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Proceedings of the Standing Senate Committee on
Energy, the Environment and Natural Resources

Issue 20, Evidence 

OTTAWA, Thursday, October 2, 2003

The Standing Senate Committee on Energy, the Environment and Natural Resources met this day at 9:16 a.m. to examine and report on emerging issues related to its mandate (implementation of Kyoto).

Senator Tommy Banks (Chairman) in the Chair.


The Chairman: We are glad to have with us today Mr. Michael Cleland and Mr. Bryan Gormley, who are the President and Director of Policy and Economics respectively of the Canadian Gas Association. I suspect that you and your colleagues have some things to say to us before you would accept our questions.

Mr. Michael Cleland, President, Canadian Gas Association: Mr. Chairman, there is a presentation of which you all have copies. It is long, and I will try to step through it reasonably quickly.

This presentation tries to give you an overview from beginning to end of Canadian and North American natural gas markets, some of the key factors driving them, implications for the economy, environment and/or climate change objectives, and other things that come out of the state of those markets today.

I will go quickly past the outline, which gives you the basic dimensions, key factors underlying price, outlooks for markets and some of the conclusions. I will skip over who the Canadian Gas Association is. I was here before you in May and I do not think I need to talk about it again. We are the organization that represents the downstream end of the natural gas industry in Canada.

On page 4 of the presentation is a simple snapshot of where does natural gas fit in our overall energy picture? It is something over a quarter of our primary energy use in Canada, very similar to the proportion that you find in the U.S.

A very important point here, on page 5, is that we do not talk about the Canadian market in isolation. It has been integrated with the North American market now for a couple of decade in several respects, including the transportation system for the supply. In some respects, that moves two ways; from Canada to the U.S., but a lot of gas also comes through the U.S. into Canada, and there is a lot of investment going both ways across the border and a lot of market transactions.

If we are to understand the market, we need to understand it in a North American context. I left Mexico out of the North American picture because Mexico is not as yet fully integrated into the market, but it will become more so. It will be a net importer of natural gas over the coming decade. It will import an amount of gas somewhere between the equivalent of what will come from the McKenzie Delta and possibly double that, so Mexico will be a drain on the system. I would not want my Mexican colleagues to hear me call them that, but that is the effect.

Patterns of gas use in North America shown on page 6 give you a sense of where it is used. There are similar patterns in Canada and the U.S., with two important exceptions: Power generation is a much bigger part of the puzzle in the U.S. than in Canada, and Canada's own use of gas is much greater.

That is explained by the fact that we are a big producer and transporter of gas relative to the size of our economy. Industries are efficient users of it but they are big industries relative to our overall gas use.

The Chairman: Would you explain ``own use'' to me? I understand residential and commercial, industrial and power generation. Who is burning that gas?

Mr. Cleland: That is the use of gas in exploration, development and production processes and in pipeline transportation, essentially.

Page 7 talks about where things are in terms of patterns of North American demand, including growth over the last two decades. Industrial use has historically been the biggest part of demand, up to 50 per cent. It grew relatively quickly over much of the past two decades, but much more slowly recently and is probably declining going into the future.

The big growth story is in the power generation sector, where you can see growth of over 5 per cent compared to overall growth of about 1.5 per cent. That is the big pressure on the natural gas system, particularly in the U.S., but to an increasing extent in Canada. That will probably be the key variable in very tight gas markets. That is something that will undoubtedly dominate the discussion when you talk to colleagues in the U.S. in the next while.

Page 8 shows North American supply growth and that will also dominate your discussions. The basic story there is that our traditional sources of supply, including the Gulf of Mexico, the mid-continent area in the U.S. and the Western Canada Sedimentary Basin are getting to the point now where their ability to supply new growth is very limited, or, in some cases, actually declining.

That means that new supply areas and unconventional gas will increasingly be the key to our ability to meet the demand growth in the North American economy.

The next two pages deal with prices. The first one is a long-term picture that is interesting when you look at what the price for natural gas looked like in Canada before deregulation. We were in a very high price world compared to what we have become used to over the past 15 years.

The main reason for that is that under regulation, we maintained a very large inventory that had a cost associated with it. Canadians paid a lot more for natural gas in that period than did the Americans.

With deregulation in the mid-1980s, the markets basically converged and have stayed roughly converged since then. Turning to the next page, the big difference in more recent times is that throughout most of the 1990s, we were working off that big inventory; in other words, there was a big supply overhang on the market and prices were relatively low. Canadian and Americans have grown used to those price ranges. That has become the norm for us.

The more likely norm going forward is two things we have seen since about 2000. One is a price probably more like $3 to $4 per 1,000 BTUs, or 1,000 cubic feet, than $2, and possibly higher than $4 on a sustained basis, and also more volatile markets because of the tight supply and demand markets. Both of those factors have implications for policy that you may wish to think about.

Let me talk about what drives demand, starting with the two key things on page 11. One is industrial growth. When the industrial economy in particular is growing quickly, that has a very direct effect on natural gas demand.

The other side of it is weather. Most residential and commercial gas is used for space heating. It is wholly weather dependent and swings widely from season to season. You have big winter demand peaks and a summer trough. Looking forward, one of the things we will see, as more and more power generation is based on gas, is that summer trough will tend to disappear, because power generation demand peaks in summer for air conditioning.

You will see a much more even demand pattern, which has a number of implications. One of the key ones is the ability to inject gas into storage during what we traditionally think of as the low demand period in the summer. There will be more regular pressure on the market as a consequence of that.

Page 12 gives you a sense of the dimensions of possible power generation demand. This is a U.S Energy Information Administration reference case. Driven by both the economics of power generation and environmental controls, there will be quite an uptick in 2010. That is the implication of the mercury controls on emissions from coal-fired plants that will be introduced in that year in the U.S.

To put all this in perspective, the number for 2010 there is for power generation, which is more than double the total demand for Canadian natural gas. Looking forward, you are seeing that number growing relentlessly.

The natural gas system cannot sustain this kind of growth. There will be some need to reconcile this. I cannot imagine any scenario in which this actually works. There will need to be some serious debate in Canada and the U.S. as to how that might be reconciled.

Page 13 gives a shorter-term perspective on price, which is the effect of storage. Another thing we need to be thinking about is how much storage we actually have in place. It is a key factor in mitigating price volatility. You can see on the bottom graph what happens when storage gets to low levels; it correlates exactly with price spikes.

The top graph deals with the overall amount of storage capacity available. What you see there is the effect of very few additions to storage capacity over the past 10 to 15 years. At the same time, demand has been steadily growing. There was a big addition to storage capacity in the 1980s, but there has been very little since the mid-1980s, with the consequent effect that storage is limited.

Page 14 looks at what happens between prices and drilling activity. When prices go up, drilling activity follows, with a lag of about six months. Typically, that has kept prices under control in the past.

Although there is a lot more drilling activity in traditional areas such as the Western Canada Sedimentary Basin, the amount of gas being proved up and brought to market is lower than we have historically been used to. We will be bringing on less gas per unit of drilling activity as we look forward. The kinds of prices we are seeing today will continue to encourage new exploration and development.

Page 15 deals with the other key factor of which you may need to be aware, which is the relationship between natural gas prices and oil prices. There is a continuing relationship because of the fuel switching capability in the industrial and power generation sectors.

The two will tend to be correlated; if oil prices are high, then so will natural gas prices tend to be high. On the other hand, fuel switching is also a way of helping to mitigate price volatility; to the extent you can maintain fuel switching capacity, that tends to be a good thing for the economy. It does have environmental consequences so there are some trade-offs.

Page 16 looks forward a little. This is the outlook from several different sources, including U.S. sources. Looking out over the next 20 years, there is a fairly strong consensus on demand growth, and some variation, depending on overall views, on economic growth and one or two other factors. You can see what kind of demand growth we are likely looking at, which is roughly consistent with what we have been seeing over the past decade as well.

What is more interesting, on the next page, is the gas supply outlook; you see a much greater divergence in use. The top line would encompass all of the possible new supplies coming on. It is consistent with the top line on demand growth outlook — in other words, Arctic gas, coalbed methane, or natural gas from coal, gas from unconventional sources, and probably more offshore gas. The simple point is if the demand growth continues towards the upper end of that range, it will need that sort of supply growth to sustain it.

The bottom line, which is a pessimistic view, is more or less that none of those new sources come on and our traditional sources just continue to decline. That is a very unlikely scenario, but the top line is probably an unlikely scenario as well.

Page 18 simply makes the key point that we are not running out of natural gas. There is a lot of natural gas in the ground and demand is running ahead of our capacity to bring it to market. One of the key things to think about is what we will do to bring it to market.

Page 19 gives a better sense of what is there and from where it will need to come. The key thing is, are there ways that we can accelerate these new supplies coming on in order to meet the demand growth that we see coming at us over the next few years.

Page 20 is a simple picture, and we do not do price forecasts. Trade associations do price forecasts for their members' commodities or the business that they peril; however, we do look at what others are saying about prices.

The simple story is that the incremental supplies of natural gas coming into the North American market from the Arctic and unconventional sources and liquefied natural gas all have higher supply or delivery costs than we have traditionally seen. The likelihood is very high that the kind of gas prices we will see over the next decade will be more in the range of $3 to $3.50 to $4.50, per 1,000 cubic feet, as compared to the $2 that we saw through most of the decade in the 1990s.

That has a lot of implications for the economy, the environment and consumers, which brings me to my conclusions. The markets do adjust, and the market is clear in competitive circumstances, but the supply response, because of the nature of the new supply we are talking about, will be lumpy.

That means it comes on in big chunks as opposed to smoothly, and very slowly, because of long lead times and approval processes, and it will be highly risky. If all of the adjustment takes place on the demand side, there will be implications certainly for the economy; a lot of industrial demand will, in all likelihood, disappear. Environmental performance will be affected — that is something to consider carefully — the ability to bring on new gas power generation will be very limited and consumers will see higher energy bills.

Although most consumers can afford that, there are a number for whom this is a real issue. The point there is if government sees the need to act on that, they need to avoid interfering with gas markets and deal with it at the income end.

The overall point is we need to maximize both the supply response and the demand response. We need to improve resource access and deliverability. By that I mean the pipes and the distribution systems that get it to consumers. Then we need to do several other things on the demand side to make sure markets are generally working more effectively.

We are working with the federal and provincial governments, as we were earlier this week at the Council of Energy Ministers' meeting, on solutions to these kinds of issues. We coordinate closely with our colleagues in the U.S., to many of whom you will be talking.

We think a number of things can help us deal with this period of tight supply and demand and I welcome your questions. All of you have been invited to an event that the Canadian Gas Association is putting on, which I highly recommend to you, October 22 and the morning of October 23, dealing with gas markets.

Senator Kenny: Storage used to take place, probably still does, in salt mines on the Detroit River?

Mr. Cleland: Yes, among other places.

Senator Kenny: Can you tell us about the other places? Presumably you are looking for storage somewhere near the market.

Mr. Cleland: If at all possible. A lot of it is in depleted gas reservoirs.

Senator Kenny: Which are not near the market.

Mr. Cleland: Some of them are. There are depleted gas reservoirs around Lake Erie and the Dawn Hub in Southern Ontario. One of the reasons it is there is because of the nearby storage. That is an issue. For example, Southern British Columbia does not have the geological conditions to allow storage.

Senator Kenny: Can you talk to us about the cost of developing new storage versus the cost of more pipelines, because it is one or the other, is it not?

Mr. Cleland: It is. It is an interesting trade-off. I was talking yesterday with Centra Gas Manitoba, which is looking at what they should be doing about storage. They contract for storage in Michigan and their other effective storage is the surplus capacity on the TransCanada PipeLines system.

Senator Kenny: When you say, ``contracting for storage in Michigan,'' is there a border in effect when we do that? Are there costs associated with crossing the border, other than the usual transmission costs?

Mr. Cleland: Just the transportation costs.

Senator Kenny: Whether you store it on one side or the other is irrelevant to duties or taxes?

Mr. Cleland: Broadly speaking, there are no duties or taxes. There may be implications in terms of different income tax treatment on different sides of the border, but it is minor.

Senator Kenny: Aside from Michigan, where are there likely to be storage places as one moves farther east?

Mr. Cleland: I am not sure I can give you the details on that. Wherever there are depleted salt caverns, they can be used for storage. I would have to have a geological map to give you a good answer.

Senator Kenny: I assume from what you are saying that there is not a lot of it, or you would know about it.

Mr. Cleland: I think that is right. The geological constraints are getting tighter. Where there are possibilities, then you have site problems. It is like a lot of other things. Storage involves injection fields, public perceptions. They may have been sitting on storage for many years and just not known about it.

When you put new storage in the ground, it catches people's attention. It is a combination of geological constraints, site issues and return on investment, which is a regulatory issue.

Senator Kenny: There is also the trade-off between that and laying new pipe.

Mr. Cleland: That is absolutely right. The two are interchangeable to a considerable degree.

Senator Kenny: The value of storage will diminish if summer demand starts to match winter demand, because then you arrive at a perfect world where you have a consistent demand and storage is only a peaking issue.

Mr. Cleland: That is probably right. You would still need storage for normal fluctuations in demand and also for handling interruptions. You do get pipeline interruptions. Storage is also more immediate. It is right there in the market and it enhances market liquidity.

Senator Kenny: Are you familiar at all with the American strategic oil reserve?

Mr. Cleland: Yes, I am.

Senator Kenny: The main difference between that and the sort of reserves you were talking about, that the NEB imposed a decade or so ago, is that inventory was carried by the producers, whereas the U.S. strategic oil reserve inventory is carried by the government.

Mr. Cleland: That is one of the differences. There are others.

Senator Kenny: I do not see the Americans using their strategic reserve to stabilize prices. It sort of looks as if somebody in the oil industry worked out something in Washington to get the government to buy a lot of oil. That is terrific for the oil producers, but there does not seem to be a public policy benefit that one would assume would follow if the government bought that much oil.

Mr. Cleland: You have to go back to 1974, to the establishment of the International Energy Agency and the creation of the Strategic Petroleum Reserve to explain that.

It was created specifically to deal with a major geopolitical emergency, a real cut-off of substantial quantities of oil. It was not created as a price stabilizing mechanism.

Senator Kenny: You had a big debate when Iraq went down.

Mr. Cleland: I was involved in those debates at the International Energy Agency as to whether the U.S. should draw with the SPR, the Strategic Petroleum Reserve. You may recall a decision was made just before the onset of the war in early 1991 that they would release some of the SPR to try and relieve pressure on prices.

The pressure had already dissipated because the market had discounted the price. Since then there continues to be a debate among oil industry analysts as to the extent the U.S. might use the SPR as a way of dampening price swings, but typically it has continued to be used as a catastrophic emergency reserve.

Senator Kenny: The reason I went so far off topic on that, Chair, was to really ask if there is a role in public policy, under the right conditions, for some form of natural gas storage and reserve in Canada.

Mr. Cleland: If you mean held by governments, I would say, probably no. The reason I say that is if governments have to make judgments about the price point at which you release — that was the problem with the U.S. Strategic Petroleum Reserve — you never know when is the right time. It created a political dilemma that was unmanageable; I think it was better to let the marketplace do that.

Senator Kenny: Are there any major cities in Canada now that do not have access to natural gas?

Mr. Cleland: In Eastern Canada, east of Quebec City, and Northern New Brunswick, but it depends on your definition of ``major cities.'' Most of Canada now has access to natural gas, save for big cities up North.

Senator Kenny: Cities over 50,000?

Mr. Cleland: That is probably close.

Senator Kenny: I am putting pressure on your geography, but that is close.

Mr. Cleland: Yes.

Senator Kenny: Do you anticipate that it will reach the cities of 20,000 in time?

Mr. Cleland: Over time, although right now with the conditions in markets, moving into a new market area is a very challenging proposition. If you had Enbridge Gas, New Brunswick or Heritage Gas from Nova Scotia here before you, they could tell you something about that.

It takes a long time to get pipe in the ground and customers connected before you start seeing a return on investment.

Senator Kenny: Are we talking 20 years?

Mr. Cleland: Quite likely, yes, but it depends. You are testing my knowledge here of the size of the market area that would justify it.

Senator Spivak: You mentioned demand here but you are not very specific about it. Is there a way in which conservation efficiency would help us in this situation? What are the numbers? What do you see happening, given what other jurisdictions are doing? In other words, how large are the savings we could achieve in terms of the supply?

Mr. Cleland: I can give you a sense of it, but there may be others who could give you more precise numbers. Certainly, that has to be part of the puzzle.

One thing that you will undoubtedly encounter in your discussions next week is the National Petroleum Council report released last week, which is a comprehensive review of what is happening in North American natural gas markets.

They have outlined a four-part strategy that encompasses supply and development, improved deliverability, demand side management and improvement of market functioning. They clearly acknowledge that the demand side management is an important part of it.

In a price environment such as the one we are seeing, that will help. It will concentrate people's minds. You are more likely to worry about energy efficiency in a $4 world than a $2 world. The problem now is we are competing against electricity that is not market priced right across the country. More people will demand more electricity and less natural gas. The problem is the electricity will come from the natural gas.

We have a broken system in that respect and I acknowledge the problem of producing electricity on that basis. If you are pushing uphill against price, your demand side management programs will always be at a big disadvantage.

I will give you an example on electricity with which I am familiar. The B.C. Hydro Power Smart program is well funded, with a strong commitment from B.C. Hydro and complemented by programs at the federal government level.

Over the decade of the 1990s, the Power Smart program reduced demand growth, according to B.C. Hydro's estimates, by 15 per cent from business as usual.

Think of it as if demand growth under business as usual would have been around 1.5 per cent a year; the actual realized demand growth was more like 1.3 per cent a year. This is a very useful contribution but you do not want to overstate its importance.

Senator Spivak: Will the pipelines that, we hear, are almost at the stage of being a go help the situation?

I am looking at a time frame here. How long does it take to build those pipelines? Is the supply of gas that they will produce enough to avert this disaster scenario that we are looking at?

Mr. Cleland: I am not sure I would characterize it as a ``disaster scenario.'' It is a difficult scenario.

Senator Spivak: It looks pretty disastrous by 2022.

Mr. Cleland: In one sense, 2022 will be the easy time, because that accounts for all the lead times to bring on new supply. The difficult time will be approximately the next five years. One way to look at it is you will have markets sending a price signal that is probably higher than the long-term price.

The long-term price will probably be determined by liquified natural gas imported from offshore. There is a lot of it in the world. It is a question of getting the infrastructure in place to bring it on. That would tend to cap prices at, who knows, but probably somewhere between $3 and $4.

As for the McKenzie Valley pipeline, it will be somewhere around 2010 by the time we actually see the gas. Put that in perspective. That is a billion cubic feet a day, and the overall North American marketplace is about 68 billion cubic feet a day, so that gives you 1 in 68. Alaska gives you 5 in 68. They are all important but there is no panacea.

Senator Spivak: In other words, the ANWR situation, the Arctic National Wildlife Reserve, is probably a political issue, because I understand that is only six months' supply or something like that. Is that accurate?

Mr. Cleland: Well, ANWR is essentially an oil issue. The natural gas in Alaska is re-injected gas from the Prudhoe Bay oil field. It is what is called ``associated gas,'' and there is a lot of it.

The supply is actually well known, and I am not sure what the overall volumes are, but they are substantial. They are very reliable numbers.

The difficulty is simply the size of the project required to get it from Prudhoe Bay down through the rest of Alaska.

Senator Spivak: The oil reserves in the ANWR are substantial, or you talking about Prudhoe Bay?

Mr. Cleland: I am talking about Prudhoe Bay. Others may be more up to date on this than I am. In the first instance, the preoccupation in ANWR is with oil supply.

Senator Spivak: Then we heard in Russia about liquefied natural gas and the suggestion was that if the Americans wanted it, Russia would be prepared to supply it.

What about the environmental considerations? Does it come in double-hulled ships? It would have to be substantial traffic to satisfy the United States.

Is the supply in the rest of the world large enough to begin to have an impact on this situation?

Mr. Cleland: Well, Russia has the largest gas reserves in the world by far. Russia is the Saudi Arabia of natural gas. I am not sure of the exact numbers.

The general thinking is the reserves of gas available throughout the world are very large indeed relative to the size of the market. They are also reasonably widely diversified — Nigeria, North Africa, South-East Asia, Russia.

In market terms, the key constraints are re-gasification terminals in markets such as the U.S. or in Western Europe. The track record of the LNG industry up to this point has been no accidents or shipwrecks, but a couple of minor accidents at re-gasification terminals, with, to my knowledge, no more than one or two casualties.

The technology has improved a lot in the last 10 to 15 years. Clearly those facilities will be subject to very rigorous approval procedures. Most of them will, in all likelihood, be built in the near offshore.

Senator Spivak: Are most vessels now double hulled?

Mr. Cleland: You are talking about oil tankers. LNG tankers have a series of tanks on board the ship. The gas is under very high pressure. I cannot go too far on this, but I do not think the fundamental integrity of the ships is in question.

I do not know what would happen if one ran aground. You would not have anything analogous to an oil spill because natural gas evaporates into the atmosphere, so you would not have the same environmental impact.

Senator Spivak: It is not as risky a scenario?

Mr. Cleland: In environmental terms, that is correct.

Senator Kenny: It is not an environmental question; it is a safety question. The difficulty is situating the port; you have huge NIMBY problems there. A port 10 miles off shore may be possible. We are talking about something that if it goes up, goes up like an atomic bomb.

Mr. Cleland: I read have a couple of reports on this, but I am not an expert. The more likely thing to happen, because of the way they are built, is you will get a leak. If it can be contained, it evaporates. The probability of a huge, atomic-bomb-like explosion is very remote, in my understanding.

Senator Kenny: Having said that, they will not go into Long Beach or Vancouver Harbour?

Mr. Cleland: I would say that would be a reasonable expectation.

Senator Spivak: This is a very hypothetical scenario; if Canada were not part of the North American market, we probably would never face a shortage of natural gas?

Mr. Cleland: It is an interesting question. We would face a shortage of investment to develop our natural gas. We have seen in the last two decades a great deal of investment in our resources because the market has been big enough to sustain it.

I doubt very much that you would see the development of Arctic gas in Canada if it were not for the fact we are tied into the North American market. We would have lots of natural gas, but it would not be at the marketplace, in my view.

Senator Milne: I wanted to point out that when LNG, liquefied natural gas, comes by sea, the ship is not full of liquid gas. It is in huge round tanks, almost the size of this table.

Mr. Cleland: Bigger.

Senator Milne: — built on top of the ship, so it is in effect double hulled already.

Mr. Cleland: That is correct.

Senator Milne: The whole purpose of this committee right now is to find ways in which Canada can meet its Kyoto targets. The use of natural gas is a natural way to do it because it is a clean-burning fuel.

Increasing our use of natural gas will help us do that. As the sources of gas become fewer and more difficult to extract — the unconventional sources, as you call them — the prices will of course go up. I do not now how we will be able to persuade Canadians not to look for the cheapest source of energy.

I would like your reaction to that and what you see coming in the future. This is excellent information, but some of your charts here are rather depressing.

Mr. Cleland: Let me assure you some of them are rather depressing from the perspective of my membership, for many of the reasons you cite.

Our business is the transporting of natural gas to consumers. When consumers face those kinds of prices, you are correct that they will look to alternatives. If the alternative is to invest in energy efficient equipment, and if we can help them do that, that is a good thing.

If the alternative is to choose electricity, which is ultimately generated from natural gas, that is a perverse outcome of the first order. That is an issue. Most electricity in Canada is not market priced. There is a built-in bias in favour of electricity.

Virtually all of the new electricity that is produced in Canada, whether in Quebec, British Columbia, Ontario or anywhere else, will be from natural gas. We have a market distortion.

Senator Milne: Unless they overcome Canadians' aversion to nuclear reactors.

Mr. Cleland: That needs to be a factor for the long term. I think we have to help the Canadian public overcome some of its present comfort with energy prices.

The real cost of energy looking forward will not be hugely higher than we have experienced until recently, but it will be higher. Consumers tend to be insulated from that. It is a very difficult political issue for governments. I do not want to be glib about it, but we do need to be thinking about how to point it in the right direction.

Senator Milne: On page 22, improved resource access, land access, environmental approvals, site approvals and fiscal treatment are all things that come under the umbrella of government, and the population is increasingly concerned about environmental approvals, or the lack thereof, environmental assessments on pipelines and site approvals.

What solution do you see, other than government sort of rolling over and playing dead?

Mr. Cleland: Which would be politically untenable. It is a very good question. I would say that is probably the central question that we and our many other colleagues in the energy industry, the electricity and upstream oil and gas industry, think that we need to look at more seriously.

We believe that there are ways of maintaining the fundamental integrity of our environmental management and assessment systems while speeding up approval processes, and also making them more certain. It is not realistic today to talk about ``letting it rip.'' You cannot do that. I do not think anyone would propose anything like that. We talk about smarter regulation, and there are some things we could do to improve that.

In particular, a lot of potential resource land in the U.S. is excluded from exploration and development with no very obvious environmental rationale and could be explored and developed with very minimal environmental impact.

It is a question of a trade-off. We want to use natural gas. The development of natural gas will have some environmental impact, just like other energy sources. That is what the political process is about, trying to find the balance.

Senator Milne: We sitting here are part of the Parliament of Canada, and perhaps part of our report should be on things that the government can do to, not decrease the required levels of environmental approvals, but speed up the processes. I would welcome specific suggestions from you; I think that would be valuable to us.

You just said that you think the McKenzie Valley pipeline will come on-line in 2010. That is pretty optimistic.

Mr. Cleland: That is probably a pessimistic view. It could come on sooner, but these things inevitably tend to take longer than expected.

Senator Spivak: When you talk about ``minimum environmental impact,'' are you considering the total external costs? Let's look at Alberta roads and what that leads to and how that impacts on ranching and so forth.

I think Alberta is probably an example of how not to develop oil and gas. It had a lot of impact on the forest industry and ranching, so in terms of environmental impact, building a road, for example, leads to a lot of other things. What is your definition of ``minimal environmental impact''?

Mr. Cleland: Let me give you example. I would not agree with you that Alberta is an example of how not to do it. I think by and large, it has been done reasonably well. Clearly there have been issues with sour gas developments that have created some problems and one would be naive to suggest it has all been rosy.

In most natural gas development, to drill a well means going on the land for a very few days, completing the well and leaving behind a footprint of about 12 feet by 12 feet that then will produce for several years.

Given the scale of the resources that Canada has been able to take out of Alberta, B.C. and Saskatchewan, I would argue that the environmental impact has been relatively modest. It would meet my definition of ``modest,'' perhaps not yours.

Senator Spivak: The thing one worries about is wilderness. Alberta really does not have any wilderness left. You will be going into pristine wilderness areas that have an economic benefit. I take your word and I hope the impact is minimal.

The Chairman: I assure you, there are some parts of Alberta that are wilderness, in which there are no roads and you cannot get there except by walking.

Senator Spivak: We do not want roads in there.

The Chairman: Well, you cannot have a gas well if you do not have a road.

Senator Kenny: You could get there on a boat and drive around.

The Chairman: That is right, if you are prepared to go upstream.

Continuing along the same thing of questioning that Senators Spivak and Finnerty were on, the report that Secretary Abraham asked for, which contains a number of recommendations having to do with the easing of restrictions on gas drilling, specifically includes a recommendation that exploration ought to take place in the Rocky Mountains. In Canada that is like attacking a national icon, because most of our Rocky Mountains, if not all of them, are in national parks or in wilderness protected areas. As you have pointed out already and recognized, it is politically difficult to say to most people, ``We are going to start drilling wells in the Rocky Mountains now.''

I think in the U.S. they mean to include not only the Rocky Mountains, but also all of the other ranges where gas might be found. I know that you are in the transmission business more than the drilling end of things, but would your association have a view with respect to the question of drilling for gas wells in the Rocky Mountains in Canada, and offshore B.C.?

Mr. Cleland: As a general proposition, yes, we do, and it is one that we share broadly with our upstream colleagues. Canada actually has better access to the Rockies in some respects. A lot of the U.S. Rockies are off limits, but we think that you can develop those areas, and you can in all likelihood develop the B.C. offshore, with a certain level of environmental disruption. It is difficult. Where is the balance?

It is a question of needing the resource for economic and environmental reasons. There will be some implications that we have to take into account. We believe that those implications can be managed.

The technology of oil and gas development has changed so dramatically over the last 20 years that the environmental impacts are very modest indeed in comparison. It is a question of continuing to improve our ability.

The Chairman: You pointed out that right now, if somebody switches to electricity, it will just mean more pressure on gas prices, production and resources.

Is it correct to say that? You made the point that if people need more electricity, it will be generated, in the main, by gas. That is true given the present circumstance, and all past predictions with respect to that are based on what know now, but other, alternative means of generating electricity may come more into play, and small generation that has not until now been seen to be economical, may become so as price pressures increase.

Would you say that might militate against the idea that all new electricity will be generated by gas?

Mr. Cleland: Over time it will have some effect, but it depends; different technologies have different uses in the overall electricity production system. Nuclear generation provides a base load; wind power provides electricity when it wants to.

Wind power will definitely be adding to our electricity generation capacity over the coming years. How much is hard to say; it will not replace gas.

Gas has the advantage of being extremely flexible, wit a low capital cost and the ability to meet intermediate and peak loads very efficiently. Wind cannot do that and nuclear cannot do that, so we need the mix.

In the next 10 years, none of the other technologies, whether it is nuclear or hydro, has any possibility of picking up much of the pressure. Gas is the one that is there and available. We would simply argue that what is important in the first instance is that consumers see the price, and that will have a helpful effect. Step one then has to be to create the demand side management programs to help them increase the efficiency of their use.

The Chairman: When Senator Kenny was asking you about access by consumers to gas, both industrial and residential, you talked about the difficulty of going into a new market and the requirement for capital investors to be patient because it takes time to bring people on-line, provided that prices remain stable.

I want to ask you a question that I suppose is naive in the extreme, but I live in Alberta and I have had hundreds of letters over the past couple of years relating to gas prices, which is not a surprise.

I am harking back to the fact that when I was a kid I used to work for the gas company. I got the job through my dad, who worked for gas companies, all of which were owned by an international utility in New York that made lots of money, satisfied its shareholders, paid nice dividends and paid its employees, who were happy.

Maybe I am looking at things through rose-coloured glasses, but in those days gas was not a significant part of the cost of running a household. It was a remarkably insignificant part. For many years it did not amount to much, except for that peculiar blip in the mid-1980s that you already pointed out to us.

I understand market forces, how prevalent they are, and I think most people do. Market forces are easy to accept when you are selling something that is optional. Most gas companies that deliver to industrial and residential consumers have an effective monopoly and therefore are regulated in one way or another. I have a hard time understanding why the normal market forces — supply is tight, therefore, prices go up — apply necessarily in those circumstances where one has a granted monopoly, for all intents and purposes. When the supply becomes short, what is the effect of raising the prices? Is that a conservation measure?

Mr. Cleland: There are several dimensions to your question. The regulated portion of the industry is still regulated, whether it is the distribution system, the local distribution companies —

The Chairman: When as a regular circumstance, a deliverer of gas to my door goes to the public utilities board or whatever body in the province and presents its case for a double digit price increase, what is the nature of that case, given that in the years when that happened, we had virtually no inflation? It is not a normal inflationary thing or keeping up with the Joneses, it has been remarkable, and I have never understood the case that is made that leads the public utilities board to say, ``Yes, you can increase your prices by 25 per cent.''

Mr. Cleland: It is important to distinguish between the commodity charge and the transportation charge; in other words, the long-distance transportation and then the distribution charge. Those are the two regulated components and our companies go to the public utilities commissions to ask for increases in those rates.

They have been very stable over the past 10 years. What has not been stable is the commodity charge, which has been deregulated since 1985. Why has it bounced around? I would argue that it actually has been pretty stable over a good part of that time and it is only in the last three years that we have seen big increases. Energy is essential; on a cold winter's night, you have to have it. On the other hand, if you mask the price so consumers do not see it, then they lose the incentive to take the steps that are available to them to insulate their houses, put in place a more efficient furnace and all those kinds of thing.

In the short run, consumers do not have many options. Basically, it is a capital stock issue. Part of it is educating consumers, letting them see the price.

For about 80 per cent of the income band, the price of all energy used — natural gas, electricity and the gasoline for vehicles — is around 7 to 8 per cent of household expenditure. It has been stable for a couple of decades.

The problem is the people in the bottom 20 per cent, for whom the cost is about double, and that has a real impact. For most of us, energy is still a pretty good deal and that will probably continue for some time. We are seeing higher prices, but in terms of the service that people receive, I would argue that is still not unreasonable.

The Chairman: I certainly understand what you said about masking the prices — we should pay what things really cost — and what you said about the bottom quintile of income earners. That should be addressed at the income level, not by controlling prices. There is a good argument for that.

One thing that you said during your presentation was that in certain circumstances, industrial demand might disappear. Would you explain that to me, please?

Mr. Cleland: The price of gas today is around $4.60 on NYMEX. It has been over $4 throughout this year and it was in the $3- to $4-range over the last couple of years.

In those circumstances, industries that rely particularly on natural gas as feedstock as opposed to energy source — although they also use it as an energy source — such as the methanol industry, ammonia, basic petrochemicals, fertilizer, lose their cost competitiveness in North America.

We have seen over the past few years, according to different estimates, anywhere up to 8 billion cubic feet a day of what we call ``demand destruction,'' in other words, permanent removal of that demand from the picture. That is permanent removal of those industries from North America. That is not a Canadian phenomenon; it is a North American one, because traditionally, their cost competitiveness has rested on a low North American gas price relative to Europe. That has flipped on its head. I talked to somebody from France recently and they see opportunities to bring LNG into North America, as opposed to Europe, because the price in North America is about a dollar more than in Europe.

The Chairman: The company that is producing sheet plastic, extracting from a feedstock, will not shut the plant down and move it somewhere else. They may import LNG and use that as feedstock?

Mr. Cleland: They might, although if they are making sheet plastic, they will, in all likelihood, be importing the bulk polyethylene from Indonesia rather than the U.S. Gulf Coast.

In some cases, if you have a very modern plant that meets the test of economies of scale, you may be able to sustain those kinds of prices. Again, much of the North American industry, and the Canadian industry in particular, have been built on assumptions of lower prices and they are having to adjust to that.

Senator Kenny: As a corollary to your comment that people should pay the cost of a product, I feel obliged to observe that while I agree in general, it needs to be qualified with the necessity for the industry to contemplate smoothing out the peaks, because it is the peaks that cause a reaction, which, in turn, causes us to want to regulate.

Gradual increases combined with relatively steady energy costs do not cause a big public reaction, but peaks do, and in turn cause voters to turn to governments and say, ``What are you doing about these people who are ripping us off?'' It is just an observation that slow, gradual pricing strategies that reflect costs and the value of the product seem, in a public policy environment, to be a lot more manageable than the spikes that come from time to time. It is not just in the case of natural gas, but also more obviously in gasoline and things like that, that policy-makers are driven to arrive at solutions that may not be in the best interests of the consumers or the industry.

Mr. Cleland: I fully agree with your observations. I think that is absolutely correct. That is one of the things we mentioned when we talked to governments about what we think is the need for discussion on these matters.

What we can reasonably do to mitigate price volatility is one of the key issues. There are things you can do about physical supply. You are obviously familiar with them because you talked about storage and pipeline capacity. There are financial measures you can take to hedge against price volatility and you can offer consumers a fixed price arrangement to help them manage that, so there are strategies. We will probably have to think a little harder about whether we are deploying all the ones we need.

Senator Kenny: What happens when you talk to your membership about this as an industry strategy?

Mr. Cleland: They are fully supportive. A lot also depends on what sort of regulatory support you get for these kinds of measures. If you live in Ottawa, Enbridge probably supplies your natural gas using hedging strategies, in a sense.

They are cutting off the very top of the peaks right now. The consequence of that is that consumers do not participate in the downside; they do not face that price at the top, but they also lose out at the bottom.

As you get into more volatile markets, you probably have to narrow that band, which means that you can cut off more of the peak, but everything costs something. You then cut off more of the trough as well. Over time, as long as you are in the long-term price band, that is a valid strategy, but you do need the regulators to cooperate with you to make it work.

All of my members are actively involved in programs of that sort.

The Chairman: I would think that would be a lot more palatable to everyone in the long term.

Senator Spivak: Now we are getting into the area of what is the role of government. What do you think about what happened in Alberta when there were subsidies, when it was suddenly deregulated? This looks like putting on a band- aid and not looking at root causes. Also, look at Ontario.

That is not, in my opinion, good public policy, but if you look at insurance rates, for example, these will be key issues on the political scene. I can see energy becoming the key issue.

If you look at the insurance area, people will begin to demand public insurance. Hopefully, from your point of view, they will not demand nationalization of the oil and gas industry, but if something does not happen, you can see how governments, faced with a huge crisis, will use the wrong solution.

Mr. Cleland: I fully agree with that. My personal view is that industry needs to be working closely with government in the political management of these issues. We need to find strategies to relieve that pressure.

In the long run, I think it would be a very bad thing for consumers if we went down some of these roads. It is quite clear that you cannot just leave the politicians out to dry, because people react and they get pressed into those kinds of things.

Our view is the recent rebates in Alberta are bad policy. The price caps on electricity are bad policy. We also have to acknowledge that there are political pressures that push governments in that direction.

Senator Spivak: You also have to maintain consumer trust, because if you look at the United States, with those companies that were engaged in absolutely criminal, fraudulent practices, people began to distrust what was happening, and in those situations you can have very bad results.

Mr. Cleland: Consumer trust is absolutely essential. Again, it goes to the strategy.

Senator Spivak: Why should we trust you?

Mr. Cleland: I will leave that entirely up to you. I suppose most of our society functions reasonably well on trust. Our members are in the business and it is a question of where our self-interest lies.

Senator Spivak: In transparency, I would think.

Mr. Cleland: It lies in transparency, in consumer confidence and in political confidence in what we do. To that extent, I think you can trust us because that is where our interest lies.

The Chairman: In that respect, would you please respond to the suggestion that deregulation is a really bad idea?

Mr. Cleland: I would not subscribe to that view. I think we have made some mistakes in deregulation. We have perhaps miscalculated the extent to which energy deregulation, particularly at the retail level, is something that consumers would want to embrace.

They have tended — and I think you could probably all see it in your own households — not to particularly want to think of energy. What you want is reliability, security and price stability.

Senator Spivak: Safety.

Mr. Cleland: And safety. I believe you can achieve that in a deregulated market; in fact, we do. The point is whether consumers want to participate in the market at that level. I would argue that wholesale deregulation, certainly in natural gas and electricity, has already demonstrated its merits and will continue to do so. Retail deregulation is a more difficult question.

Senator Spivak: In the United States, deregulation is pretty well on hold, but is that wholesale or resale? Many states that were contemplating deregulation are now abandoning it.

Senator Kenny: I think the word is ``terminating'' it.

Senator Spivak: Probably that will happen for the longer term rather than the shorter term, given the huge shock that they received. Is that wholesale or retail?

Mr. Cleland: It is a little of both. The ones that have terminated their programs are generally ones that probably went too quickly into retail deregulation, and that is where they have tended to get into trouble. On the other hand, you have ones like California, which had wholesale deregulation and fixed prices at the retail level, and which really got them into trouble. It has recovered.

Wholesale deregulation does not mean consumers see a fixed price forever. It means they see a regulated price that adjusts in response to changes in the wholesale market. I would argue that if we want to encourage effective demand side behaviour, that is, energy efficiency and conservation, and if we want to encourage innovation in the supply of energy, particularly in electricity, there is a pretty strong argument that wholesale competition is effective in that regard.

Senator Spivak: Will you advise the next government in Ontario as to what they should do?

Mr. Cleland: I will offer them our views, should they ask me.

The Chairman: We will be meeting next week in Washington with, I presume, your approximate counterparts there, the American Gas Association. Would you describe the relationship between you and them so we can understand it?

Mr. Cleland: It is a very informal relationship. We keep in touch with each other, frequently run into each other at conferences and meetings. I am in periodic communication with my counterpart, Mr. Parker, at the American Gas Association. It is pretty much an exact counterpart of the Canadian Gas Association.

We also work with others, such as the Interstate Natural Gas Association of America, which is the counterpart to our Canadian Energy Pipeline Association. We stay in pretty close touch.

The Chairman: I am presuming one significant difference is that the United States gas industry does not export a lot of gas?

Mr. Cleland: Very little. It does export gas to Mexico now and will be exporting more as the years go on. In a sense, it is one pool, but remember that we add 17 billion cubic feet a day to the North American pool, which is a pool of about 67 or 68, so the U.S. still supplies the bulk of that. In effect, you are right, if you think of it as injections into and then withdrawals from a pool.

Senator Spivak: You said we use in North America 68 billion —

Mr. Cleland: — cubic feet a day, more or less.

Senator Spivak: 68 billion cubic feet a day.

The Chairman: And counting.

Mr. Cleland: Demand growth is 1.5 per cent a year. I am not sure I have the number on that.

Senator Spivak: They are not suffering and I do not think their per capita energy use is anywhere near ours.

Mr. Cleland: It tends not to be, and that is right across the board. Europe will run into its own big problems with electricity. Certainly over the past decade, they have had access to a lot of North Sea gas, North African gas, through LNG shipments and access to the biggest source of natural gas in the world, which is Russia.

The Chairman: There are two pipelines from Russia to Central and Western Europe.

Mr. Cleland: That is correct. Traditionally, we have thought of ourselves as having a price advantage in energy, but that is not true right now.

The Chairman: Maybe we need to build a pipeline across the Bering Strait.

Mr. Cleland: Possibly.

The Chairman: Thank you very much, gentlemen, for being with us this morning. It has been very helpful. We are much better equipped and generally better informed now for our meetings next week for your having been here today.

The committee adjourned.