Canada 2020 held its first-ever event in Vancouver on October 28, 2014, hosting Mayor Gregor Robertson (Vancouver), Mayor Naheed Nenshi (Calgary), Anne Golden (Evergreen Cityworks) and R.T. Rybak (Democratic National Committee) for a discussion about the future of cities.
Coming soon!
On October 6th, 2014, Former U.S. Secretary of State Hillary Rodham Clinton delivered keynote remarks and participated in a moderated Q&A session with CIBC President & CEO Victor Dodig in Ottawa at Canada 2020’s luncheon event.
Canada’s emergence as a global energy exporter is at hand. Long a continental supplier to the world’s erstwhile largest energy consumer (China passed the US in 2012), the Canadian oil and gas sector was secured by the principle of “Alberta makes and the US takes.” By the end of this decade, Canadian oil and liquefied natural gas (LNG) will begin to flow away from the increasingly saturated US market to offshore markets, primarily in the high growth Asia-Pacific region.
The how, when, and where of this assertion remains in questions. Options for export exist on all four coasts- Pacific (BC, Oregon), Atlantic (Quebec City and St John’s), US Gulf Coast (re-exports of Canadian imports), or even to the north via Alaska or Churchill/Hudson’s Bay. Each option has cost and risk and has been, and will continue to be, debated and evaluated.
But it will happen. Canada’s oil sands reserves are too valuable to leave in the ground and failure to find some route to market would be a failure of both public policy imagination and market forces of epic proportion. What underpins this view is a world in which strategic, worldscale oil development opportunities are in short supply, while petroleum demand continues to grow, albeit not at the torrid rates of 2002-2008.
Natural gas/LNG exports are perhaps a more tenuous scenario, but only in terms of timing, not likelihood. Even if the world energy industry determines BC’s LNG plays to be marginal at the present time, the double-digit pace of annual demand growth for natural gas in Asia means LNG in BC will move forward eventually.
Of course, for these scenarios to emerge, industry and government cannot just stand still and wait for things to happen. The familiar but intractable – so far- challenges of infrastructure/market access and social license to operate on First Nations and GHG emissions will need to be overcome. Canadian voters will have a chance to judge the effectiveness of the current government’s efforts on these fronts come Octobber 2015, while the opposition parties must demonstrate to a skeptical electorate and industry that they have better ideas and solutions.
As a non-partisan institute, Canada 2020 and the author offer these ideas to all interested parties with the express hope that we can play some small role in helping Canada realize its global potential as a competitive and responsible energy power, with all the benefits that would entail not just for Western Canada but for the country as a whole.
Meanwhile, capital markets and international oil companies around the world will be watching too. There is no where they would rather do business in than Canada- including many of their home countries- if we can finally overcome the obstacles of the last decade.
We also challenge government and industry to think ahead to the risks and opportunities that await once our hydrocarbons exports reach global markets. Will there be the expected windfall that appears to be there today- or will global markets evolve with new suppliers emerging and changing demand patterns that will diminish the prize? The world is not standing still while we figure out our own internal challenges. The export markets we covet are also being targeted by a wide array of competitors, many with geological and geopolitical advantages that we lack. While we bring many assets to the table as well, we must seek to understand and plan for the global energy landscape that is emerging. Part of this understanding must account for growing concern about climate change not just among environment activitists, but among governments, corporate executives, and institutional investors.
They are big. They are costly. They are unpopular (most places outside of Alberta, Bay Street, and Houston). But unless and until there is a massive transformation in oil-dependent global transportation systems, they are irreplaceable. The world needs 91 million barrels a day of oil to match demand. Even the most bearish forecasts predict 1% annual demand growth, or roughly another million barrels a day, per year, for the foreseeable future. If (a big if because demand could just as easily exceed, rather than miss, these forecasts) demand slows, we still likely need 105mmbpd by 2035. Moreover, the world’s existing oil fields have a natural production rate decline between 3 and 10% a year, depending on whose numbers you use and the type of production you are talking about. So the replacement rate to add the incremental 14mmbpd is likely double that, once declines are accounted for.
This is generally understood but the implications perhaps are not fully appreciated. If these numbers- which again are considered conservative by many of the world’s leading government and private sector forecasters- are right, then the denial of Keystone XL or Northern Gateway, the introduction of a $30/ton carbon tax, cost challenges in labor and materials markets, and hesitation about allowing open access to investment by state-owned enterprises won’t matter. The oil sands will be developed.
There are not enough other sources of accessible oil- low cost, medium cost, or high cost- to keep up with growth. [insert supply curve table]. High cost oil from Alberta (and a number of other places) will effectively set a price floor. Even if our efforts to build coastal pipelines fail, the resulting discount in the Alberta heavy oil price would likely be steep enough to incent US and Canadian refiners to build new refineries that are equipped to process our output. A new market would be created and barrels from Mexico and OPEC countries would go elsewhere.
The main argument against Keystone XL from leading environmental groups acknowledges much of this but states that the denial of the project would represent both a stop to “unbridled” development of oil and gas resources without concern for future climate change impact, and a start to a new era where public policy prioritizes the development of non-hydrocarbon resources. So far no government has accepted either proposition without at least without massive hedges, caveats, and conditions. There is too much risk politically in switching from the fossil fuel world of the near term to the post-hydrocarbon world of well, sometime, but the sometime always seems beyond the next election.
The most likely event to “kill” the oil sands and trigger a new era of non-hydrocarbon development would be peace breaking out in the Middle East- a losing bet since 1967. Conversely, a catastrophic geopolitical event in the Persian Gulf could have the same effect, in that it would spike prices in the short term but force major Western and Asian consumers to take action to begin to shift the transport sector from petroleum to other fuels, through onerous taxation and massive subsidy of alternative transport. A disruptive technology to displace the internal combustion engine could do the same and do to the auto/oil complex what the internet has done to Canada Post, record companies, and the print media.
These scenarios fit into the category of “possible” but not “probable.” Public policy and corporate strategy should emphasize the probable while not losing sight of the possible, from the perspective of risk management.
On the LNG side, Western Canada is watching its “baseload” export market disappear as the US absorbs more of its booming natural gas domestic production. Industry optimism is tethered to the spate of LNG projects along the BC coast, none of which are actually under construction or have received final approval from their developers. Asia’s robust gas demand growth (much more material than comparable numbers for oil) is a magnet for “stranded” gas resources in northeastern BC that are no longer needed in the US or Eastern Canadian markets. Yet that same “magnet” is a powerful signal to every other potential gas play in the world- all roads in the global gas market lead to Asia. BC is competing with the US, Russia, East Africa, Central Asia, and Australia to supply Asia with gas. Giant Persian Gulf producers like Qatar may opt to increase supply in response to demand, while dormant mega-reserve holders like Iran and Iraq also loom as medium to long term alternatives.
Canada can compete in global LNG markets but we are unlikely to be the supplier of choice due to high costs. Many of the same international oil companies developing LNG in BC have been burned by runaway supply and labor costs in Australia and see the same risks in BC. The August 2014 decision by Apache Energy to sell its stake in the Kitimat LNG project was driven by the desire of its shareholders to move away from “complex” projects, not just in politically-unstable emerging markets but in high cost plays. Like Australia (where Apache is also selling its interests), the Kitimat/Prince Rupert sites will be high cost for industry because they are remote, lack indigenous skilled labor, and have environmental sensitivities. Despite this, two or more BC LNG projects will likely be built- eventually. Developers will look to lower cost projects first (the US primarily but places like Papua New Guinea and Qatar as well) but will move on Canada once the expected demand emerges in Asia. Canada’s rule of law and proximity to northeast Asia will be attractive for investors.
The core challenge is whether the industry timetable matches the needs of the BC and Alberta governments. The BC government has promised a lot to the public on the fiscal windfall from LNG, promises that were premature and under-estimated the price sensitivity of these projects and the availability of alternative investment destinations.
Given the challenges above, what strategy makes sense for the oil sands and Canadian LNG going forward? Is there a role for public policy? The role of the federal government, in our view, is likely to become more important in the very near term- despite industry, provincial and government aversion to “national energy policy.”
This is a call for more action and less talk on two fronts. First, no one is quite sure what to do with First Nations opposition to West Coast pipeline projects. Many voters and investors are unsure exactly what the problem is.
The solution here is two-fold. First, clearly define what is required under the principle of “duty to consult” with First Nations groups along the pipeline corridors. The government should state what that process looks like- where it begins and where it ends. The government should also clearly state what sovereign rights it is prepared to assert once the newly-clarified duty to consult process is complete. This should not be left to the provinces, or worse, to industry, to have to explain. The Western provinces and industry are not neutral actors in this process despite best intentions and Ottawa must define and defend its standards. Ultimately such standards would be reviewed by Canadian courts but a clarification of intent by the legitimately-elected government in Ottawa would be helpful. Such a clarification, in the eyes of many oil patch industry leaders, should simply confirm that the granting of a public interest determination by the National Energy Board with follow-on approval by the federal cabinet does in fact constitute a “social license to operate.” While such a confirmation may seem unnecessary, it would put an end to the growing view that there is an additional, open-ended, multi-stakeholder process of negotiation that must follow any NEB determination before work can begin.
Once Ottawa has unambiguously and clearly stated its approach and timelines on First Nations consultation, the Prime Minister should then decide whether or not these projects are in the public interest, once conditions around economic benefit and environmental safety are in place. In the context of the Northern Gateway project decision confirmed by the federal cabinet earlier this year, it is quite evident that the NEB process was simply the beginning of the process but not the end, as once intended in the 1959 National Energy Board Act . Given this reality, the Prime Minister should then facilitate and lead a dialogue between industry, provinces, and First Nations to reach a commercial agreement with a fixed clock time period for negotiation.
The government can determine that the First Nations have an effective veto either through a de jure “high bar” definition of duty to consult, or through a stated unwillingness to enforce pipeline approvals through the sovereign authority of the government. While such a policy would be unpopular in the oil and gas industry, it would at least clarify what the actual protocol is for energy infrastructure development and force project developers to account for First Nations “buy-in” much more aggressively and earlier in the planning cycle.
The government can also determine that there should be no de facto veto by First Nations groups (or provincial/municipal governments) once the duty to consult has been completed and a public interest determination has been made. It would then also need to declare that it will back the public interest determination with the force of the law. Obviously, this would be the preferred position of industry, to know that the duty to consult standard is high and must be met, but once it has been the government will enforce its permitting decisions as it routinely does in the building of public works projects.
Fairly or not, the current perception in industry is that no one knows which of the above two positions are held by the government or either of the opposition parties. Certainly, it is risky for any of the three parties to take a strong stand in either direction. But it is worse to have ambiguity- it doesn’t serve the interest of the First Nations or of industry and has created little more than a regulatory logjam.
Many elements of the above also apply beyond the First Nations, whether in Burnaby where the local government opposes the TransMountain pipeline expansion, or in Eastern Ontario/Western Quebec border towns with respect to Enbridge’s 9B pipeline development. Ultimately, the national public interest must be reconciled with local opposition.
The same risk-taking approach should also apply to climate change policy. The current government has so far opted not to move ahead with GHG regulations for the upstream oil and gas sector, to build on the carbon penalty system introduced by Alberta in 2006. The resistance appears to be driven by two factors. The first is an apparent distaste in some quarters of the government, particularly in the caucus, for GHG policy stemming back to the devastating attacks on Stephane Dion’s “Green Shift” program in the 2008 election. In fairness, that has not prevented government from taking action on emissions from power generation or heavy-duty trucks, but nothing yet on upstream oil and gas.
The second and likely more material cause for the delay is a desire to align the Canadian regulations with the US system. This seems smart at first glance given the vast amount of cross-border trade of commodities and manufactured goods. Yet the US carbon policy debate will ultimately be about coal, while ours will ultimately be about the oil sands. The Obama administration’s regulatory approach to reducing GHG emissions in the coal-fired electric power generation sector is not an obvious model for the oil sands. The oil sands industry would prefer a more simple system that allows for flexibility in meeting GHG emissions reduction requirements, through a carbon tax.
We will never know if proactive action on say, a $25/ton carbon tax tied to a 25% reduction in GHG emissions would have pushed the Obama administration to approve Keystone XL, by giving further comfort that the Canadian government has a plan for the climate change effects of the oil sands. Claims that such action would have “guaranteed” the project’s approval are over-stated and under-estimate the impact of the Nebraska-level issues and the strategic political importance of inflows of donations from environmentally-motivated Democrats. The point is we will never know but we might have found out if we had taken the risk of leading on a policy, that may not have been politically popular across the board and might have received some pushback from industry. Such leadership would also help inoculate a host of actors, from European super-majors to California refiners, from political resistance from home governments that feel Canada has not done enough on climate change.
It is noteworthy that three Canadian provinces (BC, Alberta, Quebec) have a carbon tax. Yet inaction on the upstream oil and gas sector at the federal level undermines the larger climate change mitigation, given the rapid growth of GHG emissions expected as oil sands production doubles or even triples, as some forecasts predict, over the next 20 years. In this context, even a lower rate of GHG intensity will not prevent the overall growth of GHG emissions due to production growth. That is not to say that greater steam-oil ratios (meaning less natural gas burned to create steam for well injection) and other programs such as carbon capture and sequestration cannot be game changers over the medium term. But from today’s perspective and today’s technology, Canada’s GHG emissions will grow with the oil sands as the largest driver.Instead of meaningful policy action at the federal level to address the concerns, too often our industry and government leaders have tried to match scientific arguments from oil sands opponents with their own scientific studies and analyses. It used to be said that you can choose your arguments but not your facts. That is not necessarily true when oil sands opponents just need to create confusion and uncertainty about the environmental impact of the projects. Even studies from Obama’s own State Department showing Keystone XL would be climate neutral were muddied by other (less robust) studies arguing that developing the oil sands would cook the planet. Oil sands industry leaders have argued (not without merit) that the emissions of the oil sands are dwarfed by a handful of the largest coal power plants in the US. Our government officials and diplomats have pointed to improvements in energy efficiency and carbon intensity in the oil sands. It wasn’t enough. It didn’t work.
Canada needed, and needs, to do something bigger and meaningful, particularly now that the Obama administration has finally released its draft rule for GHG standards on coal-fired power plants. Outsiders don’t understand the primacy of the provinces on energy policy and want to see what Ottawa thinks, and is prepared to do. The carbon tax seems like the best available idea and has been supported across industry, although not by everyone in the oil patch to be sure. The risk is that Canada will move ahead of the US and upstream oil and gas plays in Texas and North Dakota will gain a cost advantage, although that advantage could be offset by a US carbon tax. Or the US could move on policies that do not synch up with the carbon tax approach north of the border, forcing industry to manage two systems instead of one. The reward is that unilateral action would put the ball back in the US court. Talk to industry and decide what price, baseline year, and reduction target we can live with- then go out and defend it against all critics.
Canada’s position as a high cost producer could, under certain scenarios, become a precarious one again in the future. This has happened most recently in 2009, in 1998-99, and in the mid-1980s. When oil demand slows and prices fall, the high cost or marginal producers are usually affected first. Projects are put on hold, rigs are idled, and the inflows of taxes and royalties to the Crown dries up.
How is this likely to play out in the next five years? No one has a crystal ball with respect to oil prices, but there are few “possible” scenarios that are worth considering as they would likely threaten Canada as a high cost oil supplier:
• US/Iran deal on sanctions- a breakthough on Iran’s nuclear program could lead to a gradual lifting of sanctions. Even acknowledging that new investment in Iran would take a decade or more to generate new oil, the simple effect of Iran returning to its pre-sanctions level of oil production in 2011 would be very bearish;
• US liberalization of crude export restrictions- the US will likely have a surplus of light sweet barrels beyond what its refineries can handle, if current rates of production continue. If the political decision to allow this surplus to be exported is made, it will push down the price of Brent oil;
• Reversal of resource nationalism- after watching US, Canadian, and European companies redirect capital to the North American shale gas, tight oil, and oil sands plays, governments like Mexico, Brazil, and even Russia are offering less rent-seeking and more competitive terms to maintain investment; if this trend continues and spreads to other resource-rich states it will trigger a surge in investment and corresponding supply.
The purpose of the paper is not to evaluate the likelihood of any of these, or similar scenarios. Rather, the goal is to point out that if Canada cannot lower its cost, we will always be the first one to lose our chair in the game when the music stops. The above scenarios are the triggers for such downside risks.
The good news is the free market works and the lowest cost producers in the oil sands are being rewarded by investors with more capital which in turn spurs more innovation. Other companies seek to replicate or exceed the success of the leaders and the cycle continues.
The data show that significant parts of the oil sands are becoming more cost competitive. SAGD production for the most efficient in-situ wells at Cenovus Energy is less than $50/barrel- a target for others in industry to pursue. Industry is also being much more cautious about capital allocation. Sequencing of projects by each major operator means less competition against themselves for labor and materials. This is a change from the growth at all costs period of 2003-2007 when the major players couldn’t break ground on projects quickly enough, only to face soaring cost inflation.
There are lessons here for the BC LNG projects. There is almost no possibility that BC will have more than two LNG projects under construction at the same time. This does not suggest collusion by developers but rather smart self-regulation, particularly for majors that can deploy capital across dozens if not hundreds of projects around the world.
While market discipline on cost is effective, government can encourage innovation in cost reductions through tax credits and public-private partnerships. Some notable partnerships through the Alberta universities are in place, but industry appears to have appetite for more. In many ways, the appetite is driven by the fact that today’s CEOs and oil sands leaders saw the benefits of research and development from AOSTRA under Peter Lougheed and understand what it can mean.
Some taxpayers might reasonably ask why the government should subsidize the same companies responsible for those maddening trips to the gas station where the price is already too high. Yet the answer is that it is in the taxpayer interest to give up a bit of the upside to protect the against the downside. Innovation and lowering costs will protect the golden goose and make us less vulnerable to the next downturn. Anyone who was around in 2009, 1998-99, or the mid-1980s knows how bad that can be.
At times it feels like knowledge in certain parts of the oil patch about China and India is limited to the fact that they need a hell of a lot of oil and gas. If these countries are to be our new customers, we should understand our competition, the nuances of local market conditions, and how these markets are likely to evolve in the future. These countries will eventually face limits to growth similar to the US, where gasoline consumption peaked in 2005. Moreover, the energy outlook in these countries must be understood in the context of their appetite for specific grades of crude, further shaped by the existing web of geopolitical and commercial relationships.
China’s refineries are built to process light and medium barrels, not the heavy sour acidic grades from the oil sands. India’s newest private refineries can process virtually any kind of barrel but the bulk of their refinery sector is decrepit and controlled by state-owned companies. Future refinery investments in these countries will emphasize flexibility to allow the maximum range of crudes to be utilized, portending intense competition among suppliers, especially when demand is weak in a number of large “legacy” markets. Governments in both countries are also deregulating prices for petroleum products like gasoline and diesel, with China well down this road already and India likely to do more under its new government. Higher prices could temper demand growth at the margin. New taxes and social policies to curb consumption of imported oil and gas should be watched closely, as should efforts to bolster domestic supplies like Indian coal or Chinese shale gas.
The emerging Asia market is prized by the Persian Gulf OPEC states who have watched their market share decline in North America while demand stagnates in traditional “sinks” like West Europe and Japan. West Africa, Russia, and Latin America are eyeing the same prize and have opening their upstream to Chinese national oil companies, embracing the state capitalist model China offers and the low cost financing it provides. China’s incumbent gas suppliers from Turkmenistan to Qatar will seek to protect market share, even if it means accepting lower prices.
Demand attracts supply. Incumbents compete to protect and preserve market share from new challengers. Oil and gas are no different than other goods in this respect. While oil is a commodity, suppliers can be creative not just on price but on using other carrots to differentiate and secure commercial contracts. For many suppliers, this is a “state to state” transaction, between governments and giant national oil companies. When CNPC sits down with Rosneft to do an East Siberia gas pipeline deal, Mr. Putin and Mr. Xi are front and center, not just to cut a ribbon but to ensure that deals get done in the interest of the state. This is not the right model for Canada but it’s important for us to understand who we are up against.
So what can Canada offer to compete? Plenty. Open up our markets. Share our expertise. Train their regulators. Look for opportunities to work together in 3rd party markets. Invest in joint R&D. Work together on sustainability and community development. Create a true partnership going beyond buyer and seller to shared strategic interest. Security of supply meets security of demand. In this context, Canada should be very cautious about restricting investment opportunities in our upstream oil and gas sector from our future customers. While all energy companies, whether private or state-owned, should operate according to Canadian market and regulatory principles, Canada will need capital from all corners to ensure we reach our potential as a global energy exporter.
The market access debate has focused on hydrocarbon exports. Yet there is a second and highly dynamic source of “energy” exports that is a national asset- our oil services companies. Here we are exporting not the raw commodity but the technology to develop increasingly complex oil and gas resources elsewhere, along with the know-how to make the technology work. Many companies that most Canadians (and most non-Albertan politicians in Ottawa) have never heard of are best-in-class providers of a broad array of oil services technologies that are in demand in every oil and gas province around the world. Without these technologies, overwhelmingly dominated by US and Canadian firms, there is no shale gas or tight oil revolution.
These fiercely entrepreneurial and independent companies are not looking for a helping hand from Ottawa although they too will benefit from the market access initiatives that will help their Canadian customers in the upstream move oil and gas to higher priced offshore markets. If anything, these companies have a story to tell Ottawa about success in the high growth emerging markets and how to navigate the dynamics of state capitalism and dealing with giant national oil companies. They do it all the time.
The best thing Ottawa can do to support this dynamic sector is to help ensure a continuing stream of engineering talent and skilled labor to sustain growth. In addition, a unified and coherent message about best regulatory and in “in the field” practices for safe hydraulic fracturing operations will support development of services opportunities in overseas markets. In many of these markets, public mistrust of fracking is high even when central governments are supportive. Yet it will be hard for Ottawa and the industry to convince skeptical landowners in shale-rich Eastern Europe or Colombia to drill when we can’t even convince our fellow Canadians in Quebec and New Brunswick.
Canada is at an inflection point in its path to being a major oil and gas supplier to an energy-hungry world. New Alberta Premier Jim Prentice will try to overcome the political, economic, and social barriers to linking Alberta’s energy abundance to global markets. BC Premier Christy Clark hopes that by the end of 2014, at least one of the dozen or so LNG projects under consideration in her province will move to a “yes.” Many oil and gas executives in Alberta have a fatalistic view, hoping that “just one” LNG or oil sands pipeline moving forward would be a positive signal that we, as a country, still know how to get difficult projects done. To get there, it is the author’s view that greater leadership from Ottawa will be required. Most importantly, this leadership must define core principles on energy infrastructure development and climate change policy, and then move swiftly to implement and defend such principles. Waiting for the courts, industry, or Washington to move first is no longer good enough.
At the same time, we must look beyond our North American market to see what our competitors are doing and how demand-side dynamics in Asian markets are evolving. The world is not standing still while Canada debates its own path to getting our oil and gas to tidewater. Canadian oil sands and LNG projects are part of a global competition for capital and we must understand that failure to smooth the path for growth and development will lead to capital flowing elsewhere. While our political stability and huge resource base are major advantages, we have lost ground by failing to manage social and environmental issues effectively. These issues can be viewed either as a moral imperative or as a critical commercial challenge, but either way few would dispute they are the biggest factor standing between the Canadian oil and gas sector and its aspirations.
Infrastructure is central to every aspect of life in Canada. As a key driver of productivity and growth in a modern economy, as a contributor to the health and well-being of Canadian citizens, as a critical component of transporting goods and services across the country. It is a method for enabling communication and sharing of information between citizens, a means for providing core services such as water, electricity and energy and is a shaper of our how our communities grow and contribute to our collective social fabric.
And, yet, across the country, Canadians are impacted by infrastructure that has failed to be maintained or that remains to be built. This is apparent in the deterioration of our roads and highways, the over-capacity of our public transit systems, underinvestment in affordable housing and social infrastructure, and the increased prevalence of environmental incidents, such as flooding in our urban areas. Canada’s infrastructure, along with the institutional frameworks that fund and finance these assets, are in need of repair.
This paper attempts to set out the need for urgent federal attention to this issue. It will discuss some tools and levers the federal government has at its disposal to engage in what is a national issue, including proposing the creation of a national infrastructure strategy for the country.
This paper will start by reviewing the economic benefits of public infrastructure and highlight how current market conditions create a historic opportunity for increasing infrastructure investment. It will then review current estimates of the size of Canada’s infrastructure deficit, followed by an examination of how the federal government’s role in financing infrastructure has changed over the last 50 years. Finally, it will end by proposing an increased federal role in infrastructure planning and postulate what could be included in a National Infrastructure Plan.
As many have commented before this paper, it should no longer be a question of if we need to devote more resources to public infrastructure or if the federal government should be involved. The question for the Canada at this moment is how the federal government should engage and in what form and capacity.
In recent years, an increasing number of papers have been issued drawing attention to Canada’s infrastructure needs. A select few include:
• Rebuilding Canada: A New Framework for Renewing Canada’s Infrastructure, Mowat Centre, 2014
• The Foundations of a Competitive Canada: The Need for Strategic Infrastructure Investment, Canadian Chamber of Commerce, 2013
• Canada’s Infrastructure Gap: Where It Came From and Why It Will Cost So Much To Close, Canadian Centre for Policy Alternatives, 2013
• At The Intersection: The Case for Sustained and Strategic Public Infrastructure Investment, Canada West Foundation, 2013
• Canadian Infrastructure Report Card, Federation of Canadian Municipalities, 2012
The economic case for investing in infrastructure has never been stronger. In recent years – and particularly in the aftermath of the financial crisis – a consensus regarding the positive economic benefits of stronger infrastructure spending has emerged among economists and policymakers. In addition to the non-economic benefits of infrastructure, a dollar of infrastructure spending has a positive effect on economic conditions in two ways: in the short-term, by supporting jobs and businesses, leading to lower levels of unemployment and higher levels of economic growth; and, in the long-term, by boosting the competitiveness of private businesses, thereby leading to greater wealth creation and higher living standards.
Within Canada, a recent Conference Board of Canada report undertook a detailed examination of the impacts of infrastructure spending on job creation and found that for every $1.0 billion in infrastructure spending, 16,700 jobs were supported for one year1. Moreover, these jobs are not just concentrated in the construction sector, as manufacturing industries, business services, transportation and financial sector employment also benefit from the spillover effect of infrastructure spending.
Increased investment in infrastructure will not only have direct impacts on the economy but will also spread through the economic through a series of multiplier effects 2.
Examining the impact of infrastructure spending on GDP growth has found similar results. The same Conference Board report estimated that for every $1.0 billion in spending, GDP would be boosted by $1.14 billion, resulting in a multiplier effect of 1.143. Other studies have shown similar effects, with estimated multipliers ranging from 1.14 to a high of 1.78, including Finance Canada’s “Seventh Report to Canadians” estimating a multiplier of 1.64.
Critical to this analysis is that virtually all recent estimates estimate the multiplier to be greater than 1.0, implying that every dollar of spending on public infrastructure boosts GDP by more than one dollar. Thus, infrastructure spending generates a positive economic return before projects are even completed, as the construction stage alone generates enough economic activity to justify the expense.
However, the most important economic benefit of public infrastructure is the long-term effect it has on productivity and business competitiveness, which are critical components of a modern, growing economy.
In this case, investments in public infrastructure, such as roads and transportation systems, communication infrastructure, utilities, water and wastewater systems, and health and social infrastructure, result in lowered business costs and increased labour productivity.
Lower business costs result in increased private sector returns, allowing for higher rates of private investment and ensuring Canadian companies can remain competitive and grow on a global stage. Similarly, increased labour productivity results in higher wages and greater wealth creation for Canadian citizens. (See Cost of Inadequate Public Infrastructure for a discussion of the impacts of failing to properly invest in public infrastructure.)
The Conference Board has estimated that roughly a quarter of all productivity growth in recent years is a result of public infrastructure investment5. Similarly, looking over a longer period of time, Statistics Canada estimated that up to half of all productivity growth between 1962 and 2006 can be attributed to investment in public infrastructure6.
Finally, increased economic activity and higher productivity rates allow the government to recoup a portion of its initial investment through higher tax revenues. Although estimates vary, the Conference Board study estimated that governments recover between 30% – 35% of every dollar spent on public infrastructure through higher personal, corporate and indirect taxes7.
Investment in public infrastructure has an immediate, short-term benefit to the economy, while also ensuring that businesses remain competitive in the long run. The alternative is to postpone investment, allowing existing infrastructure to decay and demand for new infrastructure to accumulate, ultimately restricting Canada’s potential for future economic growth.
“The literature shows that inadequate public infrastructure is a threat to long-term economic growth. Inadequate public infrastructure lowers economic potential in a direct and obvious way according to this simple progression:
• Inadequate infrastructure results in increased costs for business.
• Increased costs result in lower return on private investment
• Lower returns—profits—mean less money for business to re-invest in new plants, machinery and technology.
• Less investment means fewer jobs and less productive labour.
• Lower productivity means less economic output and lower personal incomes.
The end result is a loss of competitiveness and lower rates of economic growth.”
At The Intersection: The Case for Sustained and Strategic Public Infrastructure Investment, Canada West Foundation (2013)
While the general case for investing in public infrastructure is clear, current economic conditions create an even more compelling rationale for investing in infrastructure – right now. Canada is at a unique moment in time where the need for a stimulative macroeconomic policy, historically low long-term interest rates and a large infrastructure deficit, together, combine to dictate the need to accelerate the rate of investment in public infrastructure.
While Canada has fared relatively well compared to its peers, economic recovery from the recent global financial crisis has nonetheless been slow, with employment and GDP growth rates lagging pre-recession levels8. Within this context, an increased focus on reducing fiscal deficits has resulted in a slowing of public spending just when economic conditions could most benefit from increased investment and infrastructure spending.
In a recent paper, David Dodge, former Governor of the Bank of Canada, called on governments to shift emphasis away from short-term deficit reduction to instead “expand their investment in infrastructure while restraining growth in their operating expenditures so as to gradually reduce their public debt-to-GDP ratio.”9 Dodge cites Canada’s lagging productivity growth as a justification for additional infrastructure spending, as increased investment would “enhance multifactor productivity growth and cost competitiveness in the business sector and open up new markets for Canadian exports.”10
In addition, faced with sluggish employment and weak economic growth, and with further monetary stimulus limited by near-zero interest rates11, economists are returning to the idea that targeted fiscal stimulus should be a component of government economic policy. As former United States Treasury Secretary Larry Summers writes:
In an economy with a depressed labor market and monetary policy constrained by the zero bound, there is strong case for a fiscal expansion to boost aggregate demand. The benefits from such a policy greatly exceed traditional estimates of fiscal multipliers, both because increases in demand raise expected inflation, which reduces real interest rates, and because pushing the economy toward full employment will have positive effects on the labor force and productivity that last for a long time12.
According to this recent line of research, traditional benefits of public infrastructure investment are even greater during periods of economic slowdown, as more traditional means of spurring the economy are much less effective. A 2010 paper by Berkeley economists Alan Auerbach and Yuriy Gorodnichenko estimated that the multiplier on government investment is significantly higher (as much as 3.42) in times of recession13. This finding was further supported by a 2012 paper by two economists from the Federal Reserve Bank of San Francisco, Sylvain Leduc and Daniel Wilson, which focused specifically on public infrastructure spending and found that the multiplier on public infrastructure investment had a lower bound of 3.0 14.
Source: OECD
Finally, historically low long-term interest rates have created market conditions that are ideal for increased infrastructure spending. As can be seen in the above chart, long-term interest rates (that is, government bonds with terms greater than 10 years) have been hovering at levels lower than any point over the past 40 years. Given the long horizon associated with infrastructure assets, long-term, fixed-rate debt financing is an ideal instrument for providing the necessary capital required to increase investment levels. Lower debt-servicing costs effectively reduce the cost of infrastructure investments, while fixed-rate financing insulates projects (and governments) from future increases in interest rates.
These macroeconomic conditions – low interest rates, a sluggish economy, and a looming infrastructure deficit – create a unique window of opportunity for the federal government. Focusing on public infrastructure investment can be a key tool for enhancing economic growth, resulting in increased productivity and employment, and improving the quality of life for Canadians.
Many recent studies have attempted to quantify the current size of Canada’s infrastructure needs. Determining a single number can be problematic, as various studies have focused on specific sectoral needs and have approached the challenge using different methodologies, sometimes resulting in overlap. Thus, instead of trying to determine one figure that represents the size of Canada’s infrastructure deficit, we will briefly review a number of areas that require urgent attention from Canada’s policymakers.
Since the turn of the century there has been growing interest in urban issues and the role that cities play in securing Canada’s economic competitiveness and high quality of life. Today, municipal infrastructure in Canada has reached a breaking point.
The majority of municipal investment was made when there was little understanding of the role that infrastructure plays in maintaining and strengthening social bonds, public health and the integrity of our natural environment. In many cases, these decisions have locked residents and communities into ways of life that are now perceived as unsustainable. This challenge is magnified by the lack of fiscal levers available to Canadian municipalities as they plan for the future.
Faced with the dual problems of declining investment and aging infrastructure, the Federation of Canadian Municipalities has estimated that Canada’s municipal infrastructure deficit is $123 billion and growing by $2 billion annually15. This estimate is comprised of four categories, including:
Moreover, this methodology likely underestimates the size of the municipal infrastructure deficit, as it fails to incorporate other types of infrastructure that are pillars of modern cities and communities. For example, affordable housing and safe shelter, low-carbon energy systems and reliable information and communication technologies help mold municipalities into livable, resilient and economically competitive places.
Efficient road networks and transportation systems are critical for the functioning of a modern economy. Reducing gridlock ensures that goods can be easily transported across the country, reducing business costs and enhancing trade. Effective public transit and uncongested road networks allow for faster commute times, reducing worker stress and increasing labour productivity.
Within this context, the need for investment has been highlighted by a number of studies:
• The McKinsey Global Institute has estimated that Canada must invest $66 billion into maintaining and repairing urban roads and bridges between 2013 and 2023.16
• Transit systems across the country require $4.2 billion annually for repair and replacement of existing assets. This estimate excludes meeting unmet or future demand.17
• The Canadian Chamber of Commerce has estimated that congestion is costing the country, as a whole, $15 billion per year, which is equivalent to almost one per cent of Canada’s GDP.18
• It is estimated that upgrading Canada’s electricity infrastructure between 2010 and 2030 will cost over $300 billion, requiring an annual investment higher than any level of investment in any previous decade.19
Extreme weather is becoming increasingly more prevalent throughout Canada. The recent spike in natural disasters has resulted in unprecedented social and economic consequences for residents, businesses and governments across Canada. Prior to 1996, only three natural disasters exceeded $500 million in damages (adjusted to 2010 dollars). However, beginning in 1996, Canada has averaged one $500 million or larger, disaster almost every single year.20 And, according to the Insurance Bureau of Canada, for the first time water damage passed fire damage in terms of the amount of insurance claims across the country last year.21
Property damage created by small weather events has also become more frequent. Canada’s sewage systems are often incapable of handling larger volumes of precipitation.22 This is particularly a problem for older cities in central and eastern Canada where there is great need to rehabilitate water and sewage systems to mitigate the chance of flooding. By 2020, it is estimated that almost 60 per cent of Montreal’s water distribution pipes will have reached the end of their service life.23 This is particularly concerning given that the International Panel on Climate Change determines that extreme weather, such as heavy precipitation, will become more frequent over the next 50 years.
The need to prepare for the new reality of extreme weather and climate change becomes clear when the economic consequences are exposed. The average economic cost of a natural disaster is $130 billion and lowers GDP by approximately 2 per cent.24 This is attributable to the rising occurrence of severe weather affecting urban areas that have high-density populations and high-value assets. In the aftermath of a disaster, lost tax revenue and demands for relief and reconstruction place enormous fiscal strain on governments. On average, it is estimated that natural disasters increase public budget deficits by 25 per cent.25
Finally, a number of global estimates of Canada’s infrastructure deficit – across all sectors and sub-national jurisdictions – do exist. A 2013 study by the Canadian Chamber of Commerce estimated that the breadth of investment needed to address Canada’s infrastructure deficit could be as high as $570 billion.26
Additionally, a recent study by the Canada West Foundation estimated the accumulated infrastructure debt at $123 billion for existing infrastructure, with an additional $110 billion required for new infrastructure.27 Finally, in a sobering report, the Association of Consulting Engineers of Canada estimates that 50 per cent of public infrastructure will reach the end of its service life by 2027.28
Moreover, estimates of the effect of chronic underinvestment in infrastructure have shown that the infrastructure deficit is hindering our national competitiveness. Between the mid-1990s and 2006, infrastructure investment within Canada declined, while the United States increased spending by 24 per cent. During the same period, Canada went from near parity with the productivity of the United States to 20 per cent lower.29
It is clear that, regardless of the exact size of Canada’s infrastructure needs, the various estimates show that the problem is significant in scale and that drastically increased levels of public investment are warranted.
Over the past 50 years, there has been a significant shift in the ownership and funding of public infrastructure between the three levels of government. In 1955, the federal government owned 44 per cent of public infrastructure, the provinces owned 34 per cent and local governments owned 22 per cent.30 Today, provincial, territorial and municipal governments own and maintain roughly 95 per cent of Canada’s public infrastructure.31
(Canadian Center for Policy Alternatives, 2013)
Municipalities own 52 percent of public infrastructure, but collect just eight cents of every tax dollar.32 In our existing taxation structure, the federal and provincial government collect more than 90 per cent of all taxes paid by Canadians.33 Senior levels of governments benefit from sales, income and corporate taxes, which are responsive to economic growth. Local governments are increasingly dependent on property taxes, a regressive funding tool that is the least responsive to growth and impacts middle-and-low-income people the hardest.34 While transfer payments from the federal government to the provincial government increased throughout the 2000s, a corresponding increase in transfer payments from the provincial government to local governments has failed to materialize.35 The shift in responsibilities without corresponding capacity to respond has created a structural imbalance between local authorities and federal and provincial governments.
(Centre for Policy Alternatives, 2013)
Recognizing that a new approach to federal funding for provincial, territorial and municipal infrastructure was needed, the Government of Canada began to re-enter the municipal infrastructure conversation in the early 2000’s. This renewed interest led to the creation of the Department of Infrastructure and a series of shared-cost infrastructure programs.
And governments of all political stripes have recognized the importance of infrastructure and have continue to invest. The 2007 Building Canada Plan for example, divided funding between transfer payments and projects that were deemed of national significance. Municipalities would receive $17.6 billion in predictable revenue over the course of seven years derived from the federal gas tax and GST rebate. At the same time, the federal government would invest $13.2 billion in national priority projects.
While we should be encouraged by the interest the past few federal governments have taken in financing infrastructure across the country, according to the OECD our federal government continues to play a relatively small role in funding infrastructure.36 The provincial, territorial and local governments in Canada play a larger role relative to the federal government in public infrastructure funding than is the case in comparative countries like Germany, Australia, the United States and other similar OECD countries.37
The renewed interest in the role and importance of infrastructure saw public investment in Canadian infrastructure reach just over 3 per cent of GDP in 2008.38 This investment barely surpasses the annual investment of 2.9 per cent of national GDP that is required just to maintain the current infrastructure stock.39 By way of comparison, the world average expenditure on public infrastructure is 3.8 of GDP per year.40 To promote prosperity and improved productivity throughout Canada, experts have postulated that a total annual investment of 5.1 per cent of GDP is required.41
While our federal government has shown great progress over the past number of years re-engaging in the infrastructure challenge, clearly there is more work to be done. The next sections lays out the case for a National Infrastructure Plan and its potential components.
Given the national importance of public infrastructure and its critical effect on economic competitiveness and quality of life, it is clear that the federal government needs to assume a leadership role with respect to the coordination and financing of infrastructure within Canada.
In particular, a larger federal role is necessary, and a rebalancing of financing responsibilities is required, for the following reasons:
• Better Alignment of Funding Responsibilities with Fiscal Capacity: As the previous section makes clear, while the federal government’s fiscal capacity is roughly equal to that of all the provinces and territories combined, it contributes only 12% of annual infrastructure expenditures. Municipalities are even worse off, shouldering almost 50% of infrastructure costs, while having the smallest fiscal capacity of all three levels of government.42 To correct this imbalance, the federal government should target a higher level of investment, by both increasing net infrastructure investment levels as well as assuming some of the burden for financing projects that is currently the responsibility of municipalities.
• Aligning Infrastructure Spending with National Macroeconomic Policy: As argued above, fiscal stimulus and, in particular, investment in public infrastructure is an increasingly important tool of macroeconomic policy for national economies. Within Canada, only the federal government has the ability and the responsibility to set economic policy at a national level. As such, to coordinate public infrastructure spending with other macroeconomic tools such as fiscal and monetary policy, the federal government needs to take a stronger role as a coordinator and funder of public infrastructure.
• Increased Investment in Federally-Owned Infrastructure: Certain areas of public infrastructure, such as ports and border crossings, airports, military infrastructure, and national rail and transportation infrastructure, are the sole responsibility of the federal government. Thus, with provinces and municipalities already strained by existing infrastructure demands, only an increase in federal funding will result in higher levels of infrastructure investment in these areas.
• Champion Nationally-Significant Projects: While many areas of infrastructure investment technically fall within areas of provincial jurisdiction, it is nonetheless incumbent upon the federal government to champion – and fund – projects of national significance. Projects such as urban transit and transportation systems, high-speed rail, climate change adaptation, affordable housing and social infrastructure, electricity transmission, and communication systems and rural broadband all touch on national economic priorities, as well as impact the quality of life of all Canadians. While respecting provincial jurisdiction, the federal government should accelerate its rate of investment within these areas.
While recent federal government initiatives such as the 2014 extension of the Building Canada Plan represent a positive step for greater federal involvement in public infrastructure, much more needs to be done to address Canada’s infrastructure deficit.
It is evident that one piece that is missing from the federal landscape is a comprehensive National Infrastructure Plan that could coordinate Canada’s planning and investment decisions with respect to public infrastructure. While a complete, comprehensive plan is beyond the scope of this paper, it is nonetheless instructive to review possible components of what could be included in a National Infrastructure Plan for Canada.
In 2010, the UK government introduced its first National Infrastructure Plan.
“…the Government is setting out, for the first time, a broad vision of the infrastructure investment required to underpin the UK’s growth.”
“The role of the Government in this work is clear. It is to specify what infrastructure we need, identify the key barriers to achieving investment and mobilise the resources, both public and private, to make it happen.”43
By 2013, the UK’s NIP, updated annually, included a pipeline of projects valued over £375 billion, status reports on projects valued over £50 million, detailed funding tools and mechanisms, and a comprehensive framework for evaluating and prioritizing infrastructure investment across the country.44
The need for a National Infrastructure Plan is clear. Countries that exhibit best practices for infrastructure investment have decision-making frameworks driven by a strong central government committed to innovation and economic development. Within these frameworks, projects move forward based on 50 to 100 year forecasting and planning, establishing a platform for innovation, resiliency and prosperity.45
For example, in the Netherlands, the Dutch government has been actively involved in setting strategic infrastructure plans since the 1960’s, particularly with respect to projects of national interest. A recent World Economic Forum report on global competitiveness ranked the Netherlands 1st for quality of port infrastructure and electricity supply and ranks Netherlands 5th overall out of 144 countries in global competitiveness.46
Moreover, national governments are helping cities execute visionary plans that are embedded in infrastructure as a means to enhance global competitiveness. These countries recognize that providing integrated, efficient infrastructure is essential to offering a high quality of life and business environment that prospective investors and residents find attractive and find the means to finance it.47
To help shape this concept, the authors propose that a National Infrastructure Plan could, at minimum, include the following components:
• A comprehensive, multi-year plan that would prioritize infrastructure projects across a number of areas of national significance. This plan would include a pipeline of projects, prioritized by status such as completed, under construction, funded and awaiting approval. Under this structure, the plan would be updated at least once a year to reflect movement in the project pipeline and changes in strategy or emphasis.
• Transparent disclosure of infrastructure planning and project prioritization. Building on the last point, any infrastructure plan would need to transparently describe the infrastructure planning and prioritization process, including publishing decision-making criteria and detailing the status of projects under consideration for funding.
• Dedicated annual targets for infrastructure investment. For example, targeting a certain percentage of GDP each year would ensure that the infrastructure deficit is slowly reduced, while demands for new infrastructure are met. The plan could include flexibility to accelerate planned infrastructure investment in times of economic slowdown or recession.
• A decoupling of infrastructure investment decisions from annual operating budgets. The long-term benefits of public infrastructure investment require a decoupling from the short-term incentives associated with deficit reduction. Although infrastructure spending obviously cannot be undertaken in complete isolation of the government’s fiscal situation and would need to be publicly reported in a transparent manner, it should nonetheless but somewhat insulated from the volatility of annual fiscal budgeting.
• A detailed inventory of infrastructure needs, including maintenance and new build requirements. The federal government should play a coordinating role in collecting and assessing infrastructure needs across Canada. This inventory should then be used by policymakers to prioritize future infrastructure funding levels and project investment decisions.
• Clear, transparent rules for infrastructure funding programs. For programs that involve partnering with provinces or municipalities, application rules should be transparent and predictable. Program funding levels should not be capped, but rather provided with annual allocations, thus ensuring that projects that are unsuccessful in one year can be prioritized in a following year.
• Accounting and budgeting provisions that recognize the multi-year nature of infrastructure investment, including a separate Capital Budget. Again, as infrastructure planning operates on time horizons well beyond annual budgeting cycles, accounting rules and budget planning for infrastructure should be updated to reflect this reality. This should include separately accounting for capital spending within the government’s fiscal budgeting process and ensuring that all infrastructure investments, including projects that are partnerships with provinces or municipalities, are appropriately capitalized over the life of the asset.
• Financial tools for municipalities and public sector entities who cannot efficiently access capital markets. Building on the success of P3 Canada, the federal government should create centres of excellence in financing, access to capital, project planning and infrastructure budgeting that smaller public sector entities can utilize. This centralization of expertise will result in the promotion of best practices across Canada and allow for smaller players to benefit from the economies of scale associated with a pan-Canadian infrastructure plan.
• Dedicated funding mechanisms to address the misalignment of infrastructure responsibilities with fiscal capacity. This could include, among other mechanisms, transferring fiscal capacity from the federal government to municipalities, as the greatest imbalance exists between these two levels of government.
Finally, this list is not an attempt to comprehensively describe what may be included in a National Infrastructure Plan, but rather an attempt to start a dialogue on the subject. The authors invite policymakers and thought leaders to build upon this outline to develop a comprehensive vision for what should be included in a National Infrastructure Plan for Canada.
Modern public infrastructure is a crucial component of national prosperity and high living standards. But decades of neglect and underinvestment have left Canada on the precipice of a national crisis in terms of our collective infrastructure needs.
Numerous studies and analyses have shown that Canada faces a substantial infrastructure deficit, both in terms of maintaining our existing assets, as well as servicing unmet demand for new infrastructure. This deficit extends across almost all areas of public infrastructure, including transportation and transit, water and wastewater, social and cultural institutions, affordable housing, electricity transmission, environmental and climate change adaptation and many more. The long decline of federal involvement in infrastructure spending has exacerbated the problem, as the vast majority of infrastructure inventory is in the hands of Canada’s municipalities and provinces, creating a misalignment between funding responsibility and fiscal capacity within the country.
This challenge, while dire, also represents a key opportunity for Canada’s federal government. The economic benefits of investing in public infrastructure are numerous and substantial, with additional investment providing badly-needed stimulative effects in the short-term and contributing to higher productivity and a more competitive economy in the long run. Moreover, current market conditions, including historically low long-term interest rates, create a window of opportunity for decisive action by an active and committed federal government.
It is time for the federal government to play a more active role in the planning and funding of public infrastructure within Canada. A critical starting point would be the creation of a National Infrastructure Plan, following the example of other countries such as the U.K. A national strategy, while respecting provincial and municipal jurisdiction, would coordinate infrastructure efforts across Canada, take advantage of the federal government’s greater fiscal capacity, create clear, transparent rules for infrastructure programs, enhance transparency of infrastructure planning and prioritization and share best practices across Canada. Only the federal government has the ability, authority and fiscal capacity to play this role within Canada.
The state of Canada’s infrastructure represents both a crisis and opportunity for our country. Only by taking decisive action now, can the federal government ensure we collectively seize the latter and avoid the former.
John Brodhead is a former advisor to the Honourable John Godfrey, Minister for Infrastructure and Communities, and a former Deputy Chief of Staff for Policy for Ontario Premier Dalton McGuinty. He was Vice-President of Metrolinx and is now the Executive Director of Evergreen CityWorks, an initiative designed to build better urban infrastructure in Canada. John has a Masters Degree in Political Science from the University of British Columbia.
Jesse Darling is an Urban Project Designer for Evergreen CityWorks. She has previously conducted research and policy analysis for the Martin Prosperity Institute and Harvard Graduate School of Design in urban affairs and municipal governance. She has a Masters degree in Urban Planning from the University of College London.
Sean Mullin is an economist, policy advisor and consultant, and has previously worked in senior roles at the Province of Ontario and in the asset management industry. Sean has a Masters degree in Economics from McGill and an M.B.A. from the University of Oxford.
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