FROM RESENTMENT TO INTERDEPENDENCE: ENERGY TRADE BETWEEN CANADA

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FROM RESENTMENT TO INTERDEPENDENCEENERGY TRADE
BETWEEN CANADA ILLINOIS

• Terrence L. Barnich
• President, New Paradigm Resources Group
• Canada-Illinois Energy Connection Seminar
• Canadian Consulate General
• Chicago, Illinois
• March 26, 2004

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TWO DECADES AGOBORDER MALFUNCTION

• At the start of the 1980s energy trade between
  the U.S. and Canada was entangled in a cross
  border mindset that saw energy as politics not
  business.
• Both the U.S. and Canada operated under heavy
  regulation of energy for many years that reduced
  supply raised prices.
• Buyers and sellers were constrained by a complex
  of old contracts and agreements imposed by
  outdated political considerations.

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1983 A DYSFUNCTIONAL NATURAL GAS MARKET

• The Border Price of natural gas was set by
  U.S./Canada agreement not by the market.
• In the 1983 the price, _at_5.30/mcf USD, was equal
  to 8.53 in 2003.
• Price agreements were based on political notions
  of the value of gas.
• Late 1970s US energy policy stimulated EP with a
  multi-layered pricing system.
• Supply availability increased dramatically.

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ILLINOIS WAS BEING MIDDLED in 1983

• Illinois was being badly hurt by the Deal.
• High regulated prices both sides of border were
  rolled into pipeline take-or-pay contracts.
• Because different parts of Illinois were served
  by different pipelines, gas prices in central and
  southern Illinois were twice the prices in the
  Chicago area. BAD POLITICS!
• Plans afoot would make matters worse.

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OVERSUPPLY HIGHER PRICES

• Northern Border Pipeline was part of the
  pre-build (lower 48) of ANGTS financed under
  existing take-or-pay contracts.
• NBP came on line in late 1982 and raised prices
  for Panhandle Eastern customers in
  central/southern Illinois by 20/30 -- just as
  oversupply began to hit the market.
• Completion of ANGTS would have increased Illinois
  gas prices in Illinois under the take-or-pay
  system.

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ILLINOIS AND CANADA GO TO THE MATTRESSES

• Application to complete ANGTS required
  Congressional loan guarantees.
• Illinois Commerce Chairmen Michael Hasten (and
  later Phil OConnor) strongly opposed approval
  since take-or-pay contracts would pass costs on
  to gas customers regardless of supply/demand.
• Canadian government reaction quite bitter over a
  state getting so vocal on a cross border trade
  issue.

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THE TIDE TURNS

• ICC took the lead nationally in promoting open
  access to pipelines for buyers and sellers of
  gas.
• The contract/common carrier debate about gas
  pipelines began in 1983 and led to total pipeline
  access and disengagement of pipelines from
  merchant function.
• Western Canadian gas producers aligned with
  Illinois to promote open access and thus freed
  shut-in gas for export to the U.S.

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TRIUMPH OF THE MARKET WAS AN INCREMENTAL PROCESS

• One by one the many obstacles to a free U.S. and
  free cross border trade in natural gas fell in
  the face of economics/politics.
• On both sides of the border, market principles to
  address energy issues became the order of the
  day. (Reagan Mulroney deserve credit for the
  change).
• Starting in 1983 North American gas prices fell
  dramatically and stayed low until just the past
  three years.

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THE KEY LESSONS FROM THE PAST TWO DECADES

• The idea of the border as meaningful in the
  energy market is misplaced. There is really a
  North American energy market.
• Regulation results in some combination of
  shortage/oversupply/bad pricing.
• Internal political motives in cross border energy
  trade end up hurting all sides.
• A few political players advocating free market
  principles can have a big impact.
• Illinois and Canada have an energy future.

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U.S. ENERGY INDEPENDENCEDRAIN AMERICA FIRST?

• Since President Nixon, virtually every American
  politician has called for energy independence
  from foreign sources.
• The 1970s oil embargoes and gasoline lines have
  created a durable political myth that the U.S.
  can wean away from imports.
• The Left fantasizes about perpetual motion
  machines while the Right congers supplies from
  dry holes.

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SOUND BITES GIVEAWAYS POLITICS MISS THE MARK

• Pending U.S. energy legislation not likely to
  pass and is a hodge-podge of good bad.
• Excessive incentives for domestic U.S. oil gas
  production will send the wrong price signals and
  stimulate inefficiencies.
• Favoring U.S. production over Canadian and
  Mexican may effectively shut in less expensive
  North American supply and drain U.S. strategic
  supply.

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REDEFINING INDEPENDENCE

• U.S. energy policy has not adequately considered
  the value of a North American energy market with
  the U.S. consumption center between two supply
  centers, Mexico and Canada.
• Redefining foreign to exclude Canada and Mexico
  goes a long way toward a balanced approach.

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CANADA ILLINOISTHE NEXT TWO DECADES

• Declining U.S. gas and oil production and
  reserves suggest that Canada will be the main
  growth source for Illinois.
• Developments on both sides of the border indicate
  a growing integration of the Illinois and
  Canadian electricity markets.
• Chicago metro is one of the largest gas and oil
  consuming areas in the U.S.
• The primary limitation is infrastructure.

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OIL CANADA IS SAUDI ARABIA WITH ICE HOCKEY BEER

• Canada is 7th largest world oil producer and
  pumps 1/3 Saudi output.
• But Canada has almost 70 as much in oil reserves
  as Saudi Arabia or as much as Kuwait and UAE
  together or Iraq Venezuela together and 3x
  Russias.
• Canada has 15x Mexicos oil reserves and is the
  most politically reliable energy trading partner
  in the world for the U.S.

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CANADIAN OIL FOR ILLINOIS

• Illinoiss two main metropolitan areas, Chicago
  (NW Indiana) and Metro East (St. Louis) are major
  refining areas for the Midwest but oil pipeline
  for all North American producing areas is
  limited.
• The only new sources of crude is Canada but new
  pipeline capacity is much needed.
• Other than central Russia, the most likely major
  new finds are in polar regions divided among
  Russia, Canada the U.S.

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CANADIAN GAS FOR ILLINOIS

• Illinois is more reliant today on Canadian gas
  than anytime in the past.
• The most recent pipeline connection, the Alliance
  Pipeline, was completed 3-4 years ago with no
  controversy, in contrast to the situation two
  years ago.
• The availability of Canadian supplies in
  competition with domestic US gas has kept
  Northern Illinois prices lower than most other
  northern consumption markets.

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ILLINOIS-CANADA ELECTRICITY TRADE NEW HORIZONS

• Movement to open access and wholesale and retail
  competition on both sides of the border is
  stimulating increased trade.
• Longtime inefficiencies in provincial electric
  corporations, especially in Ontario, are being
  exposed by competition.
• Canadian winter peaks offer a good market for
  unutilized Midwest generation.
• PJM MISO development will make Exelons nukes a
  big regional factor.

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ILLINOIS-CANADA ELECTRICITY TRADE POLICY NEEDS

• The August 2003 blackout is being sorted out and
  points to the need for both better grid
  infrastructure and management.
• A key element of the stalled energy bill would
  give FERC transmission eminent domain authority
  in identified national reliability corridors if
  states fail to act.
• Certainly such corridors will be in the
  northeast quadrant of North America.
• RTO progress should include Canada.

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BAD IDEAS ARE STILL RISKS FOR ILLLINOIS-CANADA
TRADE

• Canada U.S. could pursue different global
  climate strategies. (Kyoto contrast)
• Energy could be dragged into other trade
  controversies as leverage, with some Canadians
  suggesting export taxes. (One step closer and I
  shoot myself.)
• Release of U.S. strategic oil reserves to
  moderate gasoline prices would depress Canadian
  investment production.
• RTO progress could be stalled or states
  provinces could skew electric prices.