TransCanada deal won’t solve natural gas issues

In the natural gas space, “one of the big things that market participants have been watching is the TransCanada Mainline negotiation,” says Scott Vali, vice-president of equity for CIBC Global Asset Management.

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The TransCanada pipeline deal was signed in March, but it may not affect the price of gas in Canada the way investors hope.

The 10-year deal, between TransCanada Corp. and natural gas producers in Western Canada, calls for an additional 1.5 billion cubic feet (Bcf) of natural gas to be shipped daily from Alberta to Ontario. The deal was made to compete with pipelines being built in the U.S. and to save the industry from potentially losing billions in revenue.

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Vali, who manages the Renaissance Global Resources Fund, explains that the price differential between gas in Alberta and in the rest of North America, and at the Union Gas Dawn Hub in Ontario, is wide — it was about $1.00 to $1.20 per thousand cubic feet (Mcf), as of mid-March 2017.

So, “the [market] expectation was, with [the TransCanada] deal, that spread would start to narrow as more gas flowed out of Western Canada into the Ontario market,” says Vali (according to news reports, the deal introduces a simplified toll, versus a varied toll structure that was considered pricey by shippers).

But, he says, “we believe the market is wrong.”

That’s because 1.5 Bcf “is only half the capacity of the pipeline,” says Vali. “The way the other half is still contracted today requires a one-year commitment by a producer to buy capacity on the line, and the rate that capacity can be bought is at about $1.20 per Gigajoule.” As a result, “at least a Bcf of gas will continue to be priced at the higher toll, and that […] will price the market in Alberta.”

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This basis differential, and the reasons for it, are significant for Canadian equities in terms of the gas producers in Western Canada, says Vali. “[In March], gas [was] trading at just under $3 Mcf in the U.S., and if Canadian gas is trading at a dollar discount, it means that Canadians are receiving just under US$2 in Mcf, which is a very big discount to what other producers in North America are receiving.”

Vali adds, “That, in turn, will hurt their cash flows and growth prospects as we move forward. So, again, we believe that the Western Canadian producer is generally going to be disadvantaged relative to their U.S. counterparts, unless something else changes with respect to the TransCanada Mainline.”

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