OPINION | This 'Bitumen Boondoggle' is costing Alberta taxpayers billions

This column is an opinion from Andrew Leach, an energy and environmental economistat the University of Alberta.

"On November 8, 2012, the North West Redwater Partnership (NWRP) announced the sanctioning of Phase 1 of the Sturgeon Refinery, which it will build, own and operate."

For many people, these words were great news more bitumen would be refined in Alberta, at a new private sector refinery.

Unfortunately, these words open a section of Alberta Energy's annual report, updating Albertans on the status of the Alberta government's backing of this refinery, which has saddled us with a $26.4-billion liability. Yes, $26.4 billion.

Accounting for the value added through refining bitumen into diesel and other products, the "Bitumen Boondoggle" is now expected to be a net loss to Alberta taxpayers of more than $2.5 billion.

If you were mad about billions of government dollars going to bail out Bombardier after its C-Series debacle, the details of the Bitumen Boondoggle will make your head explode. The series of decisions that got us here, including our government effectively gifting billions to a private consortium, should be the biggest scandal in Alberta today.

The Sturgeon Refinery has its roots in the 2008 royalty review, which recommended a royalty credit be used to encourage more processing of bitumen in Alberta.

The government of premier Ed Stelmach took a different approach and announced the province would accept bitumen in-lieu of cash as royalty payments and would contract for the processing of this bitumen within Alberta.

Jeff Johnson, then a PC MLA, called the plan "an innovative way to encourage growth of the value-added sector," and extolled the lack of any large direct investment or costly tax credits coming from the government.

Albertans should have roughly 26 billion questions for Mr. Johnson today.

Taking the 'safe bet'

A competitive process yielded two proponents looking to build new refineries to process the government's bitumen: the NWRP, which secured an agreement for the Sturgeon Refinery, and the Alberta First Nations Refinery, which did not, as it was deemed too risky an investment.

If the safe bet ended up billions in the red, thank goodness we didn't build the risky one.

Given that adding value to Alberta bitumen was broadly popular at the time, there's nothing too alarming to this point in the process. Government secured what the people wanted and used competitive procurement to do so. In that sense, it's not much different from recent procurements for renewable power or petrochemical processing.

From there, though, the refinery deal gets messy.

The government of the day was not honest with Albertans, and perhaps not even with itself, about the contract it wassigning.

Then-finance minister Ted Morton has written that the government caucus at the time "heard a lot about capturing the 'value added,' but was told almost nothing about the significant financial risk." As Morton frames it, "[the government] was being asked to take equity-type risks without equity-type returns."

The contract that Alberta signed was a public-private partnership under which NWRP would build and operate the refinery that would process 37,500 barrels per day of Alberta-government-owned bitumen, along with 12,500 barrels per day of bitumen from Canadian Natural Resources Limited, Canada's largest heavy oil producer, which also owns 50 per cent of the refinery.

The Alberta government's involvement went well beyond providing the refinery with bitumen, even though that phrase is frequently used to describe the deal.

The government was committed to fund a 10 per cent rate of return on the then-expected capital costs of the facility of $5 billion, and to cover all reasonable operating costs of the refinery through tolls paid for bitumen processing.

The government would profit or lose from the spread between the value of the refined products and the market value of its bitumen risks which no merchant refiner was prepared to take at the time.

The only risks the refinery was taking, to quote Murray Edwards of CNRL from 2011, was "the risk on capital cost acceleration." Edwards assured Albertans that "if there's capital cost acceleration issues, or there are operating cost issues, those all fall back on the producer, not on the [government]."

Albertans might today have a few billion questions for Mr. Edwards, too.

Construction cost overruns and operating issues have led to a $7-billion increase in the expected costs to Albertans of refining our bitumen. These risks, it turns out, fell directly on all of us.

How we got from there to here is a true scandal. If it's not criminal, it should be.

The NWRP proposal was already expensive in part because Sturgeon is a small refinery built in an expensive jurisdiction.

Soon after the project was sanctioned in 2012, reports of cost-escalations started to come in. In December of 2013, the expected capital cost of the project was increased from $5.7 billion to $8.5 billion, andthe following June, the government's estimate of the tolls we would all pay to refine our bitumen was increased from $19 billion to $26 billion.

We now know that the total cost to build the refinery will be even greater still, at over $10 billion, but reductions in costs of debt have kept the total liability from growing much more, for now. As of the most recent government financial reporting, our liability stands at $26.4 billion.

In and of itself, a$7 billion escalation in government liabilities is remarkable. It's more remarkable when you consider that the original contract had capped the maximum project cost that the government would cover at $6.5 billion. Furthermore, if costs did get that high, there would be no rate of return paid on the capital invested.

As NWRP CEO Ian MacGregor said in assuring government that they did not face these kinds of risks, "our fee structure runs out at $6.5 billion." That's the point of a public-private partnership: the government is supposed to offload project execution risk.

A renegotiated contract

From here, things get awful. In 2014, the Alberta government renegotiated the contract to allow the project partners to earn a rate of return on a larger amount of invested capital. The cost overruns were now on the taxpayers' backs, not the refinery owners. The owners, as long as they could finance the more expensive refinery, would earn a return on their now-larger investment. They would benefit from cost overruns.

Butthat's not all: the contract stipulated a minimum equity contribution that the partnership would have to make and, with the project costs escalating, they were unable or unwilling to make it. Rather than allow the entity to fold, the Alberta government loaned NWRP a private entity over $400 millionso that it could cover itsshare of the cost. Yes, you read that correctly.

A real estate analogy might be helpful for those lost in the details.

Imagine the government signed a lease deal with a company proposing to build a new office tower. The deal held that the government would pay monthly fees sufficient to guarantee a rate of return on owning the building as well as covering all the mortgage payments and any operating costs.

Now, imagine construction runs way over budget, and the government not only agrees to increase its payments to allow the builder a return on a more expensive building, but it agrees to pay the now-larger mortgage payments and to loan the builder money for the down payment on the mortgage.

This is just not how governments should do business.

So, what's the end result of all this? The Alberta government is expecting to pay $26.4 billion over 30 years to refine bitumen into diesel, gas, oiland small volumes of other products; an average refining toll of over $73 per barrel of bitumen processed.

This is a substantial and important increase from the initial estimates of $39.67 per barrel based on the 2011 and 2012 contracts.

I don't think government should be in the refining business but, as shown in the graph above, at the initial contract values, the refinery would have been in-the-money for the government just about every week since 2015 (had it been operating), and it would have done very well at times when Alberta crude was selling at a large differential to global benchmarks (WTI-WCS differential).

With the increase to $73 per barrel tolls, the refinery will only be profitable in periods whenpipelines are substantially constrained, as they were in 2017 and 2018. With new pipelines under construction, and slow-to-non-existent oilsands production growth, that seems unlikely to be the case for many years. It's much more likely that we'll be losing money on every barrel.

So, in a sense, the Sturgeon Refinery contract is a multibillion-dollar bet against pipelines getting built. It's worth noting that by investing in the Keystone XL pipeline, the Alberta government also has a multibillion-dollar direct bet on that pipeline getting built, so we're now guaranteed to lose billions on at least one major government industrial policy bet. Fantastic.

We can't predict the future of the oil market, and pipelines like KXL are no sure thing, so it's possible that the refinery will still end up in-the-money if we see a combination of high oil product prices and low bitumen values in the future.

But even if that proves to be the case, Albertans should remember that we're paying more than $7 billion more than we should have for this refinery, and that those dollars are going to fund a return to a private entity that failed to live up to its side of a bargain with Albertans.

When the NWRP CEOassured Albertans that his consortium had spent $800 million to ensure that they could build their refinery on time and on budget, we should have held him to it. We should not have allowed project proponents to earn a utility rate of return on a $5-billion miscalculation.

The offices of six premiers played a part in this Bitumen Boondoggle, and we should hold them all accountable for it.

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