Industry Committee on July 20th, 2010

[The Chair, Conservative, Michael Chong]

Thank you, Mr. Bouchard and Mr. Fortier.

Mr. Coderre will be allowed one final question.

[Denis Coderre, Liberal, Bourassa, QC]

Thank you, Mr. Chairman.

Mr. Boles, as a start, I want to congratulate you for your honesty and your transparency. This is why we had this meeting today. I feel great about your answers. I know that you're part of the solution. You came and answered the questions straightforwardly, and we are very pleased about that. I think it's important that Canadians know that not only do we have an enterprise that's willing to be part of that solution, but we have good people also who are willing to come here and address those questions straightforwardly. So congratulations.

I just hope that Shell, whose people are still in the room, will listen to what we have said today and your answers, and that there is a buyer if there is a seller. I hope they will listen to that.

The beauty of the Canadian Parliament is that a committee can meet again.

I understand that if there's a will, there's a way. We have the way, but we have to make sure the will is there.

Mr. Delage, I know that you have been extremely patient today. You have just been listening to the discussion most of the time. However, on the committee, you were the expert and financial lobbyist throughout the time it was conducting its work. In light of what we have heard today, I would like you to explain Shell's attitude. We have a feeling about all this. I have no reason to doubt that this is a serious buyer and that Delek US Holdings is not interested in doing the same thing as Shell—in other words, to create a parking lot for gas in Montreal. I believe the company wants to protect the employees and work towards becoming player or catalyst in the petrochemical industry in Quebec and Canada.

Did Shell really want to sell? In light of your understanding and what you experienced in this process, would you say that Shell would be prepared to go back to the table for further talks? What were they like at the time?

[Claude Delage]

Unfortunately, I cannot answer for Shell, but I can tell you what I witnessed throughout the process.

We were extremely prudent and very much aware of the responsibilities that rested on our shoulders. Indeed, this was something that involved a large number of families. That's the reason why we demanded that Shell not initiate a process without having a clear framework—something we secured on February 16. As soon as we received confirmation that Shell wanted to sell and we had a framework, we began a global search for companies that would be potential candidates. We contacted those companies. We ended up with a far smaller number. We engaged in discussions. Subsequently, we presented those companies to Shell, one after the other. Shell had the right to say whether they were credible or not and whether or not they would sign a confidentiality agreement. They did sign agreements with certain companies.

What followed were of discussions. We organized conference calls in which Shell participated. They involved people in charge of mergers and acquisitions as well as managers responsible for the assets in Montreal. The idea was to answer the legitimate questions of the people making proposals. It was at that point that I had a conversation with Mr. Fortier and made him aware of my concerns.

Buying and selling companies for others is my business. In 25 years, I have learned to recognize a motivated buyer and seller. Yet I had certain doubts, which were baseless. They were doubts based on my experience alone, for what they were worth.

It was in that context that we took advantage of a visit by Mr. Rathweg and Mr. Marion to Mr. Fortier's office in Montreal to make our position absolutely clear, and we didn't beat around the bush. The fact is that we had better things to do. Our role was to act as facilitators, and we respect the fact that they own this asset and if they do not want to sell it, all they have to do is say so. So, that's what we did.

[Denis Coderre, Liberal, Bourassa, QC]

Mr. Delage, we are short of time.

How do you explain the fact that we are still at an impasse, even though Shell wants to sell its assets and get rid of the ones in Quebec and the Maritimes? A buyer is prepared to invest $150 million and $800 million over 10 years. Do you think Shell is acting in good faith?

[Claude Delage]

I cannot answer for Shell. I can tell you, however, that every time company officials asked for something, we provided it. They continually raised the bar.

When I hear Shell saying that the price they were asking was only for the refinery and that it didn't include the wholesale side, well, I would refer you back to the February 16 term sheet which states that the present value of future revenues they would receive with the terminal… What do you think “wholesale” sales are?

So, throughout the process there were numerous contradictions in terms of Shell's behaviour. I respect the fact that they want to do what they want to do with this asset. On the other hand, when interests on all sides get together to try and find a way of avoiding a closure… It would have been simpler if they had just said they were not interested in selling.

[The Chair, Conservative, Michael Chong]

Thank you, Mr. Godin.

Thank you, Mr. Delage.

Thank you to the Honourable Michael Fortier and to Mr. Boles for appearing.

In particular, Mr. Boles, as your Canadian friends and neighbours to the north, we appreciate that you as an American would come up from the United States to cooperate and participate in these hearings. We do appreciate it.

This meeting is suspended until one o'clock, when we will reconvene.

[The Chair, Conservative, Michael Chong]

On this 20th day of July, 2010, I would like to welcome committee members and witnesses to this 26th meeting of the Standing Committee on Industry, Science and Technology.

We are meeting today pursuant to Standing Order 108 to consider the impending closure of Shell Canada's Montreal refinery.

We have in front of us during this panel two sets of witnesses. First, we have Madam Dagenais and Monsieur Bilodeau from the Competition Bureau. We also have Mr. Rau, Monsieur Labonté, and Monsieur Gauvin from Natural Resources Canada.

We'll begin with an opening statement from Monsieur Bilodeau.

[Richard Bilodeau, Acting Assistant Deputy Commissioner, Civil Matters Branch Division, Competition Bureau Canada]

Thank you.

Mr. Chair and members of the committee, thank you for the opportunity to appear before you this morning as part of your study of Shell Canada's recent decision to close its Montreal refinery.

My name is Richard Bilodeau, and I am the acting assistant deputy commissioner of competition for the Competition Bureau's civil matters branch. I am accompanied today by Martine Dagenais, assistant deputy commissioner of competition for the bureau's merger branch. We look forward to assisting the committee today in its deliberations.

As the committee members are aware, the Competition Bureau is an independent law enforcement agency that is headed by the Commissioner of Competition. The bureau administers and enforces the Competition Act, which is designed to maintain and encourage competition in Canada in order to promote a number of objectives, including increasing the efficiency and adaptability of the Canadian economy and providing consumers with competitive prices and product choices.

The act applies, with very limited exceptions, to all sectors of the Canadian economy, including the petroleum sector, and sets out criminal and civil penalties for a variety of anti-competitive practices. These include, for example, entering into agreements with competitors to fix prices, allocate markets, and restrict output; abusing a dominant market position; and engaging in misleading advertising and deceptive marketing practices.

The Bureau takes its enforcement responsibilities very seriously, and is acutely aware of the importance of promoting competitive markets in the petroleum sector.

As committee members may recall, the Bureau announced in June of 2008 that criminal charges would be laid against 13 individuals and 11 companies which conspired to fix the price of gasoline at the pump in Victoriaville, Thetford Mines, Magog and Sherbrooke, Quebec. Those charges, which so far have resulted in almost $3 million in fines and jail terms totalling 54 months, arose from the largest criminal investigation in the history of the Competition Bureau. Investigators seized over 100,000 records, searched 90 locations, and intercepted thousands of telephone conversations over the course of their investigation.

Very recently, on July 15, the Bureau announced that new criminal charges had been laid against an additional 25 individuals and three companies with respect to this same price-fixing case, bringing the total to 38 individuals and 14 companies accused. Price-fixing is widely considered to be among the most egregious forms of anti-competitive conduct. And we will pursue these criminal activities to the fullest extent of the law.

The committee members may also recall that in July of 2009, the bureau completed an extensive review of the merger of Suncor and Petro-Canada. Ultimately the bureau entered into an agreement with the parties to resolve concerns that the merger would lessen competition substantially, which we concluded could lead to higher gasoline prices. The agreement required the companies to sell 104 retail gas stations in southern Ontario as well as significant storage and distribution network capacity in the greater Toronto area for ten years. In securing these remedies, the bureau not only preserved competition in those markets where concerns were identified but also facilitated entry by new and vibrant competitors.

With that background, I will now turn to the specific topic that is before this committee today, the impending closure of Shell Canada's Montreal refinery.

As the bureau has stated in previous appearances before this committee, our overriding concern in all cases is whether the conduct in question amounts to a violation of the Competition Act. The bureau obtains information on possible violations of the act through its own monitoring activities, from complaints by those in the market, and from firms that assist the bureau in its investigations in exchange for immunity from prosecution or leniency in sentencing. Where evidence establishes a violation of the act, the bureau does not hesitate to take appropriate action.

Provided that conduct does not contravene the Act or any other applicable law, businesses are free to determine how they operate. In that regard, generally speaking, a unilateral decision by a firm to discontinue the use of a manufacturing or other facility does not raise concerns under the Competition Act. The Bureau presently has no basis on which to be concerned that Shell's closure of its Montreal refinery triggers any concerns under the Competition Act.

If, instead, Shell ultimately were to decide to sell all or part of the refinery, the Bureau would likely review the transaction pursuant to the merger provisions of the Act. Any such review takes into account a variety of factors, including the parties' market shares, the level of economic concentration in the relevant industry, the effectiveness of remaining competitors and barriers to entry.

Where the Bureau determines that a merger is likely to lead to a substantial lessening or prevention of competition, the Bureau may apply to the Competition Tribunal for an order to prevent, dissolve or alter the merger.

Participants in the petroleum sector and Canadians in general can be confident that the bureau takes its work very seriously and recognizes the importance of competition as a key driver of growth, productivity, and innovation in the petroleum sector and in the Canadian economy more broadly.

With that, Mr. Chair, I thank the committee for its time and welcome any questions from committee members.

[The Chair, Conservative, Michael Chong]

Thank you, Mr. Bilodeau.

Mr. Labonté, please.

[Jeff Labonté, Director General, Petroleum Resources Branch, Department of Natural Resources]

Thank you, Mr. Chair, and thank you, committee members, for the opportunity to present to you today.

I have a number of opening remarks and a power point presentation that accompanies the remarks. I will reference particular slides as I move along.

My name is Jeff Labonté and I'm the director general for the petroleum resources branch of Natural Resources Canada. I'm joined today by two of my colleagues, Claude Gauvin and Mike Rau, who both work in the same branch as I do.

My areas of responsibility include the monitoring of oil and gas markets and the development and implementation of oil and gas policy in Canada. As well, I have oversight for advice pertaining to crude oil, refined petroleum products, and natural gas south of 60 degrees. I'm here today to speak to the committee on a number of specific points.

I'll be talking to two particular purposes today. The first would be to outline Natural Resources Canada's role as it relates to the Canadian refining sector and the domestic supply of petroleum products in Canada, as well as giving the committee some brief overview on the petroleum refining and distribution market in Canada over the past number of years and its relationship to regional economies and international events. More specifically, my remarks will cover NRCAN's role, the product supply chain, regional differences, and realities affecting Canada's refining industry.

With respect to oil and gas, NRCAN covers the following areas. First, in response to energy supply disruptions of national significance, NRCAN could act on a temporary basis to ensure Canadians have access to energy. This is in the context of Canada's market-based approach to energy policy where private sector supply and demand and investment choices are made in relation to market fundamentals and demand.

Second, NRCAN ensures that Canada honours its international obligations under the International Energy Agency's treaty. Should the IEA declare an emergency of any sort in the face of a supply disruption, Canada is obliged to act in support of that treaty.

Third, we at NRCAN provide Canadian consumers with information on Canadian oil and gas markets, and we provide policy support and advice to the government on oil and gas markets as well.

In terms of legislation, the issues from an energy security perspective, at this point in time it is NRCAN's view that the potential conversion of the Shell refinery does not pose a risk of a supply disruption on a national scale. Therefore NRCAN has no particular role to play with respect to this instance of this particular conversion. However, I would like to point out that there are two pieces of federal legislation that provide the government the authority to temporarily intervene in the case of a severe energy supply disruption of national significance. Under the Emergencies Act, if a national emergency is declared the Governor in Council can declare a public welfare emergency, which authorizes special and temporary measures to ensure safety and security during a time of national emergency. This could include the disposal of property, including energy commodities such as gas, oil, and crude and refined products.

The second piece of legislation is the Energy Supplies Emergency Act. If a national emergency has been declared, an energy emergency could be declared and the Energy Supplies Allocation Board could be activated. It has the ability to temporarily allocate energy supplies in Canada and could redirect crude oil to ensure that all refineries in particular regions of the country experience similar and manageable shortages and access to petroleum products, or draw down stocks to meet limited supply interruptions.

Moving to the next slide, which is a fairly complicated one, I'll draw attention to a number of aspects of Canada's refinery marketplace. A key point to make, as has probably been presented previously to the committee, is that the upstream crude oil extraction and transportation business and the downstream refinery and retail business operate as two independent segments in the petroleum marketplace. In other words, companies working in one market segment versus another may or may not have decisions that are independent of one another.

If you refer to slide six and you look at the map of Canada, you see a quick snapshot of what are the orbits or areas supplied by particular refineries. The map identifies that there are 16 major refineries in Canada that are each regionally located. Virtually all of the petroleum supply comes from these 16 refineries located across the country. You will note in the map that Canada exports and imports crude oil as well as refined petroleum products. So some of the equation is that Canada is both an import and export nation and that at the net scale Canada exports more crude oil and more refined petroleum products than it consumes.

It is because of transportation economics that the Canadian petroleum marketplace is also quite regional in nature. Drawing into these regional issues and variations, moving to slide 7 and going from west to east, the western provinces and territories are predominantly served by domestic refineries, with Edmonton being the largest centre. These refineries process Canadian crude oil, which is predominantly produced from Alberta as well as Saskatchewan. The region is also a small net importer of refined petroleum products from the western United States.

Southern and northern Ontario rely predominantly on refineries in Sarnia and Nanticoke, which process predominantly domestic crude, which is piped from Alberta to Ontario. However, there are some imports in this area as well, both crude and petroleum products, which come to this region via pipeline from Montreal. The region is both an importer and exporter of petroleum products.

Moving to eastern Ontario and western Quebec, petroleum product markets are supplied by domestic refiners in the province of Quebec, as well as petroleum imports from other countries. It is important to note that the refineries in the region largely process imported crude oil.

The maritime provinces and northern Quebec are supplied by refineries in Quebec, Newfoundland and Labrador, and Nova Scotia, and by seaborne petroleum products; that is, by petroleum-based products imported by ship and transport. Again, refiners in this region predominantly rely on imported crude oil, with the exception of the offshore production in Newfoundland and Labrador, which also supplies refineries in Atlantic Canada as well as other international markets.

The domestic industry in Canada operates, very clearly, in an international marketplace. Due to economies of scale, the global refining industry has been undergoing a rationalization over the last number of decades. Global demand for refined products is growing and is driven by emerging markets such as China, India, the Middle East, and Latin America, while North American demand for petroleum products has been fairly stable or declining with the impacts of the recent recession. It is not expected that demand in North America will grow significantly either, when one looks at the trend over time.

Larger and more efficient refineries are part of the rationale for this particular context, where we see overseas refineries coming onstream that are more efficient, larger, and that produce product at a cost that's difficult for North American refineries to compete with.

We see that this has had an impact on domestic investment choices. In keeping with global trends, the rationalization of the refining industry has been taking place in North America. In Canada alone, we have seen the number of refineries go from 44 in the late sixties to 16 today, while at the same time the overall domestic refining capacity has actually doubled. Most of this rationalization took place because of the oil shock in the seventies, as well as increasing economies of scale in competing nations. For example, in the early 1980s there were six refineries in Montreal; by the mid-1980s, four of those refineries had closed. These refineries were typically small in scale, and all of them had less than one-third the capacity of the Ultramar refinery that is operating near Quebec City today.

Domestic capacity has been on the rise while throughput has been declining. The current realities of the Canadian refining sector pose a challenge for profitability. From 2000 to 2009, domestic refining capacity has increased to roughly 2 million to 2.1 million barrels a day, with production refineries decreasing to the point that capacity and utilization rates have been hovering at around 80% as recently as 2008-2009 and the first two quarters of 2010. I should point out that a capacity rate, generally speaking, of 95%-plus is considered full capacity and generally viewed as optimal.

To put the degree to which Canadian refinery equipment is underutilized into perspective, in 2009 the idle capital in Canada's refining sector was close to 300,000 to 400,000 barrels of oil per day.

There has been a downward trend in refinery profit margins in Canada over the past number of years. Refining margins represent the differential, of course, between crude oil and the price refiners sell their products at on the wholesale market. Margins must meet and cover all costs. It's important to note that expenses are more or less fixed, and changes in refinery margins directly affect the profitability of the particular firms operating.

In summary, I'll reiterate the following two points.

First, from an energy security perspective, the potential conversion of the Shell Montreal East refinery does not pose a risk to the supply of national scale.

Second, the total capacity to Canada's refineries has increased over the past number of decades, even though the number of facilities has decreased, as has the utilization rate. This reflects part of a North American and global trend towards rationalization and increased competition.

Thank you.

[The Chair, Conservative, Michael Chong]

Thank you, Mr. Labonté.

We'll have about an hour and ten minutes of questions and comments for members, beginning with Mr. McTeague.

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

I don't know where to begin, Chair.

Thank you, witnesses.

I'm going to start with you, Mr. Labonté. I have a document that you didn't bother to offer, but I did introduce it to one of the previous witnesses. It's from NRCan. It's from your oil division annual survey of refiners. It's on your website. It says:

Refinery utilization rates close to 100 per cent, along with growth in demand for petroleum products, have created a need for significant additions to refinery capacity in Canada. Without investment in new refining capacity, supply interruptions could become more frequent and increasingly difficult to manage.

Due to the high demand for petroleum products in the Northeastern United States, refiners in Atlantic Canada export considerable volumes of petroleum products to that region.

You also seem to minimize, whether you've discounted this or not—I think it's rather significant for this committee—that it was written following the shutdown of the Bronte Petro-Canada refinery. You've also shown in your matrix here that the refinery in Montreal is regionally intensive and significant. Cast against the rest of the country, yes, when you have two million barrels being produced a day, that makes it, what, 6% or 7%? But when you put it in terms of the actual market, it turns out to be much higher than that, somewhere close to between 12% and 15%.

You also didn't take time to consider the fact that North Atlantic Refining sells zero gas throughout eastern Canada, except for its gas stations in Labrador and Newfoundland.

You failed to mention, although you know, that most of Irving's capacity of 300,000 barrels per day goes to the United States, thereby limiting and exposing Canada to a much wider prospect of competition or of product coming at a premium price from elsewhere.

Given that you don't have a weekly petroleum monitoring report, you have no idea of the inventory on a week-to-week basis. Given that NRCan provides some of that information to our American friends as to what the picture is here in Canada, how can you possibly conclude that there isn't a problem here?

To use your terms: “While rationalization has resulted in fewer refineries, domestic capacity has grown significantly--this is a worldwide trend that is expected to continue”.

It seems to me, sir, that what you've written in one and what you've written in the other are contradictory. Is it a lack of resources or just oversight?

[The Chair, Conservative, Michael Chong]

Go ahead, Mr. Labonté.

[Jeff Labonté]

I'm not sure where I would start with the question, but perhaps by saying that I think we've provided a summary of the current utilization and capacity issues. Given that the Shell Montreal East refinery currently processes almost exclusively foreign crude oil, the conversion of the refinery will have very little impact on the region's import dependence. At the same time, the product shortfall that might emerge will likely be, and will be, supplied by imports from Europe and the United States, as well as Asia and—

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

Mr. Labonté, I'm talking about gasoline, not oil. I don't put crude in my gas tank, nor do I use crude directly for home heating fuel or aviation fuel. Put this in the context of gasoline and refineries. We're talking about gasoline, not crude.

[The Chair, Conservative, Michael Chong]

Go ahead, Mr. Labonté.

[Jeff Labonté]

I'd like to report that I think, as the committee has probably heard from other members and other witnesses, Montreal does have a competitive import marketplace for petroleum products, gasoline and diesel, imported from other parts of the global market. Our understanding is that both companies that operate the terminals in Montreal, Olco and Norcan, almost entirely source their products from imported sources and compete quite readily with domestically refined product from crude oil imports, as well as other refineries operating in Quebec and eastern Canada.

[The Chair, Conservative, Michael Chong]

Perhaps I could just help out here. One of the questions that Mr. McTeague raised was that there's a document, apparently, from the NRCan website indicating almost 100% utilization of the capacity in the refining sector. Your slide on page ten shows utilization is quite a bit lower than that. So maybe somebody could explain, or try to explain, the discrepancy.

[Jeff Labonté]

Sure.

First off, I think the report you're referring to is dated 2007, which relies on data that had been averaged for years prior to that point in time. It references the market conditions at that point in time, in which they were quite significantly different from now, and also referenced that demand was increasing with respect to the potential for exports as well as a number of activities going on in the North American marketplace.

Foreign competition has increased since then. So has the capacity in the global refining marketplace, as has the refining capacity in Canada since then. So there are a number of aspects that make that particular report a moment in time, as well as one that's slightly outdated. I think the data I presented today is more accurate over time, and we present that to you.

I'll reference the fact that it might be time to update the website, but I will lead with the data that I presented to the committee today.

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

Mr. Labonté, I guess the issue here is really...if it is still here, and there has been a significant change, in light of 2007, the 2005-06 closure of the Petro-Can refinery. There continues to be a question not just of whether or not there's adequacy of supply, which you may or may not be aware of, but in fact that the terms of that supply may very well change. We may be subjected to vulnerabilities based on cost considerations, based on other nations making determinations as to the ability to supply.

Let me ask you this very specific question, and then I will shift over to the Competition Bureau. Do you have an understanding, in any of your discussions, about inventory monitoring--the authority to ensure that pipelines and terminals have full access to all market participants?

You do not have that authority as it currently stands, is that correct? You don't monitor the participants on the pipelines for access to supply, do you?

[Jeff Labonté]

Was that for the Competition Bureau?

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

No, that's for you for now. You don't monitor this currently.

[Jeff Labonté]

No, we do not.

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

Okay.

Let me shift to the bureau now, because I only have a few minutes before another person takes a question here.

Is the bureau of the view that even if this is not a merger, the supply potential, the disruption to the economy, and the potential for an economic hit, which could have an impact just in terms of price availability, would not concern the bureau as it did with the Texaco resolution in 1989? When you had a lot more refineries at the time--taking into consideration some of the comments that have been made here--you nevertheless ordered a divestiture order, at least a hold order, to make sure that the refinery in Montreal remained open, notwithstanding the fact that this may not have been, quote, a “merger”; it was more of a forced merger.

Why are you not looking at this with the same concerns with supply arrangements, which will have an impact ultimately on competition throughout the eastern part of this country?

[Richard Bilodeau]

First off, I think it's important to appreciate what the Competition Bureau's mandate is. As I stated—