The Parliamentary Budget Officer (PBO), Yves Giroux, produced a report this week on the estimated value of the Trans Mountain Pipeline (TMP) and the Trans Mountain Pipeline Expansion Project (TMEP). This report has a lot of people up in arms because it indicates that the Government of Canada “negotiated a purchase price at the higher end of PBO’s valuation range“. The problem with this conclusion is that the PBO specifically notes that it omitted some pretty important considerations in calculating its numbers. In this blog post I want to go into detail about why I believe the PBO report severely undervalued the TMEP and that the government may well ultimately win out big on this project.

Let’s start with the easy part, what the PBO appears to have done right. The PBO used two types of analyses to assess the value of the purchase:

• Discounted cash flow (DCF) analysis: Assessing the value of the TMP and TMEP based on the present value of future cash flows it is expected to generate.
• Comparables analysis: Assessing the value of the TMP based on key valuation metrics of similar companies in the same industry

These analyses come up with a lower and upper bounds for the purchase. As the report notes:

The Parliamentary Budget Officer (PBO) estimates that the TMP and TMEP have a value of between $3.6 billion and $4.6 billion. As such, the Government negotiated a purchase price at the higher end of PBO’s valuation range. PBO’s financial valuation assumes that the pipeline is built on time and on budget.

Now for the part the PBO missed. Let’s start by making it clear, the PBO is completely forthright about what it did. My concern is that because only a tiny percentage of the people who discuss this report will actually read it; the result will be a false narrative becoming the dominant one. As I note, the PBO admits its approach is flawed right from the outset. It literally says so in the Executive Summary:

However, PBO’s valuation does not include related assets that were bought as part of the acquisition, including multiple pipeline terminals and the Puget Sound Pipeline. Therefore, PBO’s valuation would be understated relative to the total value of all the assets bought as part of the purchase.

So what does the PBO not think is worthy of consideration? Just a second pipeline and a massive amount of incredibly valuable real estate. You see the Government of Canada didn’t just get a single pipeline for their $4.4 billion, they got two pipelines, four terminals and a lot of ancillary lands. As described in the NEB submission:

The Edmonton, Burnaby and Sumas terminals are located on lands owned by Trans Mountain. All three terminals are zoned as industrial sites. Details for the terminal sites are:

• Edmonton Terminal – about 49.1 ha (121.4 acres)
• Burnaby Terminal – about 76.3 ha (188.6 acres)
• Sumas Terminal and pump station – about 80 ha (197.7 acres)
• The Westridge Marine Terminal is located on about 6.2 ha (15.4 acres) of land owned by Trans Mountain, with the exception of a small portion of land, located between the railway and the shoreline, which is leased from Canadian Pacific
• Trans Mountain also owns sufficient lands for most of the pump stations required for the project.

As I wrote on Twitter, this is where it becomes clear that the PBO is situated in Ottawa and its civil servants appear to have no clue about property values in Western Canada.

Let’s consider the Burnaby Terminal. It is located on Burnaby Mountain just down the hill from SFU. It is proximate to all sorts of transit and represents some of the most valuable land in the Lower Mainland. A much smaller, 19 acres, block of industrial land nearby (called the Saputo property) sold recently for $209 million. They got $209 million for a lot one tenth the size of the Burnaby Terminal. Sure if the Burnaby Terminal were to close there would be clean-up costs, but looking at land value alone that property could be worth as much as $2 billion. So why does the PBO say that the terminals shouldn’t be counted as assets? Apparently because their value is “inextricably linked” to the Trans Mountain. Pardon me, but real estate prices in Burnaby are not “inextricably linked to the pipeline” they are set by the market and the market would salivate over that hunk of land.

As I hope to discuss in a later blog post, I can envisage a scenario where the TMEP fails and the current TMP continues to operate as a light oil/refined fuel pipeline that essentially terminates at an expanded Sumas facility in Abbotsford. Under this scenario virtually all the TMP crude flow would then be redirected to the Puget Sound via the Puget Sound Pipeline. To replace Line 2 (the heavy crude line in the TMEP), Alberta would ship bitumen to the coast on rails using CanaPux™ to be loaded at a re-purposed coal export facility at Roberts Bank.

This alternative approach would massively increase rail transport through our communities; increase tanker traffic in the Salish Sea (absent the protections of the TMEP) and increase the greenhouse gas emissions of the resulting crude. But it would rely on existing infrastructure and would therefore bypass the need for further assessments. By going this route it would allow a savvy owner to sell off the Burnaby Tank farm and Westridge Marine terminal for their real estate value.

But back to this post. As I infer in the previous paragraph there is another important asset missing in the PBO’s calculations: the Puget Sound Pipeline.

At the Sumas delivery point in Abbotsford, BC, the Trans Mountain Pipeline connects with the Trans Mountain Puget Sound Pipeline, a system that has been shipping Canadian crude oil products since 1954 to Washington state refineries in Anacortes, Cherry Point and Ferndale. This 111 kilometres (69 miles) pipeline system is made up of  16 to 20 inch pipe and has the capacity for up to about 240,000 bpd (28,600 m3 per day) depending on petroleum types transported and the balance of deliveries between the two destinations – Anacortes and Ferndale

The Puget Sound Pipeline Puget transported approximately 191 thousand barrels/day (mbbl/day) of mostly light crude in 2016, comprising approximately one-third of the collective capacity of all refineries in the Anacortes and Ferndale area. Not only that but the Puget Sound Pipeline is capable of being expanded to approximately 500 mbbl/d from 240 mbbl/d today simply by adding a few pump stations. The pipe is big enough, but it has never been expanded because there was not enough source material in the Trans Mountain to justify its upgrade.

The PBO chooses not to include the value of this pipeline, apparently because:

The Puget Sound pipeline system is significantly shorter than the TMP and transports less product, therefore, its cash flows and valuation are expected to be only a fraction of the TMP’s .

Remember the current Trans Mountain moves a maximum of 300,000 barrels per day (bpd) and the Puget Sound Pipeline moved 191,000 bpd in 2016. Now I do admit that 64% of the total volume moved is less than 100% but it certainly represents a large fraction of the total volume moved down the pipe. From an income perspective, by my calculations, the Puget Sound Pipeline brings in between $20 – $30 million a year. While not a massive value certainly nothing to sneeze at when calculating value for the TMEP. If my math is right it represents around 10% -15% of the income generated by the Trans Mountain system as a whole. So not a huge chunk, but still pretty significant addition that was excluded from the calculations.

To conclude let’s look at what the PBO said and what we now know. According to the PBO, ignoring the real estate value of the terminals and the Puget Sound Pipeline the TMEP is worth between $3.6 billion and $4.6 billion. Thus the $4.4 billion paid for the TMEP is at the high end of the range. However, were you only to add the land value for the Burnaby Terminal (let’s charitably call it $1 billion) then that valuation goes from $4.6 billion to $5.6 billion. That ignores the value of the Puget Sound Pipeline, as well as 200 acres in Abbotsford etc… Thus, using more complete numbers one could argue that the Government of Canada got a great deal.

The only problem with my numbers? They ruin the narrative being pushed by activists that the government got fleeced by an evil Texas-based company. The truth meanwhile is that it looks like the government did a pretty reasonable job and if it plays its cards right could make a pretty penny from this project.