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Home > Speeches and Presentations > Speeches and Presentations 2004 > The Future Role of the Regulator in a Continental Market

The Future Role of the Regulator in a Continental Market

Kenneth W. Vollman
Chairman
National Energy Board
2004 CAMPUT Conference
Halifax, Nova Scotia

10 May 2004

The Future Role of the Regulator in a Continental Energy Market

Outline

Good morning. I would like to once again welcome my colleagues, Pat Wood and Dionisio Pérez-Jácome. I learned a great deal from our discussions in Banff last May; it is my real pleasure to have this opportunity once again. I would also like to thank Neil McCrank for his helpful comments in targeting the issues we should include in our prepared remarks. Finally, I would like to thank CAMPUT for bringing all of us together in this wonderful venue and with a stimulating program.

In my remarks today, I will first discuss the energy market context that I expect for the rest of the decade. I will then touch on some of the non-market forces at play. These market and non-market influences set the stage for my comments on the regulator's role and some of the steps that we are taking at the NEB to respond to the interplay of these influences.

Crude oil prices

Energy prices in North America have increasingly been driven by international oil prices, so that is where I'll begin. This chart shows oil prices over the past five years. Starting the data series in 1999 allows me to immediately make the point about how careful we should be in accepting anybody's view of the future. It was only five years ago, with prices hovering around $10 per barrel, that many experts were warning that we should brace ourselves for single digit oil prices. The fundamentals, they argued, did not support continuing double digit prices. Well, we flirted briefly with that world, but oil prices have taken a dramatically different path in the last four years.

In March of 2000, OPEC established a target band of $22 to $28 for oil prices. I believe OPEC did this for a number of reasons, two of major importance would be firstly, to yield the revenues required by OPEC members; and, secondly, higher prices would be damaging to world economies. Of note is the fact that the OPEC basket has traded above OPEC's target price of $US 25/bbl for most of 2003.

Most of the experts I talk to suggest that a price around the upper end of the range should be expected for the next few years.

Note: OPEC Price Band introduced on 27 March 2000.

World oil demand

While there are differing views on the issue and I've just mentioned the need for caution with respect to forecasts, there are some fundamental reasons to believe that oil prices will remain high. The first is that world demand for crude oil has continued to grow steadily at current price levels. Economic recovery in the western world, coupled with strong growth in Asian markets are major contributing factors.

Asia-Pacific oil demand is expected to grow significantly for the remainder of this decade. China is projected to lead Asian growth at a pace of slightly above 5 percent per year. However, a depreciation of the U.S. dollar versus China's currency and a subsequent cooling of the Chinese economy could result in a slowing in the growth of Asian oil demand.

Notes: Sources of data; BP Historical Review 1980-2003; PEL Forecast 2003-2010.
Other category includes Africa and Latin America.

World crude oil production

As a consequence of the steady growth in demand, ample market opportunities are available for expanding production from OPEC, non-OPEC and, most strongly, the former Soviet Union.

World oil production has grown steadily since the mid-1980s. In particular, non-OPEC production has grown by almost 60 percent since 1980. In its role in managing the market, OPEC's share has not grown to the same extent.

Notes: Sources of data; BP Historical Review 1980-2003; PEL Forecast 2003-2010.

Canadian crude oil production

Closer to home, this price environment and concerns about supply security could create huge scope for developing Canada's vast oil sands. Canada currently produces about two and a half million barrels day. That is expected to increase to three and a half by 2025, largely due to new oil sands development.

Canadian natural gas prices

Natural gas has experienced dramatic price increases as well. For many years, supply and demand have come into balance with prices in the vicinity of $2.00 Cdn/MMBtu. Since the winter of 2000 however, in response to steady gas demand, maturing of many supply basins, and high oil prices, we've seen prices averaging $5.60 Cdn/MMBtu but with great volatility around that number. To introduce the subject of future prices, I've also included on the chart a number of recent forecasts.

I think it is impossible to accurately project gas prices to the year 2010. The price path will depend on the energy policy framework, the response of supply and demand to price, and on the decisions that we take as regulators.

There are those who argue that LNG can provide a price cap at current delivered prices. I am skeptical about that because of, amongst other things: the small market share it will have in the near term; the costly infrastructure requirements; and also because suppliers of LNG will likely seize opportunities that exist in a tight market to improve netbacks.

Source: CAPP Natural Gas Report: weighted average of all deals completed in previous month for month of delivery.

Canadian natural gas production

The Western Canada Sedimentary basin is an important part of the natural gas outlook, currently providing about 20 percent of North American supply. After deregulation in the mid-to-late 1980s, gas production increased rapidly, growing by almost 10 Bcf/d by the turn of the century. What happened in effect was that the WCSB satisfied 75% of incremental U.S. gas demand.

However, as production from the WCSB appears to be flattening out, it will no longer be possible for this basin to satisfy a large portion of incremental requirements. The maturing of the WCSB is a fact, however there probably exists some misunderstanding about possible future production levels in Canada. Canada has large resources of natural gas as outlined in the EMA we released in Mid-April. These include coal-bed methane, tight gas, and frontier gas. A number of sites are also being studied for LNG import terminals. While LNG is not Canadian production, it is a supply source that could be available to Canada which is why it is included here. A possible scenario as to how these sources could contribute to a growing gas supply outlook is shown in this chart.

Over the past 20 years, supply growth has come mainly from short-term incremental investments in conventional gas producing areas. This must change if a scenario like the one shown is to happen. Large lumpy investments will be required and will occur only if energy and regulatory policies are supportive.

Current WCSB production

As a brief aside, let me say a few words about the current state of production from the WCSB. It is now commonly accepted that further growth from conventional gas is unlikely and that a substantial drilling effort will be required to offset declining production from existing wells. However, some of what you may have read lately about current production may not be accurate.

We are watching the response from the basin very closely and our current interpretation of the data suggests that production in 2004 will be essentially flat compared to 2003. The graph provides a summary basis for this view.

You can see from the graph that field receipts for the first four months of this year follow very closely the receipts from the same period last year, in fact, they're about one percent below on average. One might have expected a stronger supply response from the high levels of drilling. On the other hand, the new production had to replace the normal declines from old wells plus the precipitous drop from Ladyfern. This should have less of an effect for the rest of the year, with the result that conventional production should again come in at around 16.2 Bcf/d.

Note: We have developed a methodology for monitoring field receipts on a real-time basis to complement reported production data because of the time lag in reported production numbers.

Canadian power generation by fuel

The last of the major energy forms I'll discuss is electricity. Generation has not kept pace with demand growth in Canada during the past two decades with the result that reserve margins have consistently declined. We expect electricity demand will continue to grow apace with the economy, which will require major new investments in generating capacity. We estimate that some 40 000 megawatts of incremental electrical generating capacity will be needed over the next two decades.

Summary of market environment

Before moving to non-market influences, let's summarize the market environment in Canada. Energy prices are likely to be persistently high and volatile for the rest of the decade. Although there will continue to be improvements in energy efficiency, economic growth will drive energy demand. The appetite for oil, natural gas and electricity are all steady or increasing, even in an environment of higher prices for the rest of the decade. To meet this demand, industry will seek to extend its reach with respect to conventional production and the development of non-conventional energy sources such as coalbed methane, frontier onshore and offshore gas supplies, imported LNG, and the oil sands.

In addition to the capital required for new oil, gas and electricity supply, major investment will also be required for other forms of energy as well as energy conservation. In total, expenditures would need to increase from recent levels in the range of $30 to $40 billion per year to something in the order of $50 billion per year over the next decade.

This is a market very different from that we have experienced in the past 20 years.

Conclusion #1

This means that very substantial investments in the energy industry are likely over the next few years - conventional production in western Canada, offshore drilling in the Maritimes, northern pipelines, oil sands plants in northern Alberta, coal bed methane development, new power plants and LNG terminals at tidewater. Much of this proposed development - for example, LNG, coalbed methane and the frontier - takes us into less familiar territory.

As I said in my remarks last year, regulators must provide clear processes on which project proponents can rely for fair treatment within reasonable timelines. Uncertainty deters investment so reliable regulatory processes are necessary if industry is to bring on projects which are in the public interest on a timely basis.

Non-market influences

The development of new energy supplies is affected by a number of external factors, which I'll call non-market influences, and their impact has been increasing. First, the desire for healthy and diverse environments is a "given" - a fundamental aspect of the public interest. Industry is continuously improving its ability to protect these values through effective facility location, design and operation.

Second is the growing complexity of regulatory and assessment processes about which I'll have more to say later.

A third factor is growing citizen involvement in regulatory processes. Recent NEB hearings have set new records in terms of numbers of participants. In addition to environment and health concerns, many communities are becoming intolerant of new industrial development.

Lastly, there is the growing interest of Aboriginal communities in resource development on their traditional lands. They are concerned about environmental impacts on their traditional lands, economic opportunities from resource development activities and impacts on their treaty and aboriginal rights. Additionally, issues around the Crown's obligation to consult with aboriginal people where development may have an impact on treaty or aboriginal rights pose further challenges.

Conclusion #2

The growing need for energy must be balanced with these important non-market influences. There is an expectation that regulators will protect the public interest and there is an obligation to do so. The Board's responsibility is to promote safety, environmental protection and economic efficiency in the Canadian public interest in its regulation of pipelines, international power lines and energy development. Regulation must reflect the broader interests of our society which includes having the ability to satisfy its energy requirements.

Policy environment

A third factor underlying energy markets, in addition to market forces and non-market influences is the policy environment. In this regard, Canada remains committed to market-based principles. However, for the first time in almost 20 years, some parts of the industry are asking governments to examine energy strategy. The demands range from "tweaking" current policy through to creating a more comprehensive policy framework.

We truly have a continental energy market in natural gas and oil, with both commodities flowing freely across borders. While trade in electricity between Canada and the U.S. is not as extensive as it is for oil and gas, the electric power systems are intimately integrated and this is an important aspect of reliability for utilities on both sides of the border.

Mexico's impact is felt by Canada indirectly through its role in the continental market as a supplier and a consumer of energy. We do affect one another. For example, both Mexico and Canada have LNG projects proposed which, if constructed, would affect the dynamics of the gas market.

Conclusion #3

This brings me to conclusion #3. Regulatory policy and practice must be cognizant of the reality of an increasingly integrated North American energy market driven by market forces. If you think you've been hearing this point for almost 20 years, you probably have...

Integration of oil and gas markets

...but the integration has grown steadily over that period. One way of graphically expressing that integration is to look at the trade numbers. Canada now exports over half of its oil and gas production to the United States and an examination of prices shows that those markets are efficiently integrated. Proposed developments such as the frontier, LNG and oil sands will further increase integration and bring with them new regulatory challenges.

Integration of electricity markets

Electricity markets are less integrated, but trade does occur smoothly in wholesale bulk markets. Overall trade numbers however, are relatively small and last year our net exports to the U.S. amounted to only one percent of production, largely due to low water levels which affected hydro-based exports. Because this chart shows net exports, it underestimates the significance of the trade.

The regulator's role

This brings me to the third and principal part of my presentation, which is to discuss the regulator's role.

I suggest to you that the regulator's role in the emerging market environment will boil down to two words - 'protect' and 'enable'. We will need to both enable and protect in order to achieve outcomes that are in the public interest. The "protection" part of the role probably comes more naturally to those of us appointed to regulatory tribunals. Indeed, much of what we listen to in public hearings concerns protecting property, protecting rights, protecting earnings, protecting safety, protecting consumers, protecting the environment, protecting wildlife, and so on.

Enabling and protecting

I believe the concept of 'protect' is well understood. In harnessing our energy resources, we must protect the things that are important to Canadians, protect integrity of our environment, respect individual property, protect public safety, protect consumers from market failure and charge for services in a manner that is fair to investors.

The Board takes its protection responsibilities very seriously. For example, with respect to environment, lands and socio-economic matters, we have 37 specialists working in this area alone. In public hearings on energy infrastructure, the largest proportion of hearing time is dedicated to these matters. I want to make it clear that finding the balance between enabling and protecting means we must pursue the two objectives - it does not mean reducing one at the expense of the other.

I will elaborate more thoroughly on the word 'enable' here and with the next few slides. I use the word enable because it implies a responsibility to 'make possible'. Investment in energy infrastructure is needed to get energy where consumers ask for it - to heat our homes, power our appliances, move us around and make sought-after products. Good regulatory processes and policies are required to identify the best means to let supply meet demand, and enable the necessary investments.

Enabling

Enabling encompasses many things. It means providing an efficient and effective framework for disclosure of information and negotiation between various stakeholders to reduce uncertainty and shorten timelines. It means providing a clear set of rules which protect investors as well as consumers, thus encouraging investment to proceed.

Finally the concept of enabling implies a responsibility to ensure that projects found to be in the public interest can proceed. The purpose of both protecting and enabling is to serve the public interest.

Three types of enabling

Ensuring that our processes meet the needs of all stakeholders is the first of what I see as 3 types of enabling. For example, with respect to the regulatory framework for a Mackenzie Valley Pipeline, enabling involves getting fourteen boards and agencies to effectively coordinate their activities and responsibilities. Several other examples of process enabling are shown on the graphic.

Second, enabling in the context of regulatory policies means examining our policies to ensure that, in the absence of other public interest considerations, they are not an impediment to the long-term efficiency of markets. Do we, or other regulators, have policies in place that discourage pipelines and their customers from entering into the contractual relationships necessary for the effective operation of the market and the development of adequate infrastructure?

Lastly, once a project has been found to be in the public interest, the regulator should facilitate construction that is within approved terms and conditions.

Regulation is bucking the trend

Regulation has received a lot of attention lately as one of the impediments to desirable investment. Earlier I discussed the increased integration that has occurred in energy markets. But regulation has bucked that trend. While commodity markets in North America have become more integrated and less regulated - moving from the lower left quadrant in this diagram which depicts markets as segregated and regulated, towards the upper right quadrant which is competitive and integrated - the regulation of infrastructure has actually moved towards more jurisdictional and regional segregation in Canada.

The result is a tension between the two worlds, the world of commodity markets and the world of infrastructure, where it has become more complicated to bring new energy projects on stream.

Simplifying regulation...

A number of ideas have come forward for getting the regulatory arrow pointed in the direction of a more simplified process. I've listed some examples on this slide with the sole purpose of stimulating some thinking and discussion.

To date, the default course has been to ask regulators to get together to coordinate our processes. And we have responded. Concurrent processing of applications by various agencies has been a major achievement of cooperative efforts to date. I must emphasize however, that talking about coordination is one thing - delivering a silk purse is quite another. Regulators will tend to be governed by their jurisdiction as prescribed by the laws and regulations and often they have no mandate "to cooperate." Cooperation amongst regulatory authorities may not go far enough in some cases to reliably solving the problem industry has identified. Other approaches include: memoranda of agreement based on service standards; designation by government of lead authority; substitution for duplicative processes; delegation of authority to one regulator; and creation of unifying institutions.

Open for discussion is which level of simplification is desirable, whether it varies by project, and who has the responsibility to make it happen.

Smart regulation

This brings me to the fourth theme of my remarks which is "What is the Board doing to better enable resource development which is in the public interest?" I'll touch on a number of ways that we are improving predictability, efficiency, clarity and speed, all aspects of smart regulation.

In the big picture, smart regulation is about enabling innovation and instilling trust, confidence and credibility while still effectively protecting the public interest. It is intended to contribute to innovation and economic growth. At the Board, we believe that a smart regulation strategy must:

focus on goal-oriented regulation
provide clear and timely regulatory processes and decisions
reduce administrative burden on business or improve the efficiency of the Board's own processes, both of which are often referred to as 'streamlining'
reduce regulatory burdens through effective partnering with other agencies.

Let me touch on these in turn.

Goal-oriented regulation

The Board is focused on goal-oriented practices, a hybrid between entirely 'goal-based' or entirely 'prescriptive' approaches. This path towards goal-oriented regulations began with the Onshore Pipeline Regulations, 1999. By laying out the goals, companies were given flexibility to determine how best to meet those goals given their unique circumstances. Companies are encouraged to innovate and find new ways to achieve the goals. The Board's role is to ensure that companies have the appropriate management systems in place, including measurement systems, to meet the goals and that the company is following the practices outlined in the management systems.

Where companies have a good track record of meeting goals, based on audit and inspection data, (lets call them the high-performance companies) less time and effort needs to be spent on regulatory oversight. This is a risk management approach which allows the Board to focus its resources on circumstances where the goals are not being achieved.

A number of new regulations following the goal-oriented approach are coming. These include Damage Prevention Regulations, Diving Regulations and Offshore Pipeline Regulations.

Regulatory clarity

Regulatory clarity implies a no surprise environment. Applicants should understand what is required of them and why. Towards this end, the Board has just released its new Filing Manual to provide further clarity and understanding of the Board's expectations with respect to application requirements. Staff will be providing training to industry in May and June on the application process and use of the Filing Manual.

The Board has developed guidelines for meetings between companies and Board staff prior to filing an application to ensure the Board's expectations are well understood early in the process.

At the Board, we've been busy the past couple of years measuring cycle times for all of our business processes. Our goal is to establish service standards for most types of applications. The advantage to our stakeholders will be more transparent and timely regulatory processes.

Streamlining

Streamlining means making our processes and procedures more efficient and effective - for ourselves, for the companies we regulate, and for their stakeholders. Streamlining can take the form of removing unnecessary processes that no longer serve the public interest, for example by exempting small projects where there are no third party interests or engineering or environmental issues. It can also be done by adding new process tools where appropriate or by improving those we have. For example a template has been developed so that screenings under the CEAA are done more consistently and more transparently.

Appropriate Dispute Resolution was developed to provide flexibility to resolve some issues either within or outside a traditional regulatory process. Technical conferences and pre-hearing conferences are another important addition to our tool box.

We are continually seeking opportunities to streamline our processes and operate more effectively. For example, the Board is in the process of clarifying what activities require section 58 approval. The objective is to determine where best to focus our regulatory oversight. Industry input will be sought in the near future.

Partnering

The Board has many opportunities to work with other regulatory agencies to ensure that environmental assessment and regulatory issues are dealt with in a coordinated manner, thereby eliminating duplication while ensuring that projects are in the public interest. The agreements also allow us to share resources, thereby lowering the overall cost of regulation.

The NEB has over 20 such agreements, 5 of which I've selected for illustration in this slide. The last of these is brand new and you'll be hearing more about it later today!

Other regulatory roles

In the course of our work, regulators develop considerable expertise and knowledge of the industries we regulate. Consequently, we have an important role to play in informing markets. For example, at the end of March the Board released its report Natural Gas Prices in the Maritimes following a survey of wholesale natural gas prices carried out by the Board. In comparing domestic and export prices, the analysis found a very close linkage and consistency in pricing between domestic and export markets and it found that Canadian buyers have historically had access to gas at prices similar to export customers.

Other recent Energy Market Assessments released by the Board include an overview and assessment of the British Columbia Natural Gas Market and a report on ultimate gas potential; both reports were issued in April. We will soon be releasing a comprehensive review of the oil sands.

Perhaps due to higher energy price levels and greater uncertainty with respect to supply of natural gas, market participants are increasingly suggesting that it is time for a public debate about energy issues. There is a desire for a clear energy strategy. With its extensive involvement in energy markets, I believe that regulators also have a role to play in informing policy and participating in this discussion. I note that our colleagues at the Ontario Energy Board, under the leadership of Howard Wetston, have produced a number of reports recently aimed at informing markets and policy makers.

The regulatory challenge

In conclusion, regulators are charged with regulating in the public interest. To do that job effectively, we must maintain a high level of expertise and knowledge of matters related to the energy sector. I have described what I believe to be some major changes in the market and non-market influences which shape the regulatory environment. These include:

demand growing faster than supply has grown recently;
high and volatile energy prices; and
mounting landowner, environmental and aboriginal concerns.

The pace of change in the energy industry has accelerated, creating new challenges and issues and the need for different and creative regulatory responses. It is incumbent on regulators to pro-actively pursue desirable outcomes, e.g., adequate infrastructure. Identifying desirable outcomes would be easier with a comprehensive energy strategy in place.

We must always remain objective. We must 'protect' without sacrificing the 'enabling'. I could just as well have said, "we must enable without sacrificing the protection". The key is to get the balance right.

This means both enabling projects found to be in the public interest to proceed while protecting environmental, social and landowner interests. I believe that it is only by both protecting and enabling that we can properly serve the public interest.