Is Canada still considered an LNG supplier of choice?

Transcription

1 Is Canada still considered an LNG supplier of choice? Examining the fundamental requirements of Asian buyers September 18, 2015 kpmg.ca

2 Contents Introduction 1 1. Demand Drivers and Global Supply Situation 3 2. The Canadian Potential, Evaluating Advantages and Challenges from the Investor and Asian Buyer Lens 5 3. Can Canada Remain Competitive in this Economic Climate? The Path Forward and Imperatives for the Winning Canadian Projects 12

3 Is Canada still considered an LNG supplier of choice? / page 1 Introduction A Final Investment Decision yes for Canadian LNG projects is increasingly challenging for investors and related Asian buyers today. Despite Canada s advantages and world class gas reserves, current global oil and gas industry challenges and uncertainties are buffeting the industry and have reduced investment and Asian buyer appetite. Currently, a perfect storm of global supply side, demand side and related price factors have combined to reduce interest in Canadian and other LNG. On the global front, the headwinds take the shape of significant LNG volume entering the market in the next 3 years increasing global liquefaction capacity from 301 MTPA 1 by 50% to 453 MTPA 2 combined with prevailing low oil prices and weakened current gas demand from Asian buyers. This coupled with reduced capital funding availability from integrated oil and gas majors and lower LNG oil indexed prices are all stressing the relative affordability and economics and thus appetite for more LNG now. The cyclical nature of the LNG industry suggests a re-pacing and re-positioning of Canadian LNG to investors and Asian buyers, which may be the winning basis to carry Canada on the next wave. If this holds true, the opportunity may be fewer, higher quality projects sanctioned now with more coming later. And through staging and repositioning, proponents can improve on Canada s competitive positioning to Asian buyers as a supplier of choice. This will include demonstrating Canada s ability to provide an attractive investment environment by working through the domestic complexities of developing a nascent industry in an environment of strong stakeholder expectations and cost escalation challenges. This paper evaluates Asian buyer interest and Western Canadian LNG project development considerations. In doing so, we assess the global climate, demand drivers and buyer and investment expectations in the context of what Canadian LNG projects and industry can offer, informed by both a global market appreciation and a Canadian on-the-ground perspective. We will comment on successful Canadian project alignment with investor and Asian buyer interests and the basis forward to steer the Canadian advantage and to navigate LNG to Asian ports. 1 First, we frame the demand drivers and global supply situation. 2 Then we assess the Canadian potential, evaluating advantages and challenges through the investor and Asian buyer lens. 3 Then we place those considerations on the realities of the current economic climate. 4 Lastly, we present a path forward and imperatives for the winning Canadian projects looking to fulfill the potential. 1 World LNG Report 2015 Edition, International Gas Union 2 KPMG Analysis 2015

4 Is Canada still considered an LNG supplier of choice? / page 2 Overview: North American and Canadian Supply Advantage: The North American supply advantage has been enabled largely by advancing technologies for shale gas recovery creating surplus supply relative to domestic demand. This supply advantage, coupled with an ever increasing demand for cleaner fuels in Asian countries, has created a substantial opportunity. Canada, with massive resources relative to domestic demand, an export oriented industry mindset, and significant Asian sector investment, can present as a natural market for investors and Asian buyers. Competitive Supply: However, the supply opportunity is intensely competitive with upwards of seven times demand from several regions competing to supply Asian and other demand centres with LNG. Competitors vying to supply LNG include the US, East Africa, Australia and Russia (both LNG and piped gas) as well as some niche players, new aspirants and most recently, Iran. For Russia, it has set a new low long term price point with significant new volumes of piped gas and more volumes available from LNG. For Australia, the bloom is off on expansion given the rampant cost escalation in development, with Asian buyers bearing the economic consequences as minority investors. For East Africa, it must show it can develop an LNG industry from the ground up in a whole new economy. For the US, the initial appeal of Henry Hub gas indexed pricing is being challenged by lower oil prices and, potentially, limits to export thresholds. Dynamic Markets: The future market opportunity is dynamic and will be limited to those who, as table stakes, can demonstrate cost effectiveness and meet delivery timing windows to secure offtake agreements. In Canada s case, the opportunity is to help successfully position the merits of supply diversification in geopolitics, geography and long term investment in and access to significant resources given price competition. Recent Supply Market Activity: Recent activities in all supply markets have been focused on chasing the Asian LNG supply gap prior to the 2020 s with the US following Australia s lead. The drop in oil prices has since impacted the affordability and economics of projects, resulting in deferrals and likely abandonments as companies grapple with reduced CAPEX budgets. Adding to the challenge of economics, investors and Asian LNG buyers have become more cautious, pricesensitive and opportunistic buyers who are starting to assert their power in buyer consortiums. These changes create a more challenging supply environment with more discerning buyers and increased uncertainty around which projects will proceed. Canada s Opportunity: Canada has an opportunity to be a world leader in global LNG supply owing to its proximity to Asia, its stable and supportive political environment, its vast reserves relative to domestic demand and its pre-existing Asian upstream investments. However, the opportunity is not without challenge. Western Canada projects that will appeal to shifting investor and Asian buyer priorities and interests will have to be cognizant of three imperatives: 1. Clear alignment with buyers needs and acquisition of offtake agreements. 2. Timely project development and stakeholder management. 3. Careful cost control and optimization to help avoid the pitfalls of other jurisdictions.

5 Is Canada still considered an LNG supplier of choice? / page 3 1. Demand Drivers and Global Supply Situation a) Asian Buyer Demand Drivers That Inform Needs and Aligned Interests Derived Demand: Key to understanding demand and informing aligned interests is to appreciate that LNG is a derived demand. The base demand is not LNG itself, but natural gas; and further, demand, is not gas specifically, but electricity or heat and, increasingly in the future, gas-fueled transportation. As such, LNG demand is therefore closely tied to the cost, availability (including receiving and distribution infrastructure) and acceptability of competing energy sources or substitutes. Such substitutes include gas delivered by pipeline, coal, oil, renewables and nuclear power. Fundamental Demand Drivers: So in turn, key demand drivers are medium and long term fundamentals of substitution including policies and continued innovation related to: Fuel mix such as coal competition, renewables (economics and policy) and nuclear outlook Efficiency initiatives, carbon taxation, and subsidy reform New pipeline supply (Russian, Middle Eastern, Caspian gas to Europe; Russian, Central Asian gas to China; domestic shale) Price of pipeline gas and LNG price competitiveness Regulatory and Policy Key Long Term Drivers: Taking a closer look at these drivers highlights that LNG demand is strongly influenced by regulation and government policy. Examples of the policy range include the public funding of LNG infrastructure such as import facilities, targets for diversity of fuel mix or suppliers, as well as policy and regulation of nuclear shut-downs and restarts, air quality regulations, carbon pricing and greenhouse gas emission standards. Sectoral Demand Drivers: Additionally, new sectoral demand is expected to increasingly drive overall LNG demand with growing interest in LNG as a bunker fuel for ships. LNG shipping has potential cost advantages to oil and improved compliance with the growing extent of Emissions Control Areas, where the use of high-sulphur fuel oil is banned. LNG trucking has also been attracting attention, in addition to electrification of the transportation system. Top Country Demand: Asia comprises over 70% of the LNG demand with Japan taking 50% of LNG imports to Asia and Korea taking over 20%. Despite Japan and Korea taking the lion s share of shipments, China is most poised for growth 3. Japanese demand arising from nuclear shut-downs has most recently contributed to the strong demand growth in LNG. Going forward, China is expected to usurp Japan with its more rapid growing economy and expected future focus on cleaner source electricity feedstock and potentially, a natural gas focused transportation sector. Beyond the big three buyers, there is expected to be strong growth in other Asian countries India, Thailand and Indonesia for example. 4 3 World LNG Report 2015 Edition, International Gas Union 4 Medium-Term Gas Market Report 2015: Market Analysis and Forecasts to 2020, International Energy Agency (June 2015)

6 Is Canada still considered an LNG supplier of choice? / page 4 While demand growth is down currently, it remains significantly dynamic and influenced by demand from economic growth, substitution preferences (influenced by policy and regulation) and price both in the short and long term with a cyclical history. Portfolio Interests: Beyond demand fundamentals and price, key aspects driving investor and Asian buyer behaviour and preferences are LNG portfolio interests. Portfolio considerations include supply source, term, pricing structure and increasingly, expansion potential, control over value chain and ownership position and availability of diversification mechanisms to manage portfolio risks. Underlying these are fundamental geopolitical tensions and security-of-supply concerns. b) Global Supply Competition Continues to Mount Intense Competition: Current global competition is significant with Canada, Australia, US, Russia and Mozambique aggressively vying for demand. Even more supply seems possible around the corner with new finds in Egypt, continued and new production in the Middle East, and evidence of large, but possibly inaccessible gas, under the UK and even Paris. The chart below shows the possible amount of supply that could enter the market from leading locations. While much of this overall supply is speculative, the potential competition is 6 to 7 times relative to demand. Canada will need to shore up its competitiveness and showcase its unique advantages to investors and Asian buyers amid the intense competition against existing and future suppliers. Source: KPMG c) Implications for Canada Long Term Play: For Canadian LNG investors and sponsors, key demand take-aways on the Asian buyer perspective are considerable long term currents of demand need, with demand interest rooted in the complex of price, competitiveness and portfolio attractiveness. Importantly for Canada, with a relatively higher marginal cost supply on price competitiveness, the imperative of investor and Asian buyer alignment on portfolio interests is critical. Here, Canadian LNG differentiators such as access, term and value chain ownership interests, including on the resource or even the use side (i.e. consumption of power), are important.

7 Is Canada still considered an LNG supplier of choice? / page 5 2. The Canadian Potential, Evaluating Advantages and Challenges from the Investor and Asian Buyer Lens Using the investor and Asian buyer lens, Canada s relative advantages can be better shaped and challenges addressed to realize the country s potential to be an LNG supplier of choice. a) Advantage in Scope and Scale of Resource The North American supply advantage has been enabled largely by advancing technologies for shale gas recovery, creating surplus supply relative to domestic demand. Canada, with massive resources relative to domestic demand, an export-oriented industry mindset, and significant Asian sector investment, can present as a natural market for investors and Asian buyers. Western Canadian supply advantage starts with low-cost shale technologies, opening up massive gas formations in Northeast British Columbia allowing access to a gas supply of upwards of 407 tcf (8140 mt) that could be recoverable with today s technology 5. The Liard, Horn, Montney and Deep basins are considered world class formations, some with valuable liquids to extend the base benefit and economics of these huge gas formations. The relative scale of these reserves helps to provide a longterm availability match for Asian buyers with an ever increasing demand. 5 British Columbia s Shale and Tight Resources, Natural Resources Canada, 2015

8 Is Canada still considered an LNG supplier of choice? / page 6 d) Advantage in Shipping Proximity Shipping access is the second most important advantage of Western Canadian supply, following access to a large long-term basin of the gas itself. An 8,600 kilometre advantage over Louisiana in shipping to Asia 6 allows for quicker transport and lower costs (in fuel and ship use) relative to the Gulf coast and despite Panama Canal improvements. Reduced time to market allows for more shipments with less tankers improving throughput to the customer. Additionally, reduced risk of shipping incidents due to shorter seaborne delivery routes is a notable advantage to Western Canadian projects. e) Advantage for Asian Capital Canada has proven itself as a welcome and safe home for Asian capital, providing relative safety for Asian investors. Asian capital has grown from 14% in 2007 of foreign direct investment (FDI) in Canada s oil and gas extraction industry to 22% by Chinese firms in particular have been active in the Albertan oil sands landscape. 8 In turn, Canada is host to LNG ventures that feature investment by and through Asian partners, including wholly owned upstream, mid and downstream value chains. Furthermore, Asian investment activity benefits from Canada s bilateral international agreements with countries like Korea (Free Trade Agreement) and China (Foreign Investment Promotion and Protection Agreement). For countries such as China, Japan and India that do not enjoy US Free Trade Agreements, Canada also offers improved access to offtake agreements. Western Canadian projects stand to benefit significantly from Canada s relationship with Asian energy firms in Alberta and a supportive investment environment. 6 SeaRates LP, searates.com 7 International investment position, Canadian direct investment abroad and foreign direct investment in Canada, by North American Industry Classification System (NAICS) and region, Statistics Canada 8 Acquisition include 40% stake in Dover Commercial Project, 40% stake in MacKay River oil sands project, in addition to acquiring entire firms like Nexen Inc, Energy Markets Fact book , National Resources Canada, 2015

9 Is Canada still considered an LNG supplier of choice? / page 7 f) Stakeholders Stakeholder considerations in Western Canada present as a double-edged sword. The LNG sector is a complex ecosystem of stakeholders which must come together to support, build, fund, supply, and regulate the industry across each stage of the value chain. In this regard, Western Canadian LNG projects have many positives. Supportive Government: First, British Columbia has a supportive provincial government, eager to facilitate the formation of the industry. While there has been substantial concern over the LNG Tax and the mounting costs of other taxes, carbon costs and regulations, the government has responded with reductions and improvements in a number of key areas. The LNG Tax itself was reduced to help project economics while providing the province of British Columbia with a significant and fair amount of the benefits which are aligned with broader stakeholder interests. Carbon tax assurances and incentives have been put in place to encourage responsible development while providing clarity on the price. Many of these assurances have been offered to proponents by way of Project Development Agreements, reinforcing these assurances through legislative approval. The Federal government has played an important part in two instances. One, in a reclassified depreciation rate of LNG facilities from 8% to 30%, Net Present Values (NPV) have improved by approximately $700 million for every $10B of CAPEX spend. Also, export license durations are to be increased from 25 to 40 years. This extension both improves the NPV economics and improves Canada s position as a long-term low risk environment for exporters, further complementing Canada s general experience working with Asian investors and stability exporting to non-free Trade countries. Strength of Proponents and Joint Ventures: British Columbia and Western Canada also benefit from the inclusion of sophisticated global LNG players in the stakeholder ecosystem. Western Canadian projects are characterized by their tendency to be large, integrated plays which tie up the entire value chain. Compared to tolling based models, investors have the benefit of controlling the entire value chain and spot market risk where gas prices can spike. These projects are in turn backed by some of the best LNG producers and operators in the world which have joined forces with key Asian companies to align interests and to help ensure that projects can be built and operated in the safest and most effective manner possible. Integral to the LNG eco-system is a host of interested suppliers, funders, and stakeholders who must come together to help ensure the sector is a success from a cost, cost of capital, social and environmental perspective. Here, Canada s history with large infrastructure and energy projects have primed the ground for these interests to assemble and have provided a wealth of experience and lessons learned to apply.

10 Is Canada still considered an LNG supplier of choice? / page 8 g) Challenges While Canada s benefits to investors and Asian buyers are clear and compelling, challenges are present which are being tackled by proponents with impending Final Investment Decisions. Cost Challenges lead the concerns for investors and buyers of Western Canadian LNG. Nowhere in the world does the term greenfield ring more true than in British Columbia. Known for its rugged beauty and endless vistas of green forests, mountains and pristine deep coastal fjords with renowned fish stocks, British Columbia offers a unique complex of environmental and engineering challenges to the projects contemplated. Value chains will need to vastly expand drilling activity in the North East, lay hundreds of kilometers of pipeline across mountains and rivers, and construct their liquefaction plants in world class ports but often on very tough terrain with sensitivity to local environmental considerations. Competitive advantages Long-term supply security Energy self-sufficiency, large reserves Minimal risk of future export license challenges Key challenges Evolving policy and regulatory environment Un-finalized LNG fiscal framework and GHG policy Regulations under development Complex environmental approvals Super major backing and integrated projects Projects developed by global players Integrated to upstream plays LNG buyers making investments Greenfield value chain Facilities are greenfield projects Pipeline infrastructure required Undeveloped upstream resources Geographic advantages Gateway to Asia: 8,600km advantage No reliance on Panama Canal Powerful First Nations and stakeholder interests Interests across value chain Active, well funded ENGOs FN involvement in approvals Supportive governments LNG, gas development key in provincial government plans Governments smoothing approvals Potential cost/pricing disconnect Current prices challenge greenfield development costs Few contracts secured; push-back Open to non-free trade countries Minimal risk of future export license challenges Labor/resourcing Scarcity, escalation exposure Source: KPMG

11 Is Canada still considered an LNG supplier of choice? / page 9 Stakeholder Interests: Powerful First Nations, community interests and other stakeholder interests add significant complexity to project development. First Nations must be consulted in the development of projects and represent one of the single most important parties to work with when developing projects. They are often landlords, key suppliers, important contributors to the labour force as well as custodians of the lands with significant rights and powers. Local community interests are critical as well, needing coordination and consultation to help ensure that investments can benefit, not hinder, those in the area. Successful projects will need to find an alignment of interests across all stakeholders. Labour Availability: Availability of labour represents the final significant challenge of LNG development in British Columbia. British Columbia LNG is not alone in labour challenges. Australian issues with labour scarcity, are well documented and have been cited as one of the major contributors to cost increases. Despite having its roots in fishing, forestry and mining, the workforce in British Columbia is currently highly geared towards service-based industries. This worker mismatch to jobs is most exemplified by one fact: it is estimated that there are currently 13,000 workers in the Oil and Gas industry in BC while one value chain could employ 10,000 workers directly at peak. Successful projects will need to tackle potential labour scarcity proactively by understanding needs, exposure points relative to current sources and by building and accessing the necessary labour. Given stakeholder expectations, successful LNG projects will seek to staff as many jobs as they can locally, including augmenting the existing pool through training and apprenticeships, while accessing workers nationally and likely internationally. Mitigating this labour risk is the recent downturn in oil projects locally and globally adding labour supply to the market, as well as the presence of many local service companies in British Columbia which are poised to support the industry. The Alberta oil sands are expected to release significant numbers of workers back to the market, with Canadian Association of Petroleum Producers claiming 35,000 jobs already cut as of September , which could benefit the LNG sector. 9 Alberta has lost 35,000 oil patch jobs, petroleum producers say, CBC, 2015

12 Is Canada still considered an LNG supplier of choice? / page Can Canada Remain Competitive in this Economic Climate? The recent downturn has meant dramatic shifts for the LNG sector which have tested Western Canadian LNG investor and buyer commitment in terms of timing, funding and economics. a) Timing Timing for massive, long-life LNG projects is difficult to predict at the best of times, and during market turbulence can test even the steeliest oil and gas veteran. The question for the near term is whether the supply-demand window has closed for this cycle. b) Supply glut creating post 2020 opportunity? Supply is mounting from a number of jurisdictions. The years 2015 to 2018 will see a large amount of this supply reaching the markets with as yet to be confirmed sales for some of the cargos. Estimated LNG Capacity Additions Project Name Country Capacity (MTPA) Start Gorgon AUS 15 Train 1: 2015 / Train 2 & 3: 2016 Queensland Curtis AUS 8.5 Train 1 & 2: 2015 / Full Production: 2016 Gladstone AUS 7.8 Train 1: 2015 / Train 2 & 3: 2016 Wheatstone AUS 8.9 Train 1: 2016 / Train 2: 2017 Ichthys AUS 8.4 Train 1: 2016 / Train 2: 2017 Prelude FLNG AUS 3.6 Full Production: 2018 Aus. Pacific LNG AUS 9 Train 1: 2015 / Train 2: 2016 Sabine Pass LNG USA 18 Train 1: 2015 / Train 2: 2016 / Train 3: 2017 / Train 4: 2018 Freeport LNG USA 9.3 Train / Train 2 & 3: 2019 PNG LNG PNG 6.9 Train 1: 2014 / Train 2: 2015 Source: KPMG The pre-2020 demand window has no doubt closed. But for projects sanctioning and beginning construction over the next few years, the question remains as to whether demand will be robust enough to require new production in the early 2020s or much later. One perspective is the combined effect of the current oil and gas markets and of reduced gas demand, current low prices and capital constraints will effectively reshape demand to the future and create supply opportunities for those that stay the course and are poised to supply in the early to mid-2020s. c) Demand Profile Predicting the shape of demand for LNG is difficult. Whether and when supply lags imposed by capital constraints create the next cycle remains to be seen. Energy mix questions will form a large part of determining future demand with national politics and economics dictating policy decisions. Japan s nuclear power industry is making tracks to reassert itself within the power mix but as Fukushima continues clean up, this mix is certainly not assured. Within China, a sputtering economy may see more leverage of China s local and cheaper coal assets to power the nation despite the impact on the environment. Over what time frame these conditions prevail and how this will be managed as China positions itself forward and to showcase itself in events, such as the 2020 Olympics, is uncertain.

13 Is Canada still considered an LNG supplier of choice? / page 11 Source: KPMG While this demand-supply picture unfolds, oil and gas majors around the world have to grapple with reduced oil prices impacting their cash flow and changing the funding and economic picture of their projects. Over the long-term project production, the expectation is that oil and gas prices at some point must rebound. But in the meantime, scarce capital will be metered out to fewer projects or deferred. Mergers, such as Shell and BG, are likely to add to the culling of projects in the short-term. The graphic below illustrates the uncertainty that oil and gas majors face in understanding the shape of potential demand as well as the positioning and timing of new supply that could meet future demand. More specifically, it shows the range of demand forecasts that could materialize relative to potential supply and highlights the potential for a supply glut or a wave of new demand to fill. How will the next years of LNG supply and demand unfold? How can Canada play a part in supplying clean energy to the world? Asia Pacific LNG Supply and Demand Forecast In Billion Cubic Feet per Day (BCFPD) & Oil Price (USD), BCFPD Oil Price 55 $ $ $ $90 35 $80 30 $70 25 $60 20 $ $40 5 $30 0 $ EM Demand Projections EIU Demand Projections BP Demand Projections Prev. Demand Projections Other supply sources United States (Proposed) United States Canada East Africa Australia Middle East Oil Price

14 Is Canada still considered an LNG supplier of choice? / page The Path Forward and Imperatives for the Winning Canadian Projects At KPMG, we see opportunity within turbulent markets for Canadian LNG to navigate the new terrain and supply the next LNG demand window. Indeed, a number of companies are actively progressing toward their Final Investment Decision. The following projects have most noticeably advanced. These projects are characterized by an advanced position in the environmental assessment and are a subset of the 23 LNG projects currently looking at investing in British Columbia. Project Location Size Notes Pacific Northwest LNG (partners, Petronas, Sinopec, India Oil and Brunei) Prince Rupert, BC 13.2 MTPA Conditional FID subject to environmental approval. LNG Canada (partners, Shell, Mitsubishi, KOGAS and PetroChina) Kitimat LNG (partners, Chevron and Woodside) Kitimat, BC 13.0 MTPA Well advanced. Target 2016 FID. Kitimat, BC 10.0 MTPA Woodside is new partner. Timeline being reassessed. Woodfibre LNG Squamish, BC 2.1 MTPA Brownfield. Target 2016 FID. Douglas Channel LNG (partners, AltaGas Ltd., Idemitsu Kosan Co., Ltd., EDFT Trading and EXMAR) Source: KPMG Prince Rupert, BC 0.55 MTPA Under new ownership with AltaGas. Floating with existing pipeline. No environmental assessment required. Target 2016 FID. For the projects that are looking to advance within British Columbia, we see three imperatives for success: 1. Clear alignment with buyers needs and acquisition of offtake agreements 2. Timely project development and stakeholder management 3. Careful cost control and optimization to help avoid the pitfalls of other jurisdictions Clear alignment with buyers needs and acquisition of offtake agreements is arguably the largest hurdle for many of the proponents to prove to back the tens of billions of dollars of investment. For many buyers in growing Asian economies, an essential requirement is LNG delivery assurance and timing certainty to fuel existing and new power plants. As Asian markets continue to evolve and their buying behavior shifts, more competition for their contracts creates a buyer s market. This has created an imperative to closely align with Asian LNG buyers that have become more cautious, price-sensitive and opportunistic, and at the same time are increasingly asserting their power in buyer consortiums. These changes have created a more challenging supply environment with more discerning buyers and increased uncertainty around which projects will proceed.

15 Is Canada still considered an LNG supplier of choice? / page 13 For Canada, it will be critical to show itself as a preferred supplier with cost certainty and the ability to meet delivery windows. Reliable, long-term supply benefitting from a supportive and stable political environment, huge gas formations, a short delivery route to market, as well as portfolio considerations of value chain control, ownership position, and risk management mechanisms should be the hallmark of Canadian supply. These attributes should align with buyer s needs and add value to offtake agreements. Cost certainty is benefited from control of the entire value chain, as opposed to tolling models offered in the Gulf Coast. However, costs will ultimately be driven by the total project spend. Herein lies the major challenge for Canadian project developers whom must demonstrate their ability to control and improve on the Asian experience for other recently developed projects. Stakeholder engagement is of particular importance with Canadian projects. The stakeholder environment in British Columbia as described above is characterized by involvement from a large number of stakeholders and First Nations, most of whom are relatively new to LNG. Canadian LNG leaders will have to demonstrate that they can successfully navigate a complex stakeholder environment. To date, First Nations relations have proven challenging for several proponents, struggling to come to the appropriate terms for land access and right-of-way. For others, early and active involvement with First Nations, who are integral in the environmental assessment process, creates a significant reduction in the timeline of several regulatory approval processes. Government advocacy has been shown to be a critical element of project development promoting the ancillary benefits to the public and other stakeholder and advocacy groups. This has led the government to establish competitive fiscal frameworks, GHG emissions standards and material changes to tax regulation surrounding LNG facilities, including favourable treatment of capital cost allowance. These measures provide a competitive tax regime relative to the US and should be promoted to investors and Asian buyers as a value-add both in lower taxes and stability of lower taxes 10. It will be necessary for governments to ensure that Canada s fiscal framework remains competitive in the future. Careful cost control and optimization has become of greatest focus during the current oil price drop where many proponents are experiencing reduced CAPEX budgets and spending, and the affordability of supporting projects has been challenged. Canada has the opportunity to show its ability to leverage the spare resource capacity in the oil sector and manage its supply chain costs and address its challenging cost environment. Below we outline some of these considerations that will be key to manage and improve on to earn commitment from investors and Asian buyers as a preferred supplier. a) The Cost Imperative: Greenfield sites and the sheer scale of investment required to build across the British Columbia environment are at the forefront of Western Canadian cost challenges. These factors have resulted in an above-average base level of costs versus other jurisdictions, which individual project developers must overcome through cost management. The map below outlines the relative cost positioning and cost challenge to Western Canadian LNG developers. 10 Managing tax in the LNG and FLNG industry: Lessons from the front line, KPMG Global Energy Institute, 2014

16 Is Canada still considered an LNG supplier of choice? / page 14 KPMG sees opportunity for meaningful cost reductions in the cost profile for LNG projects, as broken down into categories of construction/labour (32%), equipment (30%), bulk materials (20%), owners costs (10%), and engineering and project management (8%). Proactive supply chain management is key to address cost challenges complicated by scale, challenging locations and cumulative impacts Unlocking the supply chain for LNG project success, KPMG Global Energy Institute, 2015

17 Is Canada still considered an LNG supplier of choice? / page 15 b) Labour Labour cost challenges for LNG projects include high base rates that have been established throughout the oil and gas industry and are now expected by LNG workers; a limited supply of qualified, local personnel as well as training capacity; and union considerations. Successful projects will need to demonstrate that can maximize labour certainty before Final Investment Decision by ensuring labour supply in: Conducting labour market analysis and collaborating with government (local and national) and trainers to build the workforce. Mitigating against wage escalation through negotiations with contractors and unions. Attracting and retaining project workers through good Human Resource strategy and project branding. Reducing overall downtime and boost labour utilization by optimizing on-site training, shift patterns and commute schedules. Investing in experienced supervisors who can help projects stay on track day-to-day. Working with contractors to determine these key positions and investing more for qualified personnel to fill them can help avoid costly setbacks. Throughout all of these efforts, successful players will need to understand the labour providers in play and manage or influence key groups of government, trainers/educators, unions and contractors to help achieve a level of certainty around labour availability and cost inflation avoidance as this is a critical success factor. c) Supply Chain LNG supply chains experience major challenges due to the remoteness, size and complexity of projects. Finding reliable suppliers and streamlining logistics can be difficult and expensive. Canadian projects which can achieve success with the following strategies can turn a challenging environment into a competitive advantage. Revaluate relationship with suppliers to take advantage of soft markets. Companies can negotiate cost reductions with suppliers who are facing similar economic conditions and will want to keep existing business. Maintain the balance between optimization and standardization of materials, equipment and services. Respect the complexity of logistics and adjust sourcing and scheduling accordingly. Just in time supply does not typically work for LNG projects.

18 Is Canada still considered an LNG supplier of choice? / page 16 d) Engineering and Project Management Engineering and technical design of LNG projects can become misaligned with commercial or stakeholder realities, leading to expensive redesigns. Typical of many mega-projects, LNG projects suffer from scheduling and budgeting issues, which are compounded by remote locations and seasonal limitations. Having multiple layers of contractors can also exacerbate challenges and make coordination and oversight difficult. Key success factors will be to: Align the project s engineering department with commercial, regulatory and stakeholder teams early on to ensure optimal and feasible design. It is easy to pursue the best technical route, but it may not align with local needs. Resist the urge to diverge from tried and true practice by balancing risks and benefits. Develop a system for effective project planning, logistics, tracking and analysis. This can reduce the costs and mitigate the risks of remote site locations and its associated challenges. e) Owners Costs Project owners often incur large costs associated with external relations complexities. Owners devote time and resources to coordinating with and tending to regulators, stakeholders and First Nations. To help minimize costs, companies should invest in stakeholder mapping that defines clear roles for managing each stakeholder group. This fosters early and consistent engagement with stakeholders, which reduces the number of unanticipated conditions and major project changes. f) Overall Cost improvement opportunities for LNG projects are obvious but elusive. The competing interests of various stakeholders, including contractors, workers, government and unions make it hard to implement cost-reduction strategies without resistance. However, capturing improvements across each of the categories mentioned above can result in capital cost savings up to 10 per cent or more. These improvements will help Canadian projects compete on the global stage.

19 Is Canada still considered an LNG supplier of choice? / page 17 Summary/Conclusion: Whether Canada is a supplier of choice for Asian buyers needs to be answered as a qualified YES. The current demand shortfall window is no doubt closing and with short term circumstances and medium term uncertainties buffeting the industry. Today s Asian buyer appetite is reduced, and in turn has reduced, but not eliminated, interest in Canadian LNG. Western Canada offers many advantages to Asian LNG buyers. Canada s relative advantages are compelling and many of the perceived disadvantages can be addressed with disciplined project development to realize the Canadian potential to be an LNG supplier of choice. To be successful, projects and proponents will need to strive to align with Asian buyer s interests, demonstrate they can address stakeholder and regulatory complexity as well as a high cost environment, while leveraging the Canadian advantages. These advantages include reliable, longterm supply benefitting from a supportive and stable political environment, huge gas formations, a short delivery route to market, as well as portfolio considerations of value chain control, ownership position, and risk management mechanisms as the hallmark of Canadian supply. The cyclical nature of the LNG industry suggests a re-pacing and re-positioning of Canadian LNG to Asian buyers may be the winning basis to carry Canada on the next wave to navigate LNG to Asian ports. If this holds true, the opportunity may be fewer, higher quality projects sanctioned now with more coming later. And through staging and repositioning, proponents can improve on Canada s competitive position to Asian buyers as a supplier of choice, including demonstrating Canada s ability to work through the domestic complexities of developing a nascent industry in an environment of strong stakeholder expectations and cost escalation challenges.

20 Contact us Mary Hemmingsen Partner, Advisory Services Leader for LNG, Power and Utilities KPMG in Canada T: E: Michael Reitsma Senior Manager, Advisory Services KPMG in Canada T: E: kpmg.ca/lng The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International.