EUR_20141219 (1) petrochemical canada

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Canada’s Petrochemical ExpansionPotential

Introduction

The Canadian petrochemical industry has renewed potential to enter anera of renaissance bolstered by the abundance of cheap US shale gas, adeveloped service sector and availability of land. Canada's key petro-chemical production clusters, concentrated in Alberta, Ontario andQuebec are starting to see a new wave of investment after a decade ofstagnation following the recent global economic downturn.

A new focus on using cheap US shale gas to provide ethane as a feed-stock for petrochemical products will likely boost production, allowingpetrochemical producers to stay competitive against their US counter-parts.

However, an abundant energy supply is not all that is necessary to givethe industry a new lease of life. Pipeline infrastructure, new roads andrailways are also paramount as without them transportation of anyfeedstock can be prohibitively expensive. In addition, if Canada wants totap into its own shale resources, it will need to develop the necessaryinfrastructure to access them at often remote locations.

The disadvantages that the industry is facing are not impossible toovercome, however. With co-operation between Canada and the US,new pipelines can be built at relatively short notice. These barriers can beovercome with the help of legislature at local and national levels. Whatcould somewhat hinder progress is environmental opposition fromresidents and green organizations.

However, without investment in new pipelines, getting liquefied naturalgas (LNG) sales deals signed with key Asian buyers and increased govern-ment support the expansion of the petrochemical industry will remainconstrained. A coordinated, cross-province effort to monetize thecountry’s oil and gas resources is necessary to deal with cost inflationand labour shortages, which are also key challenges for the industry.This report lays out in detail the potential to expand Canada’s petro-chemical industry, the advantages and opportunities available to inves-tors in Canada and the obstacles which must be overcome to allow theindustry to expand.

Canada’s oil and gas supply potential

Canada has vast oil resources which could fuel a boom in the country’spetrochemical sector. Canada, the world’s fifth-largest crude producerhas 173 billion barrels of proven oil reserves according to the US EnergyInformation Administration (EIA). Almost all these – around 167 billionbarrels – are located in the oil sands of Alberta.

Alberta’s Industrial Heartland, a 582 sq km region northeast of Edmonton,is home to Canada’s largest concentration of petroleum refining, petro-chemical, and chemical process

© FC Business Intelligence ® 2011

Canadian Petrochemical Market

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The Downstream Petrochemical Sector in Canada

Alberta is Canada’s leading producer of petrochemicals. Located primar-ily in Joffre and Fort Saskatchewan, petrochemical production is one ofthe largest manufacturing industries in the province. It features fourethane-cracking plants, including two of the world’s largest, with com-bined annual capacity to produce 8.6 billion pounds of ethylene.Ethylene comprises the bulk of Alberta’s petrochemical production, withup to 245,000 bpd of ethane feedstock being extracted from theprovince’s natural gas supply. As natural gas production continues to fallin the province, there will be a corresponding drop in supplies of ethaneand other natural gas liquids.

To offset this decrease, there are plans to extract ethane from off gasesfrom bitumen upgrading. It is estimated that with new refining capacityadded, up to 150,000 bpd of ethane could be produced from bitumenupgrading and used for petrochemical feedstock.

In Ontario – Canada’s other key petrochemical production centre - theSarnia-Lambton Refining and Petrochemical Complex lies at the heart ofOntario’s manufacturing district at the site of Canada’s first crude oildiscovery in 1857. The complex receives crude oil and natural gas feed-stock mainly from western Canada via the Enbridge Pipeline andTransCanada’s Pipeline.

Plants in Ontario and Quebec are better situated than those on the GulfCoast to supply the large customer base in Canada and northeastern andcentral US. In contrast, commodities manufactured in Alberta are largelyshipped to central and western US markets or offshore because of a lackof pipeline access.

Sarnia benefits from its proximity to nearby oil refineries, extensivepipeline infrastructure, a tanker terminal for offshore shipments, andready access to large US and Canadian customers via excellent transpor-tation networks.

In Quebec the petrochemical industry is located around Montréal anduses solely oil-based feedstocks. Crude oil arrives in Montréal by tankeror via pipeline from Portland, Maine. Although on a smaller scale thanSarnia, Montréal is also an integrated petrochemical complex that offersoil refineries, a tanker terminal for ocean shipments, and access to themarkets of eastern and central Canada and the US.


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Canada’s Gas Reserves

Canada has vast shale gas reserves of its own which could serve asfeedstock for the petrochemical industry.

According to the US EIA, Canada has the fifth largest shale gas reserves inthe world with around 573 trillion cubic feet thought to be recoverable -around 8% of the global total.

However Canada’s huge shale gas fields are land-locked in northernBritish Colombia. The remote geographical location of the resourcesincreases capital costs for upstream operators, as they have to build newinfrastructure to get the resources to markets. And with US gas prices at

multi-year lows, Canadian projects have struggled to get past the plan-ning stage and are unlikely to be able to compete with low-cost abun-dant supplies from the US.

The key to increasing Canada’s gas production and improving supplies offeedstock will be diversifying from its traditional sales market - the US.Getting LNG export projects off the drawing board and getting long-termsales deals signed with Asian buyers, will be crucial, industry experts say.All of Canada's natural gas exports are directed to the US via pipelines.Canada accounts for 97% of US natural gas imports, most of which comefrom western provinces.

Rising US Shale Gas Production and Its Impact onCanada’s Industry

Another challenge facing the Canadian petrochemical industry is thatrising shale gas output at its southern neighbour has created the pros-pect for long-term availability of relatively low-cost natural gas andnatural gas liquids in North America. This in turn, has curbed Canadiandrilling activity and reduced availability of ethane over the past decade. Inaddition, the growing shale gas output in the US has dampened demandfor Canadian natural gas.

EIA Projections For US Crude and Natural Gas Production to 2040. Source: EIA


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When less gas is produced, fewer liquids are recovered. This then resultsin Alberta’s petrochemical industry not having sufficient supplies ofethane, which results in ethylene-based derivative units at petrochemicalplants running under-capacity.

Raw material and utilities make up almost two-thirds of petrochemicalmanufacturing costs, according to the Canadian government, thus lowfeedstock costs are critical to the success of Canadian operations.

Nova Chemicals is exploiting the US’s vast unconventional gas reservesto access ethane from natural gas shale regions in the northeastern USfor its crackers in Corunna, Ontario, and Joffre, Alberta. In 2014 Novaswitched from using naphta to using natural gas liquids to reduce costs.The company says this could help open the door for future expansion inCanada’s Sarnia-Lambton's Chemical Valley by having access to stableand low-cost feedstock supplies.

They also plan to increase ethylene production capacity by 20% at theirCorunna cracker in Ontario, to 1 million t/y, between 2014 and 2018. Inaddition, during the last two years the company has spent $250 millionconverting its Corunna site to use up to 100% ethane from natural gas

and connect the facility by pipeline to the US’ Marcellus shale reserves.Other Canadian companies have also responded to the impact of soaringUS shale gas supply by trying to utilise ethane imported from the US tosupply the Canadian petrochemical industry.

Growth Forecasts

Canada’s industrial chemical sector saw operating profits reach anall-time high of $3.9 billion in 2013. Sales of industrial chemicals grew10% to $29.2 billion, exceeding a previous high set in a pre-recessionpeak of 2008.

Chemical exports increased by 5% last year, reaching $19.6 billion – theindustry’s second-best year ever, according to the Chemistry IndustryAssociation of Canada (CIAC). Industry-wide capital expenditures alsoincreased by over 20%, reaching $2.6 billion.

The CIAC is forecasting capital expenditures in the sector will jump by30% next year, to $3.4 billion, after a decade of very limited expansion.


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“We are slowly starting to get companies recognising the potential here.A lot of low hanging fruit in the US has already been picked up. Socompanies are starting to look around elsewhere,” said Neil Shelly,Executive Director Alberta's Industrial Heartland Association.

“There’s also the political and economic stability in the region. If you’regoing to invest $1 billion in a region you want to know your investment isgoing to be safe,” Shelly added.

If Canada can create the right investment conditions, especially for bigprojects, then further investment will follow. While this year the CIACexpects chemical sales to fall by 7%, mainly because of lower oil and gasprices, over the medium term the association is optimistic about theindustry’s prospects for growth and attracting investment.

The association estimates that the industry could attract up to $10 billionin new investments over the next 10 years, thanks to the availability ofNorth American shale gas and the continent’s other natural resources.

Pipelines, Infrastructure and Market Access

However, Canada faces an array of challenges in attracting the invest-ment needed to expand it petrochemical sector.

Source: Canadian Energy Pipeline Association

A lack of access to new pipelines, which restricts the sector’s ability to

take Canada’s crude and natural gas to new markets, is the biggestobstacle preventing the petrochemical industry from expanding.

Source: Canadian Energy Pipeline Association

Despite a wealth of natural resources and a developed service sector,Canada’s lack of pipeline capacity also restricts its ability to transport itsoil and gas to other markets for its crude and natural gas.


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Pipeline Operators

Canada can transport 3.3 million b/d of oil over 22,000 miles of pipeline,according to the Canadian Energy Pipeline Association (CEPA).

Three companies operate the majority of Canada’s crude export pipe-lines: Enbridge, Kinder Morgan, and TransCanada. All these companieshave new or pipeline expansion projects in development which aim toultimately increase the pipeline capacity to deliver oil from Alberta to theUS Midwest and US Gulf Coast.

Virtually all of Canada’s crude oil exports are directed to US refineries

because of a lack of domestic refining capacity which is capable ofprocessing heavier crudes and a legacy of cross border trade betweenthe two countries.

Traditionally the US has been Canada’s main crude and gas exportmarket. Almost 97% of Canadian oil exports were directed to the US in2013, according to the EIA, making Canada the largest supplier of foreignoil to the US.

Soaring crude and gas output from the US has exacerbated Canada’scrude infrastructure problem as it struggles to find new markets for its oil.A surge in North Dakota oil output over the past decade has brought newcompetition for markets in the US Midwest – historically the end pointfor Albertan oil.

Clement Bowman, Chair of Canada’s Energy Pathways Task Force (EPTF),said that improving Canada’s refining capacity and improving access topipelines to bring bitumen from east to west Canada would double thevalue of the product for export markets and improve feedstock availabil-ity for the petrochemical industry.

“The key thing is for Canada to establish access to pipelines as a long-term national priority. The next step is building a pipeline to bring bitu-umen from east to west Canada. That will be met by considerable env-ironmental challenges from activists and local groups,” Bowman said

He added that reducing Canada’s reliance on the US as its sole oil andgas export market, targeting new markets in Asia and boosting its pipelinetransportation capacity will be crucial to the future success of the indus-try.

Enbridge and Kinder Morgan have proposed new or expanded pipelinesto the US West Coast, which are only in the preliminary stages of plan-ning and regulatory review.

Kinder Morgan aims to expand its existing Trans Mountain pipelinesystem by building a second pipeline, which would increase Trans Moun-tain's capacity to 890,000 b/d. The company has submitted an applica-

tion with the National Energy Board and expects to begin construction inlate 2015.

Enbridge is pursuing the Northern Gateway Pipeline Project, which wouldend at a deep-water port in Kitimat, British Columbia. Northern Gateway


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would include a 525,000 b/d crude oil pipeline and a smaller parallelpipeline to carry condensate back to Alberta. It is expected to beginoperating in 2018.

There is also TransCanada’s Energy East proposal – a plan to build a4,600-km pipeline, which would carry 1.1 million bpd crude from Albertaand Saskatchewan to refineries in Eastern Canada.

The pipeline would to be constructed using, in part, surplus gas transmis-sion capacity to connect with refineries in Quebec by 2017.However, the project has met with delays because of the lengthy processof applying for regulatory approval from Quebec’s National EnergyBoard. The pipeline would be North America’s largest and would involveconverting 16,000 km of unused natural gas pipelines.

The completion of either or both of the competing Kinder Morgan andEnbridge projects would create a new export outlet for oil sands crude.Additional pipeline capacity to Canada's west coast would provide a hugetrade boost for Canada and would reduce its overland dependence onthe US market while providing access to growing Asian economies in thePacific Basin.

The need to factor in the cost of pipeline construction to transportremote reserves to markets is another reason project costs have esca-lated across Canada’s entire energy sector.

In July last year US firm Apache, Chevron’s development partner forKitimat LNG terminal on Canada’s west coast, said it was pulling out ofthe project due to the $15 billion price tag.

Rail Transportation

An increasing amount of oil is transported by rail to overcome infrastruc-ture constraints in the mid-continent region but this is more expensiveand there are safety issues with transporting by rail.

ADD STOCK PHOTO OF OIL TANK TRAIN

Current rail loading capacity is estimated at 300,000 b/d and the Cana-dian Association of Petroleum Producers (CAPP) projects that by 2016,

Canada will transport up to 700,000 b/d of crude oil by rail.Issues related to availability, reliability and liability for rail car shipmentscontinue to pose a challenge in getting product to market, leading tohigher transportation costs and negatively impacting on competitiveness.


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LNG Opportunities

The prospect of LNG exports to Asia opens up a new opportunity formoving gas from stranded pools to markets. However, monetising thesereserves will depend on whether upstream operators can get long-termLNG export deals signed with big Asian buyers beforehand.

“We think there is huge potential [for petrochemical expansion]. We havethe same advantages they [the US] do. The downside we have is that ourmajor export market is the US. The challenge for Canada is to find newmarkets for its natural gas,” said John Margeson, Director of Business andEconomics at the Chemistry Industry Association of Canada (CIAC).

“LNG is the first thing that has to happen. It will signal that gas productionrates will go up then companies will do the maths to see if it will warrantnew investment.”, Margeson added. He also said that boosting Canada’sdomestic gas consumption, especially in rural areas would likely providea boost to the industry.

Costs and Labour Shortages

Overcoming crippling cost inflation and signing sales deals with newmarkets in Asia will be keys to incentivising upstream operators to investin new projects, in turn ensuring there is sufficient feedstock available.

However, these will only be the first hurdles to overcome in an industryplagued by a shortage of skilled labour - although the sector is known toemploy a highly skilled workforce.

Concerns about labour costs are most evident in Alberta due to robustdemand for workers in the energy sector, especially for the oil sands. Thestrong pull from the oil sector is placing upward pressure on chemicalcompany wages in order to retain workers.

In other provinces, labour issues are related primarily to the limitedsupply of skilled new workers that will be needed as an ageing workforcebegins to retire in larger numbers.

However industry experts said that if oil prices remain depressed for anextended period of time, this situation might begin to change again.“In western Canada there is an issue where there has been a lot ofdemand for skilled workers so it has pushed up costs. In Sarnia there is ahuge availability of labour that is not utilised. Costs in Ontario are 30-40%lower than in Alberta.”

Bowman, from Canada’s EPTF, said that as oil prices have come downthere has been a slowdown in investment in upstream projects. This willeventually create an incentive to build new infrastructure and boost theindustry outside of Alberta.

“Previously most capital was invested in the oil sands. Alberta has apopulation of 4 million people so labour is stretched.”

“With oil prices dropping to $50 per barrel we have seen a big drop incapital costs so competition for skilled labour will ease up.” Shelly fromAlberta's Industrial Heartland Association said.


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Shelly added that the current weakness of the Canadian dollar, relative tothe US dollar, has provided a cost advantage for Canadian exporters,particularly those selling into the US.

Social License and Environmental Concerns

Other obstacles to expanding the industry include social license andenvironmental concerns.

Canada's petrochemical industry, along with other chemical and relatedsectors, must deal with a variety of environmental issues being addressedby federal, provincial and municipal regulators. These include:

• control of odours • release of toxic chemicals

• volatile organic compound (VOC) emissions

• generation of greenhouse gases

• emissions of contributors to acid rain

• ozone depleting substances

• testing required prior to introduction of new substances

• land contamination and storage

• handling mishaps.

Another uncertainty for operators is the effects of carbon taxes andenvironmental legislation going forward. The federal government have

pledged to support carbon capture and storage and are committed todeveloping clean energy sources. In the future this could impact theamount of fossil fuels which are allowed to be used as petrochemicalfeedstock.

Receiving public approval for projects is also crucial to winning regula-tory approval. Maintaining constructive dialogue with all the partiesinvolved, including government bodies, First Nations communities toreceive public approval for projects is essential to get them off thedrawing board.

Business Climate and Competition with the US

The Canadian petrochemical industry faces stiff competition for invest-ment with the US, particularly from the US Gulf Coast, which has existinginfrastructure and abundant supplies of cheap US gas as feedstock.

One of the biggest advantages to operating in Canada is that there’sgreater availability of land than in the US, in part because petrochemicalinvestment has been directed south to the US for so long, renderingsome Canadian projects unable to remain competitive.

“A lot of older plants have been torn down. There are a lot of brownfieldsites which can be developed and the energy infrastructure is also inplace so we think there is a significant opportunity here for further

development - the main difference between the US and Alberta is marketaccess,” Bowman from Canada’s EPTF said.


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For Canada to compete with the US petrochemical sector it must offerattractive investment conditions and show it has strong governmentsupport – both financially and in terms of there being a swift and trans-parent regulatory approvals process.

The chemical industry is currently taking advantage of the government’scompetitive corporate tax rate and the temporary accelerated capitalcost allowance (ACCA).

Canada currently offers an Accelerated Capital Cost Allowance (ACCA)that provides a cash-flow advantage for new investments in manufactur-ing machinery and equipment. However, the ACCA is scheduled to expireat the end of 2015. The CIAC is lobbying the government to extend thisto a long-term, between 7-10 years, policy measure, saying it will becrucial for attracting industry investment. This, the CIAC expects, willlevel the playing field with the US and support a competitive businessclimate in Canada.

Corporate tax rates in Canada are currently pegged at 26.5%. In the keyprovinces of Alberta and Ontario, the combined federal/provincial rate is25%. In British Columbia the combined rate is 26%, and in Quebec it is26.9%, which is more competitive than the US, where according toKPMG, the corporate tax rate in 2014 was 40%.

ConclusionCanada’s petrochemical industry has huge potential to expand butwhether it achieves this will be dictated by feedstock availability andaccess to transport infrastructure to open up new markets for its oil andgas. This will be critical for Canada to stay competitive against its south-ern neighbour. In addition competitive electricity prices, advantageousenvironmental policies and strategic tax measures such as the Acceler-ated Capital Cost Allowance need to be in place supporting the growthof the industry.

Alleviating regional skills shortages and containing construction costs willalso play a role in attracting investors to the sector.

Canada has the potential to create a petrochemical boom and all theobstacles it is facing are solvable as the country has low natural gasprices, a quality industrial services industry and everything is in place toeducate a skilled labour force.

Currently the domestic shale oil and gas industries are still in their infancyand any major growth will be restricted by the availability of cheap USfeedstock production, but the potential is certainly there for investors tomake it big in a country famous for its legislative and economic stability.


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