. Kinder Morgan got an additional boost from the IPO of its Canadian subsidiary, which lured investors to pay a premium for the potential upside from the Trans Mountain expansion. So, in reality, Kinder Morgan was in a position to walk away and virtually break even.

The market’s initial reaction to Trudeau’s bailout of Kinder Morgan was fairly predictable: Kinder Morgan saw 3 percent rise in its stock value at the opening bell, and ended the day up slightly—on a day when the market overall declined by well over one percent. Meanwhile, Kinder Morgan Canada initially saw a surge in its stock price, which quickly eroded as investors realized that the real winners were in Houston, not the Canadian investors who’d bought into the Kinder Morgan Canada IPO. By the end of the day, Kinder Morgan Canada stock had fallen 3 percent, as markets ingested Kinder Morgan’s admission that 70 percent of the money paid by the Canadian government for the pipeline would flow directly to the Houston mothership. As one Kinder Morgan shareholder observed about the deal: “It’s actually better for Kinder Morgan than it is for Canada. They are getting a very good value.”

In the end, then, Richard Kinder proved a consummate card shark, parlaying a no-lose position—simply walking away from a beleaguered and high-risk pipeline—into a big win for himself.

Meanwhile, Justin Trudeau has turned the people of Canada into Richard Kinder’s marks.