Viewing cable 03OTTAWA503, NATURAL GAS IN NORTH AMERICA:

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UNCLAS SECTION 01 OF 05 OTTAWA 000503 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR EB/TPP/BTA EB/ESC/ISC (MCMANUS AND ERVITI), 
WHA/CAN (MASON AND RUNNING), OES/EGC (MIOTKE AND 
DEROSA) 
 
WHITE HOUSE FOR NSC (SAMMIS AND BROCK), OPD (MCNALLY) AND 
OVP (KNUTSON) 
 
DOE FOR INT'L AND POLICY (A/S BAILEY) AND IE-141 (DEUTSCH) 
 
STATE PASS FERC FOR CHAIRMAN WOOD AND DONALD LEKANG 
 
COMMERCE FOR 4320/MAC/WH/ON/OIA/BENDER 
 
E.O. 12958: N/A 
TAGS: ECON EPET ETRD CA
SUBJECT: NATURAL GAS IN NORTH AMERICA: 
 CANADIAN PERSPECTIVE 
 
REF: (A) 02 OTTAWA 2098 (GOC AGAINST ALASKA "SUBSIDIES") 
 
 (B) 02 OTTAWA 1689 (ENERGY CONSULTATIVE MECHANISM) 
 (C) 02 OTTAWA 2474 (ELECTRIC POWER OPPORTUNITIES) 
 (D) 01 OTTAWA 2857 (NORTHWEST READY FOR GAS DEV'T) 
 
SENSITIVE, BUT UNCLASSIFIED - NOT FOR DISTRIBUTION 
OUTSIDE USG CHANNELS. 
 
SUMMARY/INTRODUCTION 
-------------------- 
 
¶1. (U) Although Canada's energy exports to the United 
States have grown at impressive rates in recent decades, 
making Canada our largest total energy supplier, Canada's 
conventional natural gas resources are maturing and 
production from current areas could peak within a decade. 
GOC forecasters expect that Canada's exports of natural 
gas will peak in 10-15 years and their share of U.S. 
demand will decline from about 18 percent at the peak, to 
perhaps 13 percent by 2025. Yet, like other countries, 
both the U.S. and Canada continue to build gas-burning 
infrastructure at high rates. There is a risk that 
future tight gas supplies and high prices could "strand" 
some of this investment (i.e. make it uneconomic before 
the end of its intended lifespan). 
 
¶2. (SBU) Gas industry observers are increasingly focused 
on what is required in order for yet-to-be-developed 
northern gas resources - in Alaska and in Canada's 
northern territories - to take the place of these 
"maturing" conventional supplies. Because Canada is a 
net energy exporter, it is much more willing to accept 
high energy prices, and thus its economic interests with 
respect to northern gas development differ significantly 
from those of the U.S. 
 
¶3. (SBU) An outcome attractive to key Canadian interests 
would likely entail (1) ensuring that two pipelines 
(Mackenzie Valley and Alaska Highway) are constructed, 
and (2) locating industrial benefits - perhaps a gas- 
liquids separation facility - in Canada. Observers argue 
that, while such a "big political deal" could be 
relatively straightforward and low-risk, only the USG has 
an overwhelming interest in brokering it. 
 
¶4. (U) This message is based on conversations with 
contacts in Ottawa, Calgary and Edmonton and was prepared 
with assistance from Amconsul Calgary. 
END SUMMARY/INTRODUCTION 
 
 
GAS DEMAND GROWTH CONCENTRATED IN POWER SECTOR 
--------------------------------------------- - 
 
¶5. (U) Recent rapid growth in overall demand for natural 
gas has been driven by this fuel's low cost and 
availability, and its low emissions relative to oil and 
coal. In electric power generation, another important 
factor is at work: gas-burning plants can be located 
very close to power markets, avoiding the need to 
construct additional power transmission lines, which has 
become very difficult politically (ref C). 
 
¶6. (U) As a result, ExxonMobil forecasts that while total 
world energy demand will grow at an average 1.8 percent 
annual rate through 2020, gas demand will grow faster - 
2.6 percent overall, and 3.6 percent in the power 
industry. By ExxonMobil's projection, gas will fuel 29 
percent of the world's electricity by 2020 (versus 21 
percent today). 
 
CONVENTIONAL GAS SUPPLIES MATURING 
---------------------------------- 
 
¶7. (U) Most of Canada's natural gas production so far has 
come from the Western Canada Sedimentary Basin (WCSB) 
(ref B), where conventional production is expected to 
peak in 2008-2013. Symptoms of this maturation include 
simultaneous high drilling rates and declining new 
discoveries; steeply rising drilling/discovery costs; and 
a withdrawal from gas drilling activity by major energy 
firms. 
 
¶8. (U) Coal-bed methane and other nonconventional gas 
sources, while they are promising, might not be large 
enough to fully offset the decline in conventional 
production. It appears unlikely that they will be 
sufficient to cause overall Canadian gas production to 
grow beyond the period 2015-2020 (see figure 5.6 of the 
National Energy Board study, "Canadian Energy Supply and 
Demand to 2025," at neb-one.gc.ca). As a result, the NEB 
expects Canada's natural gas exports to peak in the 
period 2013-2018. Canadian exports' share of total U.S. 
gas demand is projected to fall from 18 percent at the 
peak, to 13 percent by 2025. 
 
THE NORTH IS WILD 
----------------- 
 
¶9. (U) The "wild card" in this supply-demand projection 
is the development of gas resources from Alaska and 
northwestern Canada. Canada's northern territories 
(roughly north of 60 degrees latitude) contain 
significant oil and gas resources, notably gas in the 
Beaufort Sea and near the mouth of the Mackenzie River, a 
few hundred miles east of Alaska's Prudhoe Bay. National 
Energy Board (NEB) projections guesstimate that this gas 
will start coming to market in the period 2009-2017, and 
contribute modestly to supply - perhaps 1.5 to 2 billion 
cubic feet per day (Bcf/d) by 2025, on the order of one- 
tenth of Canada's total production. This GOC forecast 
limits itself to Canada, and is silent on Alaskan 
developments. Also, over longer time periods, 
development could extend to far larger reserves further 
north, in Canada's Arctic Islands. 
 
¶10. (U) IN RECENT DECADES, THE OBSTACLES TO OIL AND GAS 
DEVELOPMENT IN THE TERRITORIES HAVE SHRUNK DUE TO A 
NUMBER OF TRENDS - INCLUDING TECHNOLOGICAL ADVANCES, 
INCREASED DEMAND FOR NATURAL GAS AS OPPOSED TO OIL (GAS 
BEING EASIER TO TRANSPORT IN COLD CONDITIONS), PROGRESS 
ON ABORIGINAL LAND CLAIMS SETTLEMENTS, AND GREATER 
RECEPTIVENESS TO RESOURCE DEVELOPMENT AMONG ABORIGINAL 
GROUPS (SEE REF D FOR DETAILS). THE GOC HAS HELD 
REGULAR AUCTIONS OF EXPLORATION RIGHTS IN THE NORTHERN 
TERRITORIES SINCE THE LATE 1990'S (SEE WEBSITE 
INAC.GC.CA/OIL FOR DETAILS). NEVERTHELESS, GREAT 
UNCERTAINTY REMAINS ABOUT THE LENGTH OF THE POLITICAL- 
REGULATORY TIME LAG FROM PROPOSAL TO THE START OF 
CONSTRUCTION. 
 
PIPELINE PLANS TO ACCELERATE THIS YEAR 
-------------------------------------- 
 
¶11. (U) With rising energy prices in 2000-2001 and the 
release of the USG's National Energy Policy Report in May 
2001, interest in northern pipeline developments revived. 
Various stakeholder groups formed alliances to promote 
one prospective route or another. The two most 
frequently suggested options are: 
 
-- A relatively short, flat "all-Canadian" line from the 
Mackenzie Delta southward up the river valley and into 
northern Alberta. (In an ambitious, one-pipeline 
solution known as the "over the top" route, the north end 
of this line could conceivably extend westward to Prudhoe 
Bay - but this would greatly expand both the project's 
scale, and the political/environmental/aboriginal 
barriers to approval). 
 
-- A more mountainous "Alaska Highway" line from Alaska's 
North Slope southward to Fairbanks, thence more or less 
along the highway route through the Yukon Territory and 
northern British Columbia to northern Alberta. 
 
¶12. (U) The stakeholder alliance in support of the "all- 
Canadian" Mackenzie Valley line involves the Government 
of the Northwest Territories (NWT), the Aboriginal 
Pipeline Group (APG), and likely either or both of the 
largest pipeline operators -- TransCanada Pipelines 
(transcanada.com) and/or Enbridge (enbridge.com). 
Insiders expect the NEB to receive a formal application 
regarding this line during 2003. Supporters have lobbied 
the GOC for fiscal incentives, but so far without 
success, as the GOC (like the USG) remains officially 
"route-neutral." 
 
¶13. (U) Backers of the "Alaska Highway" line include the 
Governments of Alaska and the Yukon Territory, as well as 
Foothills Pipelines (foothillspipe.com). Foothills holds 
permits dating from the 1970's (and now of undefined 
value) to build a gas line on this route. Supporters and 
opponents are intensely interested in the final version 
of forthcoming U.S. energy legislation, since it may 
include various fiscal measures ("subsidies," pricing 
mechanisms, tax credits) which would affect the project's 
economics. 
 
A MACKENZIE LINE ALONE WON'T BE ENOUGH 
-------------------------------------- 
 
¶14. (U) While the "Canada-only" pipeline proposal may seem 
at this point to be moving toward realization, even if it 
were built first, it is not projected to offset either the 
decline in gas production from the WCSB, or the need to 
bring Alaska's North Slope gas to market. A "Canada-only" 
line would only deliver perhaps one-third as much gas as a 
line from Alaska. Moreover, Mackenzie gas is expected to be 
mostly or entirely consumed in Northern Alberta, since gas 
will be the main energy input to the production of crude oil 
from Alberta's oil sands. (This energy-intensive, heat- 
driven process will see immense capital investment over the 
coming decade as conventional oil production declines in 
Western Canada). 
 
¶15. (SBU) If, as now seems quite possible, the "Canada-only" 
line begins construction first, this is considered unlikely 
to make much difference to the economic case for building a 
larger line from Alaska's North Slope soon afterward. On 
the other hand, if an Alaska line were to begin construction 
first, this could well put off the construction of a 
Mackenzie Valley line for at least several years. For one 
thing, the demand generated by the larger Alaska project 
would drive up prices for already scarce skilled labor, 
pipe, and other inputs; for another, the resulting gas 
supply would undercut the economic case for the smaller 
line. 
 
ALASKA GAS: U.S. HOLDS THE BIGGEST INTEREST BY FAR 
--------------------------------------------- ------ 
 
¶16. (U) Obviously, Alaska natural gas development must 
answer many questions and clear many hurdles in order to 
become reality. How much would it really cost to build? 
What are the environmental consequences? How can aboriginal 
groups best participate? Might liquefied natural gas (LNG) 
facilities make more sense as a transportation option? 
 
¶17. (SBU) But those discussing these questions should be 
cognizant of Canadian factors which are too easily 
underestimated in a "lower 48" perspective: 
 
-- If a pipeline (rather than LNG) is to be the means of 
transport, Alaskan gas must cross Canadian territory in 
order to reach major markets. That territory is at least 
1,500 miles wide and is under four or more jurisdictions. 
 
-- The usual close alignment of national economic interests 
will not necessarily hold in this case. Indeed, Canadian 
economic and regional interests could work against this 
development - at least, without some major political deal- 
making. And Canada, as an energy exporter, can tolerate the 
higher natural gas prices that might result if Alaskan gas 
remains undeveloped. Simply put, an Alaska gas pipeline is 
much more clearly in the U.S. national interest than it is 
in Canada's national interest. This is particularly true as 
a Canada-only Mackenzie Valley pipeline moves toward the 
proposal stage. 
MAKING THE CASE TO CANADIANS 
---------------------------- 
 
¶18. (SBU) Construction of a natural gas pipeline from Alaska 
would have positive economic spin-offs in western Canada, 
but Canadians in that region understand well that such 
effects are small and brief, because construction tends to 
employ "flown-in" skilled trades and lasts only a few 
seasons. The key sustained payoff for Canadian interests 
would be in hosting "gas stripping" facilities to separate 
liquids from the relatively "wet" Alaska gas. These liquids 
provide inputs for petrochemicals and plastics industries 
that are already established in Alberta, and which the 
provincial government is determined to expand in the long- 
term. 
 
¶19. (SBU) On the downside, there are two major "negative 
risks" for Canadian interests. First, subsidies or other 
incentives granted to Alaskan gas could take market- 
distorting forms that would be inconsistent with both 
countries' expressed energy policies. Second, both 
construction and the resulting gas flows could undercut the 
economics of a Mackenzie Valley pipeline. Regional and some 
national leaders very much want the latter pipeline for its 
wider regional development effects - including all-season 
roads and stimulus to hydrocarbon and mineral exploration 
(see ref D). 
 
¶20. (SBU) It bears noting that these concerns could be easy 
for U.S. interests to address. Alberta (or northeastern 
British Columbia) may well be the most economic location in 
North America for gas-liquids separation, given northern 
Alberta's already massive gas processing capacity. Market- 
distorting subsidies are, after all, not in either country's 
true interest. And as noted above (para. 15), the Mackenzie 
Valley line, which may have a head start anyhow, is not 
expected to change the fundamental economic case for Alaskan 
gas development. 
 
COMMENT: THE BOTTOM LINE 
------------------------- 
 
¶21. (SBU) COMMENT: North America will need to have its 
"north of sixty" natural gas developed during the next two 
decades. We can discern features of a possible low-cost, 
low-risk political bargain that could pave the road to 
developing this gas - by assuring key jurisdictions that 
they will benefit, without imposing gross distortions on 
energy markets. 
 
¶22. (SBU) The USG and GOC are already committed to "route- 
neutrality" and in most parties' opinions - as well as from 
an economic standpoint - they should remain so. If fiscal 
regimes must be tilted in favor of developments preferred by 
the State of Alaska, it is clearly in the broader U.S. 
national interest (economically and diplomatically) to 
minimize the bias. 
 
¶23. (SBU) Most stakeholders will be satisfied if two 
pipelines - both the Mackenzie Valley (probably first) and 
the Alaska line -- eventually get constructed. This would 
satisfy top concerns of the sub-federal governments and 
other groups in both the Yukon and Northwest Territories. 
This outcome is also positive for northern Alberta oil-sand 
interests and for the Government of Canada - as well as for 
North America's continental energy security. Finally, a 
"politically ideal" compromise would deliver some industrial 
benefits to British Columbia as well as to Alaska and 
Alberta. 
 
CELLUCCI