Federal purchase of Trans Mountain pipeline distorts incentives, sets dangerous precedent
Today, Finance Minister Bill Morneau (pictured above) announced that the federal government will purchase all assets related to the Trans Mountain pipeline. This includes the existing pipeline first built in the 1950s, and construction of the new $7.4 billion pipeline expansion. While expanding the Trans Mountain pipeline is important for Canada’s energy sector and economy more broadly, the announcement will distort incentives and set a dangerous precedent.
With the British Columbia government aiming to block the project, there has been considerable uncertainty around the pipeline expansion, despite it already having undergone a review and receiving approval by the federal government. In light of the uncertainty, Kinder Morgan cancelled all “non-essential spending” on the project and said it will decide after May 31 whether to continue with the project.
Again, in today’s announcement, the Trudeau government said it will provide a financial guarantee for construction to resume over the summer and then purchase the Trans Mountain pipeline assets for $4.5 billion, pending approval by Kinder Morgan shareholders. According to Minister Morneau, the hope is that private sector investors will at some point purchase the pipeline from the government.
Notably, this plan fails to address the problems that caused the Trans Mountain pipeline expansion to be delayed in the first place, namely the regulatory and political hurdles imposed by the B.C. government. And Minister Morneau’s proposed “solution” creates a new set of issues.
For instance, take the government’s loan guarantee to cover Kinder Morgan’s construction costs until the purchase is completed (expected in August). This means that for much of the summer the government will backstop construction costs by a private firm.
Such a guarantee will dampen incentives for the company to keep costs low and deliver the project on time and on budget because they will not bear the full costs—a situation that economists refer to as “moral hazard.” If a company such as Kinder Morgan knows that a portion of costs will be paid by taxpayers instead of shareholders, it’s less likely to invest the effort to minimize or avoid unnecessary costs.
And the backstopping won’t end if a new private entity purchases the pipeline from the government, which has already said it will provide an indemnity to pay for any costs that are due to “politically motivated delays.” What’s worse, the government says it will guarantee “a reasonable return” if future owners abandon the project or can’t complete the project by a certain date.
All of this creates a dangerous precedent. If future high-profile projects run into similar trouble (assuming investors are even interested in Canada anymore), the firms behind these projects now know if they cry foul loudly enough there’s a chance the government will dole out money and financial guarantees.
Morneau insists this is an “exceptional situation,” but the door is now open to the possibility of Ottawa doing something similar for other projects.
It’s good that the Trudeau government is taking the importance of the Trans Mountain pipeline expansion seriously, despite its lacking support of other pipeline projects (Northern Gateway and Energy East, for example). But the government’s plan distorts incentives, puts taxpayers on the hook, and creates a dangerous precedent for the future.