http://qwlaw.ca/qw-law-blog      May 11, 2014

The BC government has one devil of a problem on its hands.

Last year, it won re-election largely on the basis of promises of enormous wealth and revenues flowing from the birth of a massive Liquefied Natural Gas export industry. Billions of dollars would flow into the treasury, the provincial debt would vaporize, and we would all be awash in jobs, jobs, jobs.

FortisBC Energy Inc.’s LNG plant at Mt. Hayes, serving BC utility customers – and a target for the upcoming BC LNG Revenue Tax

But has something gone wrong? Last spring, the government announced that by autumn it would unveil its taxation scheme to extract this revenue from an LNG export industry. The months passed, and the taxation plan was postponed to the winter. In the February budget, it said the plan would be made public next fall.

Why the delay?

Because figuring out how to extract significant provincial revenue out of LNG exports is a very difficult problem – and this is on top of the uncertain prospects for the LNG industry to happen at all, or on the kind of scale the Premier heralded on the campaign trail.

There is no obvious point in the process for a provincial government to insert itself and extract a share of the money.

The gas starts out in the ground. When it is extracted, there is no way of telling which molecules are destined for export and which will be burned to keep homes warm in Prince George or Surrey.

The gas is then refined. Same problem here – there is no way to sort out which gas is headed where.

Then it’s shipped by pipe to the coast, where it is super-cooled and condensed, loaded onto tankers, and off it goes to Korea or other points west. There it is sold for perhaps double or more the price it was worth on our side of the Pacific Ocean.

So imagine you are a provincial government and you want to make billions of dollars out of this activity. Here’s your great big problem: the province cannot impose an export duty on the gas, whether it’s called a duty or disguised as something else.

They already charge a tax called a “royalty” on the gas when it is sucked out of the ground. The only way to get a higher rate of revenue at this stage is to increase the royalty on all the gas at the point of extraction. Some of that royalty will come out of the LNG trade, but the rest will come out of BC homes and businesses who use natural gas for heating and other purposes.

They can’t charge a tax at the dock in Japan when the gas is offloaded into the Asian market.

Somewhere in between? What happens “in between” is the refinery, the pipeline to the Coast, the liquefaction plant, and the tanker ship terminal. If the gas belongs to the same company throughout these steps, there are no financial transactions to tax. It’s just the company’s gas being moved along through its system.

What Victoria has hit upon is to tax the revenue from the liquefaction process. Sounds fine, but there’s one problem – what if there is no revenue flowing from that step? Is Shell paying itself at the LNG plant for the gas it delivered there in its pipeline? Not likely.

So what they will need to do is invent some sort of make-believe commercial transaction at the point of liquefaction. Calculate some notional value-added by that process and tax it. I can hear the wheels spinning in the heads of the companies’ tax lawyers about ways to structure the whole arrangement to minimize the tax hit.

And there’s yet another problem – if the government singles out LNG for export, they are probably guilty of imposing an unconstitutional tax. In its budget announcements this winter, the government said that the LNG tax would apply whether the gas was for export or for domestic use. They really have no choice, if they want an LNG tax at all (see above – disguised export duties).

Did you know that there are already two LNG plants in BC? One is on Tilbury Island in the Fraser Delta, and the other is on Vancouver Island at Mount Hayes. They belong to FortisBC Energy (aka BC Gas or Terasen). Those facilities are used for the utility’s BC customers.  They are LNGs for domestic use and therefore would be caught by the new tax.

So the supreme irony is that it is possible that the LNG tax will only be paid by BC residents. That’s because it is not at all certain that we will see an LNG export industry in BC. If we do, it is highly unlikely to be on anywhere near the scale the Premier was trumpeting during the election.

But more about that in a future article.