The following is an abridged version of a paper which Kevin Keyes presented recently to the Inter-Pacific Bar Association in Los Angeles. Footnotes and some statistics have been deleted from the original, and are available on request .
>Abstract: An expanding economy and population, coupled with a limited and aging infrastructure, present huge opportunities for private sector investment in Canada's two westernmost provinces. Even areas traditionally controlled by the public sector offer investment opportunities through "public-private partnerships". This article examines several sectors in these two provinces which will be looking for major sources of capital in the coming years.
The Challenge and the opportunity
Energy and infrastructure and related spin-off industry sectors are driving investment opportunities in Western Canada. Strong local economies and regulatory climates that encourage investment have resulted in significant population growth which in turn is putting a strain on schools, hospitals, transportation networks and other essential infrastructure.
As a funding alternative to tax-based capital reinvestment programs, all levels of government are entertaining private sector-sponsored finance and construction projects that will enable near-term redevelopment of aging facilities as well as construction of new infrastructure.1
Many of Canada's utilities, roads, tunnels, bridges, hospitals, schools, courthouses, recreational facilities and other public and social infrastructure are coming to the end of their expected life spans. Canada's national infrastructure deficit is currently projected at anywhere between $50 billion and $125 billion, approximately six to ten times the combined annual infrastructure budgets of all levels of government in Canada.
The Great Canadian Compromise
Current levels of taxation, by all levels of government, cannot fund the entire cost of infrastructure replacement. This reality, when combined with existing public sector debt and the difficult task of coordinating, managing and building new public works, has led the federal and provincial governments to partner with the private sector. These projects are officially called "public-private partnerships" (P3s) in British Columbia and Alberta, "alternative financing and procurement" in Ontario and "private financing initiatives" in some other quarters.
P3s present a classic "Canadian compromise", allowing for some degree of continued public control over essential assets and services while shifting risks and costs to the private sector. P3s encompass a range of models involving different degrees of private (versus public) participation and risk; however, few involve true legal partnerships between government and the private sector.
Government Procurement and Alternative Financing
Canada's federal government recently announced measures to provide support for P3s. PPP Canada Inc. was created as a federal Crown corporation to promote the use of P3s in Canada. A $1.3 billion P3 Fund has been established to support innovative P3 infrastructure projects and invest in public-private partnerships using a range of innovative financing instruments such as loans, loan guarantees, non-voting shares and repayable contributions.
Alberta published the Alberta Infrastructure Guidance Document to assist the government's approach in assessing P3s. While Alberta has a limited track record in embracing P3 models to date, British Columbia has established Partnerships BC to promote P3s and to identify options for maximizing the value of public capital assets. Partnerships BC is currently overseeing more than 14 P3 projects, five of which are healthcare facilities.
Pension Funds Investment
The pension industry has encouraged the government to create the necessary conditions to capitalize on a shift in investment policy by pension funds away from equities and toward infrastructure as an asset class necessary to meet long-term pension requirements. It has been reported that fewer than 20 design, build, finance and operate projects have reached financial close over the past few years in Canada, compared to some 600 P3 projects in the U.K. since 1990. As a result, even Canadian pension funds are searching for opportunities to invest in public infrastructure outside Canada.
Private Equity Financing
The private sector has raised huge sums to invest in infrastructure projects around the world. During the past two years, the flood of money into private infrastructure funds has been astonishing: the world's 20 largest funds now have nearly $130 billion under management. Taking into account leverage, the global market can likely support $1 trillion in capital projects. Key attractions of investments in infrastructure include the potential for reliable cash flows, the prospect of predictable operations and relatively low overall risk.
The following sectors are providing energy and infrastructure and related spin-off investment opportunities in Western Canada:
Oil and Gas
Canada is an emerging energy superpower. Next to Saudi Arabia, it has the second-largest petroleum reserves on the planet (around 179 billion barrels) and is the largest exporter of oil to the United States. The oil and gas industry employs 500,000 people in Canada and pays $26 billion per year in taxes and royalties. It represents 25% of private sector investment in Canada and accounts for 81% of Canada's trade surplus (representing 14% of all Canadian exports).
Alberta recently appointed its own diplomatic representative in Washington (the only provincial envoy with an office within the Canadian Embassy near Capitol Hill). In the coming years the United States will look increasingly to Western Canada for its secure supply of imported petroleum products, and as the safe transmission corridor for its own Alaskan resources.
Oil Sands Development
The Athabasca oil sands currently account for 50% of Alberta's petroleum production and, in a few years, will dominate the industry due to declining conventional reserves. Capital investment in 2007 was $16 billion and operating expenditures were $9 billion. According to the Canadian Energy Research Institute, by 2020 the Canadian oil sands development will add almost $800 billion to Canada's gross domestic product (which is about two-thirds of current annual GDP).
The global economic boom has made the oil sands viable but has also fuelled inflationary pressures that have sent development costs out of control. Labour shortages in Alberta are reaching crisis levels, housing is in short supply and existing pipelines - critical to moving products to market - are reaching capacity.
Oil sands companies are currently the fastest-growing greenhouse gas emitters in Canada (at 40 megatonnes per year), a figure which is expected to double in the next 10 years. As Canada begins to impose emission targets on the country's emitters, oil sands companies will be eager to trade "carbon credits" on the recently-launched Montreal Climate Exchange, Canada's first trading floor for carbon futures contracts. Through the exchange, carbon emitters who exceed their quota will be able to buy carbon credits, while companies that emit below their quota will be able to sell carbon credits. The global market for carbon trading is roughly $100 billion, based on World Bank estimates.
Commercial Real Estate
Although Calgary and Edmonton are seeing significant investment in retail and industrial projects, the bigger story is housing and social infrastructure, as the expanding economy attracts a mobile labour force that needs to be housed and cared for. The problem is even more acute in Northern Alberta; Fort McMurray has doubled in size in the past ten years, and both housing and services are stretched beyond their limits. It is estimated that the cost of the municipal infrastructure needed to keep up with the current pace of development in the Regional Municipality of Wood Buffalo is about $1.2 billion, and the provincial government has recently committed $400 million towards infrastructure spending for this town of 60,000 people.
The federal government funds Canada's provinces for health and social services through the Canada Health and Social Transfer program. The provinces must directly provide all "medically necessary" hospital and physician services. This approach affects the scope of P3s in health care because it forces the distinction between "clinical" services (which cannot be contracted out) and "non-clinical" items (i.e. "bricks-and mortar" facilities and non-clinical services such as maintenance, food services, parking, etc).
In Alberta and British Columbia, P3s have emerged as the preferred method for tapping private sector resources for non-clinical resources. Recently the Alberta government has been advocating an expanded private sector role in delivering and funding a broader scope of health care in the province. Its recommendations have been endorsed by a Senate Standing Committee report, which concluded that "Canada's publicly funded healthcare system as it is currently organized and operated is not fiscally sustainable given current funding levels", and which encouraged both federal and provincial governments to explore P3s for hospitals.
Historically, the generation, transmission and distribution of electricity in most provinces were strictly controlled by provincial and municipal governments. Over the past few years, some governments have permitted P3s and other forms of private sector involvement.
Alberta deregulated its electricity industry in 2001, with the market separation of generation, transmission and distribution. Several independent firms operate as franchise monopolies; about half of the electricity is generated from coal-fired generators, while most of the balance comes from natural-gas fueled generators. Two of the three major vertically-integrated utilities are investor owned (the third is municipally owned but is operated mostly on commercial terms). Additionally, a private-equity joint venture now owns Canada's first major independent transmission company, and electrical generation in Alberta is primarily in the private sector.
The boom in oil sands production is placing Alberta on the verge of the largest power build in its history. According to recent figures from the Alberta Electricity System Operator (AESO), which plans and regulates the transmission system, the province will need to boost generating capacity by at least 40%, or 5,000 megawatts, by 2017. The new sources of power will cost at least $10 billion and the province will also need up to $5 billion worth of transmission upgrades.
Most electricity generated in British Columbia is hydroelectric and is controlled by provincially owned BC Hydro, which is responsible for generation and distribution, while British Columbia Transmission Corporation operates the province's transmission grid. Although these two companies are controlled by the provincial government, virtually all new generation projects are offered to the market. BC Hydro recently awarded 38 contracts to independent power producers throughout the province, including 29 hydro, three wind, two biomass, two waste heat and two coal/biomass projects.
Using preliminary estimates, Canada's provinces and territories have identified the need for approximately $97 billion in capital investment in transportation priorities over the next 10 years. Canada's large western cities (combined population of about 4 million people) reported a critical infrastructure deficit of $564 million in 2003.
Partnerships BC is currently overseeing six transportation infrastructure projects which include bridges, highways, interchanges and a rapid transit rail line connecting downtown Vancouver, Richmond and Vancouver International Airport (construction is expected to be completed in time for the 2010 Winter Olympic Games to be hosted by Vancouver).
In Alberta, construction is well under way on a $500 million P3 ring road in Edmonton. The project involves a 30-year concession between the Alberta government and Access Roads Edmonton, a consortium of 12 engineering, construction and maintenance companies.
Education has traditionally been within the purview of provincial governments; however, recent experience in the U.K. has shown that construction and operation of public education facilities can be delivered cost effectively by the private sector. The Alberta government is now moving ahead with the planning and construction of 14 new schools that will focus on innovative design and operational concepts for middle and senior high schools in the Calgary and Edmonton regions.
Neither the federal nor the provincial governments have the capability or the funding necessary to maintain and upgrade the existing infrastructure, let alone to build for the future. It will become increasingly necessary for Canada to look to global sources of funding and expertise, which will translate to enormous opportunities for new players to enter the market and participate in the development of Western Canada's energy and infrastructure sectors.
Investment opportunities in Calgary and Edmonton are fuelled by the energy sector and the oil sands developments, while Vancouver is experiencing construction activity in connection with the 2010 Winter Olympics. The increasing strain on schools, hospitals, transportation networks and other essential infrastructure will translate to immediate opportunities for engineering, construction and management companies that develop the infrastructure, but more importantly will provide an enormous opportunity for infrastructure funds and other private sector participants to invest in long-term low-risk projects that will comprise Canada's infrastructure future.