Interview: Russ Girling
The Ivey Business Review is a student publication conceived, designed and managed by Honors Business Administration students at the Ivey Business School.
IBR: In spite of your troubles with Keystone XL, TransCanada’s future has never been brighter. Fifteen years ago the story was much different.
RG: Yes, at the time there was a belief that the North American energy infrastructure industry was a sunset industry. TransCanada was generating significant free cash and needed avenues for growth, which forced us to look outside our conventional businesses and geographies. One way TransCanada sought to grow was through its merger with our competitor NOVA. Together we had an organization that appeared to have great promise, the largest Canadian corporate merger at the time. What we quickly realized was that the businesses (chemicals, international, etc.) that both companies had pursued for growth didn’t hold the promise they were hoping for. Pro forma earnings per share (EPS) estimates post-merger were estimated to be in the range of $1.80 per share but turned out to be around $1.00 per share with the dividend pegged well in excess of earnings. That, combined with significant non-core capital investment meant more money was going out the door than we had coming in. This was not sustainable because all of the company was over levered, with roughly 74% debt.
IBR: In order to turn around TransCanada, you had to sell-off a lot of assets. How did you decide what was non-core?
RG: It was based on what we believed fit our A grade credit rating, which we were on the verge of losing. The strategy was more based on preserving our financial integrity and the long-term viability of our pipeline and power businesses, which were flowing cash and needed little future capital. There were other businesses, for example, our Mexican business, which fit our profile–long-term contracts, good cash flow–but we had to rank our preferences and make some difficult decisions. There were some good businesses that had to be sold even though they fit our model because we needed to pay down debt.
IBR: Why then did TransCanada, soon after this sell-off, move to commodity exposed merchant Alberta power, which is the opposite of credit friendly?
RG: It was somewhat opportunistically driven. The way I think we add value to our shareholders is by maximizing the spread between our return on capital and our cost of capital. We tend to operate at the low risk, lower return end of the spectrum so our cost of capital is low. Merchant power while it appears to have higher returns also comes with a significantly higher cost of capital. You have to ask yourself, for the increase in risk, are you getting any increase in spread compared to keeping your risk low? In your portfolio, you can keep a small set of higher return, higher risk assets as long as it is small enough to not affect your cost of capital. Basically, you’re able to fund your riskier business with your low cost of capital and capture a wider spread for your shareholders. Just not so much that it increases your cost of capital. In the case of Alberta merchant power, the capital investment was low, coal fired generations was base load power in the province (lowering risk), and the earnings and cash flow potential was immediate which helped our cash credit metrics. Further, this small investment did not impact our cost of capital.
IBR: Given the importance of maintaining a strong credit profile, why hasn’t there been a strong emphasis to diversify your pipeline business away from Western Canada, where most of your pipelines originate?
RG: There is strategic merit in diversification, but you have to have some competitive advantage that uniquely qualifies you to compete and win in those markets. If you don’t have a base position you have to build one, or in mature areas acquire one. You have to find a base asset and pay a price that will generate acceptable returns going forward.
We did acquire ANR Pipelines, which was part of a strategy to give us exposure to a number of US basins including the US Gulf Coast. Interestingly though, I believe that owning long haul infrastructure, in a world where it appears that we have much more gas than we can ever consume on this continent, is a huge advantage. When the existing infrastructure is full, you have to build new infrastructure. The thing about new infrastructure in heavily populated areas is that if you can build it, it is going to be more expensive than old long haul infrastructure. Old fat pipe is the cheapest way to move gas to market, and producers are starting to see significant value in securing long haul transport on existing systems. Contracting from new shale basins onto pipes like ANR is going up. Where we traditionally thought we’d be moving gas from south to north, producers in the Northeast US are now saying they need to move gas north to south to access power and export markets in the southern US because they know that it’s cheaper to sign up for existing infrastructure at our historic regulated rates than it is to sign up for a new pipeline.
IBR: How much does the lack of diversification come down to a capital allocation decision?
RG: The amount of diversification a company has is always a capital allocation decision. In our case we have to prioritize, to decide which opportunities are going to give us the most strategic value, and which ones are going to ensure that we don’t compromise our core business. With our Alberta gas pipelines, for example, we’ve allocated significant capital towards protecting our system. We wanted to protect our competitive advantage in our most important market; so that opportunity would have a higher priority than opportunities to diversify into the Marcellus, for example. Back in the early 1990s the company didn’t have the discipline to live within its own capital measures, and often over-extended itself. In the pursuit of diversification, the company allocated its scarce capital in too many directions and in projects that took longer to transition from investment to cash flow than we had initially expected. We need to be careful not to repeat that situation by over allocating capital in too many directions. Today we have three attractive platforms for investment: gas pipelines, oil pipelines, and power. All three have more opportunity than our financial capacity. We need to remain disciplined in how we allocate capital and live within our means. If we do, I believe we can deliver significant shareholder value.
IBR: Why did you move back into oil with Keystone and Keystone XL so soon after selling your oil pipelines in the restructuring?
RG: This was driven by a fundamental view that the Canadian oil sands were growing and that there would be a need to move this product to market. At the same time, US Gulf Coast refiners were seeing their heavy oil supply declining from places like Venezuela and were looking to access Canadian heavy oil as a replacement. A pipeline between Alberta and the Gulf Coast with the ability to pick up US Bakken crude made tremendous sense strategically. We knew that we were in the pipeline business, and we were good at it. We build pipelines. The regulatory process was something we understood. Linear infrastructure, land owner issues and aboriginal community issues were all things of which we had core competency. Further, the oil pipeline businesses had historically tended to yield greater returns than the gas pipeline business. This was a natural extension of our existing business.
In order to get the producing community and the refining customers to underpin such a project with long-term contracts, we needed something unique about our product offering. What we were able to offer up was about 1,800 km of pipe already in the ground, which we could convert from gas to oil service, making our project cheaper than the other alternatives in the marketplace. By doing this, we were able to position ourselves as a growing business and repurpose existing gas infrastructure which was experiencing declining throughput, a true win-win for our existing gas business and entry into a new business.
IBR: The opposition to Keystone XL is something that caught TransCanada off guard. How have you managed to navigate the opposition to this pipe?
RG: The fundamentals for supporting Keystone continue to improve. Today we are three quarters complete and we are awaiting approval of the final phase, Keystone XL. At the same time, the noise and rhetoric from those opposed continues to get louder. It is clear their true opposition is not the pipe itself but what is in it, fossil fuels, and they would like them to stay in the ground. I think they are misinformed, they need better information, but we also need to do a better job as a company in explaining our message. The US consumes 15 million barrels of oil per day, and, imports 8-9 million barrels a day. Even with growth in US production and greater emission standalones on vehicles, the US will continue to import crude oil for many decades to come. The safest and most reliable way to get that supply is via a pipeline from a reliable ally: Canada. These facts, along with the many jobs and economic stimulus created by Keystone XL, are the reasons that two thirds of the American public, majority of US Congress, trade associations, labour, Canadian government, and customers continue to support the project. Without their support the project would not have been able to endure the protracted and multiple delays. At the end of the day it is just a pipeline similar to the other 2.5 million miles of pipeline in the US today.
IBR: How does TransCanada, which has risked its own capital on Keystone XL, work with the oil sands producers to help bring their product to market?
RG: We need to work with oil producers to ensure the public has the facts about oil sands production, the safety of pipelines, and what happens in the event of a spill. We need to communicate our collective commitment to ensuring the oil is produced, transported, and refined in the most environmentally sound and safe manner. People know they need energy to go about their daily lives, but they also expect it to not harm the environment they live in, which is our expectation as well.
With Keystone XL, we followed the historic process of filing our application with a regulator, expecting an 18 to 24 month turnaround on environmental review, obtaining our permits, and commencing construction, which obviously turned out to be a bit optimistic. We figured out what we have to do to keep public support on our side and that is going to the grassroots and building support for the project. By getting down to the grassroots and talking about the risks with communities we can understand their issues and reduce their anxieties. It is better to be first to tell our story than to be on the defensive side responding to misinformation from project opponents.
With Energy East, TransCanada has spent time with over 500 communities listening to their concerns well in advance of filing an application about the risks, the mitigations, and the benefits. As a result, the dialogue on Energy East seems to have gotten off on the right foot, unlike the difficulties the industry has faced on projects like Keystone and Gateway.
IBR: Do you foresee similar difficulties with your gas pipelines to proposed Liquified Natural Gas (LNG) facilities on the BC coast especially with regards to fracking?
RG: No, in BC producers have been producing unconventional gas for some time now and it doesn’t appear to have the same notoriety as it does in New York or New Brunswick. There are those opposed to fracking in Northeast BC, but I think there’s a greater awareness of what the actual risks are because producers have been doing it for some time and the government regulation is in place to ensure it is done safely. I don’t think the employment of fracking technology is an impediment, at least from what I’m seeing so far. Those aren’t the kinds of questions we’re being asked in the communities in BC. The primary questions are more with regards to, “What is the impact in my community going to be as a result of you traversing with this infrastructure? What input will the community have on how this infrastructure gets built and operated? And, what benefits can accrue to my community both in the short term and the long term?” In other places like New Brunswick producers are having difficulty, because fracking is not what people are familiar with. When people have sufficient knowledge, experience, and understanding of a particular form of resource development, they can get comfortable with the risks. For example, when you think about loading tankers on the coast of New Brunswick, it’s done every day at Irving’s facilities and there are minimal issues because people are aware of the safety protocols in place, the economic benefits it has, and the Irving’s have a reputation for safe operation in the community. In BC this has become a large issue because it is new to those communities; there is a significant amount of education and consultation that will have to take place.
At the current time our LNG projects do not appear to be embroiled in the concerns about spills and I don’t believe our project sponsors, Shell and its consortium Progress Energy ,are experiencing the same marine issues that proponents of the oil projects going to the west coast are facing.
IBR: Over the long term where do you see as TransCanada’s focus: gas pipelines, oil pipelines, power, or something else altogether?
RG: Sometimes you just have to wait and be patient, which is something I’ve learned most about in this job; make sure you have a strong and diversified enough portfolio that you have the capacity to wait. When we first had the Keystone XL delay, and then the subsequent denial, our portfolio wasn’t large enough because our shareholders were overly focused on what happens to Keystone. Today, having the larger ($38 billion) more diversified portfolio of investment opportunities we are pursuing reduces our exposure to any one project and allows us to be able to wait out long delays.
