Opportunities and Challenges Facing Shell’s Canada LNG Project

The oil and gas industry has high hopes for the future of the global LNG trade. With global demand for natural gas expected to double by 2025, several companies are investing heavily in LNG export projects around the world.

In the U.S., the Department of Energy (DOE) has already approved four projects to export LNG to non-free-trade countries, including Cheniere Energy's (NYSE: LNG) Sabine Pass terminal in Louisiana, the first U.S. LNG export project to receive government authorization, and Dominion's (NYSE: D  ) Cove Point LNG terminal in Maryland, the most recent project to receive DOE approval.

But the U.S. isn't the only nation with massive LNG export potential; our neighbor to the north also sees plenty of opportunities. In fact, a handful of major oil and gas companies have already secured permits to build LNG export facilities on Canada's West coast. Let's take a closer look at one of these proposed ventures -- Royal Dutch Shell's (NYSE: RDS-A  ) Canada LNG project in Kitimat, British Columbia -- and some of the challenges and opportunities it faces.

Shell's Canada LNG project
So far, three LNG export ventures have received approval from Canada's National Energy Board (NEB), though none of them have been finalized. They include Apache and Exxon's Kitimat LNG project, which would produce between 10 and 15 million tons of LNG per year starting in 2021; LNG Partners' Douglas Channel LNG project; and Shell's Canada LNG project. Six additional projects are currently under review by Canada's NEB.

Shell, in partnership with Korea Gas Corporation (KOGAS), Mitsubishi Corporation and PetroChina, has proposed to construct an LNG export terminal in Kitimat, British Columbia, that would include a gas liquefaction plant, as well as storage and export facilities, with an expected capacity of up to 24 million tons of natural gas per year. Shell would serve as the project's operator, with a 40% interest, while the other three companies would each hold a 20% stake.

Challenges facing Canada LNG
But development costs for Canada LNG and other Canadian LNG export projects are expected to be significantly higher than costs for similar projects based in the U.S. for a couple of main reasons.  

First, most Canadian projects will need to be built from scratch, while many U.S. LNG projects simply need to be converted from import facilities to export facilities. And second, labor shortages in Canada have led to skyrocketing labor costs, with Canadian oil and gas workers currently pulling in about 60% more than their U.S. counterparts.

But Shell believes that Canada LNG may have a leg up on projects like Chevron's (NYSE: CVX  ) Gorgon in Western Australia, which saw its cost estimates skyrocket from an initial $37 billion to an expected $52 billion, as well as on competing projects in Canada, for two major reasons.

First, Shell and its partners are planning to construct Canada LNG on an existing site and have already tapped TransCanada (NYSE: TRP  ) to design, construct, and operate the 700-kilometre, 1.7 bcfd pipeline that will ship natural gas from gas fields in British Columbia to Shell's proposed LNG export facility near Kitimat. By contrast, Gorgon saw costs soar largely because of its remote, offshore location, which required all raw materials to be shipped via sea.

Second, Shell believes it is in a much better position to find foreign buyers for Canada LNG, owing to the fact that its three consortium partners are among the largest LNG buyers in Asia. With their involvement in the project, Shell may be able to receive much more favorable agreements on price and volume than it would have otherwise been able to.

1 uncertainty to consider
But one major uncertainty remains: British Columbia's tax regime governing exports of LNG. The province's government, which finds itself with an uncomfortable debt load, is currently considering a tax on LNG exports. But it hasn't revealed any final details on the rate of such a tax or how it will be implemented, creating a great deal of uncertainty for companies like Shell who plan to build LNG export facilities in Western Canada.

Indeed, the tax rate on LNG exports is one of the biggest considerations for Shell in determining what price it will sell its LNG for. If the British Columbia government doesn't disseminate these vital details by next year, Shell and its partners would likely have to push the date of their final investment decision back.

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