East Coast OffshoreIssue 31, July 2014

East Coast Offshore highlights emerging legislative, regulatory and competitive issues affecting the Atlantic Canada oil and gas industry.

All monetary figures expressed in C$ unless otherwise noted.

Navigating tax: the race for development of a liquefied natural gas export facility in Nova Scotia Christopher H. Sullivan, Senior Manager, Tax Services, Halifax, Nova Scotia

The global natural gas markets are undergoing significant change. Anticipated growing demand for liquefied natural gas (LNG) driven by Asian markets is expected to exceed existing LNG export capacity in the near future. However, an ever-increasing amount of new capacity is proposed around the world to meet this demand. In Canada alone, 15 LNG export projects have been proposed, and nine have already received export permits.

In Atlantic Canada, the export of Canadian natural gas to the US is no longer sustainable due to long-term increased supply and near-term decreased demand. In the Northeastern US, the Marcellus now produces as much natural gas as all of Canada. In offshore Nova Scotia, the province’s deep water could hold as much as 120 trillion cubic feet of natural gas. As a result, new customers must be found for Canadian gas and excess US supply.

In March 2014, Pieridae Energy Canada received conditional environment approval for its Goldboro LNG project. This proposed LNG facility could be operational by 2020 and would capitalize on the existing Maritimes and Northeast Pipeline (MNP), a 1,400 km transmission pipeline system built to transport natural gas between developments in Nova Scotia and the Northeastern US. The majority owner of the MNP is considering a retrofit to change the flow north for the export of US gas. Another LNG export facility is also being proposed by H-Energy of India, for the Strait of Canso, in Nova Scotia.

These proposed LNG facilities provide some promise that an LNG export facility could be developed and provide significant economic benefits to Nova Scotia. Given the high development costs and risk, any project will proceed only if the economics work. One important element in evaluating the economics for an LNG facility is taxation.

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Tax-efficient structureWe expect that the proposed LNG export facilities in Nova Scotia will be foreign owned or have foreign partners. Tax treaties, carrying on business in Canada, and permanent establishment issues are key considerations for the nonresident proponents; engineering, procurement and construction contractors; and other nonresident stakeholders. The Nova Scotia LNG projects will require careful consideration of a tax-efficient legal and financing structure. Such a structure must meet the commercial and financing needs of the various stages of the project and allow for the tax-efficient entry, operation, distribution of profits and exit by the various parties. The combined federal and Nova Scotia income tax rate is 31%, one of the highest rates in Canada. Unlike BC, Nova Scotia has not yet proposed an LNG tax. If this changed, it could significantly impact the economic viability of any project in Nova Scotia.

Transfer pricingTransfer pricing will be an important aspect for any LNG project analysis. For Canadian transfer pricing purposes, sales of LNG from Canadian to related marketing entities, the provision of management, technical and other services by related nonresident entities to Canada; and the cross-border use of intellectual property will need to be properly evaluated and documented, along with possible tolling fees paid to Canadian processors. The Canada Revenue Agency (CRA) will want to ensure that the profits taxed in Canada reflect an appropriate return based on functions, assets and risks. Given the complexities of the supply chain arrangement in exporting LNG, an advance pricing arrangement with the tax authorities may be desirable.

Capital expenditures and GST/HSTThe cash flow of the project will also be impacted by the tax classification of the capital expenditures. The optimal tax classification will need to be fully considered, given the magnitude of expenditures in constructing an LNG export facility.

Canadian goods and services tax/harmonized sales tax (GST/HST) is generally recoverable by businesses. However, LNG participants need to understand the GST implications of their particular operating structure to ensure that significant payments of GST/HST can be fully recovered and that any recoverable taxes can be recovered as quickly as possible.

Foreign employees and contractorsPayments made to nonresident employees and contractors are subject to Canadian regulation 102 or 105 withholdings, even in cases where they will not ultimately be taxable in Canada. These withholding requirements may be mitigated in limited circumstances at the CRA’s discretion by filing a request for a waiver. Therefore, it is important that the appropriate processes are in place to comply with these withholding and reporting requirements in order to avoid additional costs.

ConclusionCurrently, there are many uncertainties in the fiscal regime applicable to LNG players in Canada. These uncertainties include the potential impact on foreign inbound structures and financing relating to the global Base Erosion and Profit Shifting (BEPS) initiative, Canada’s proposed anti-treaty shopping rules and possible changes to depreciation rates on facility equipment.

Atlantic Canada’s advantages of existing pipeline infrastructure, access to supply and a stable political environment will not be enough to attract the attention of investors and secure long-term supply contracts in today’s competitive LNG market. Capital will always flow to the most economically viable project. To succeed, participants must avoid unnecessary costs by optimizing the tax treatment of these projects and ensuring adequate processes are in place to deal with withholding and compliance requirements.

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Industry developmentsNew projects bring promise of growth and new marketsThe term “new project” brings thoughts of growth, success, cost-and risk. In oil and gas, it can conjure up thoughts of new frontiers, long-term potential and new beginnings. Certainly East Coast offshore has had its share of cautious new beginnings over the years, along with the challenges that setting up new operations in deepwater brings.

The rising interest for Nova Scotia deep-water offshore and prospective LNG export development continues an optimistic view on growth. The Atlantic Provinces Economic Council’s annual project inventory estimates a 7% increase in investment commitment, to total $122 billion in investment value over 439 projects in the region.1 Strong oil and gas project spend helped boost current-year major project spend in Newfoundland and Labrador to $9.8 billion, a rise of 10%. Similarly, Nova Scotia’s spend increased 10% to $3.4 billion.2

New projects, including a growing number of LNG export project candidates, could expand Atlantic Canada’s energy infrastructure. On the back of BP’s and Shell’s combined upstream commitments

in the Nova Scotia offshore valued at approximately $2 billion, the area is seeing more interest in exploration. Contenders for local LNG development of projects are making headway. For example, the $8.3 billion Goldboro LNG project:

• Has received Nova Scotia Minister of Environment assessment approval for the planned 10 million tonnes per annum facility

• Expects to reach final investment decision (FID) in 2015

• Expects to be fully operational in 2020

Atlantic Canada LNG export projects will feel similar challenges to other proposed LNG projects in Canada, including competition, complex regulation and uncharted territory for stakeholder engagement. EY’s latest comment on the Canadian and global LNG dynamics notes the significant level of competition Atlantic Canada can expect, outlining key considerations such as addressing complex capital allocation decisions and developing frameworks to garner stakeholder support.3

On the non-LNG front, East Coast offshore operators are staying the course. For example, Husky has several East Coast offshore projects named specifically on

its 2014 capital projects priorities list, including Mizzen, White Rose, North Amethyst Hibernia, South White Rose, Harpoon and Bay du Nord.

Encouragement of new exploration also continues. Notably, the Canada and Newfoundland-Labrador Offshore Petroleum Board (C-NLOPB):

• Is seeking bids for parcels spread over one million hectares in water depths ranging from 100 to 3,000 meters, in Area B in western Newfoundland and Labrador offshore regions

• Has modified the existing land tenure system, giving more time for exploration companies to conduct scientific assessments of hydrocarbon resources in the lesser-known offshore areas4

Can Atlantic Canada continue to attract investment? Will long-term certainty be needed for LNG investment? Can Atlantic Canada compete with the global LNG market? These and other key questions remain unanswered as plans evolve. Still, economics are good, deepwater activities are successful and fiscal regimes remain attractive. Expect new development plans to continue.

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Regulatory practices are “under construction” Over 50% of the participants in EY’s recent energy financing survey identified regulatory changes as the largest operational challenge for oil and gas projects.5 Regulators are also feeling the pressures of growth, particularly with regard to monitoring new major projects and their future operations. How to provide successful oversight is an increasingly complex question.

C-NLOPB is tackling the challenge by looking for ways to keep pace with growth and change of the exploration and production landscape. It plans to implement a new safety environment oversight management (SEOM) system to cover C-NLOPB territory. The system, once designed, is envisioned to integrate new activities with the departments of Safety and Environment. In part, the new system aims to help guide offshore operators on strengths and weaknesses of their operations.

Thus, the prospect of growth, with its set of complications, offers opportunity for performance improvement and adaptation to new ways of doing business for regulators charged with a growing need to proactively manage risk.

Noteworthy news• C-NLOPB released a request for

expressions of interest for implementing a SEOM system to cover C-NLOPB territory.

• ExxonMobil reports that the Hebron project is on track for operations in 2017 and expects the gravity-based concrete platform to be floated to a nearby deep-water site to finish construction this summer.

• ExxonMobil anticipates the Hibernia South expansion to develop 170 million barrels of oil and add 55,000 barrels a day of production capacity, effectively extending Hibernia’s producing life enough to double the field’s estimated recoverable oil.

• Suncor Energy won the President’s Award, a 2014 Responsible Canadian Energy (RCE) award, for its reduced emission of volatile organic compounds (VOCs) in the Hydrocarbon Blanket Gas and Recovery System at the Terra Nova site, which improved costs and environmental impact.

1 “East Coast projects at all-time high,” Calgary Herald, 27 May 2014, via Factiva, © 2014 Calgary Herald; “Major Projects 2014 report now available,” Atlantic Provinces Economic Council press release, 26 May 2014, © Atlantic Provinces Economic Council.

2 “Spending on major projects hits record high in Atlantic Canada, report says Canadian Press”, 26 May 2014, via Factiva, © 2014 The Canadian Press.

3 Competing in the global LNG market: evolving Canada’s opportunity into reality, EY, June 2014, © 2014 EYGM Limited, ey.com/CA/lng

4 “Four new oil, gas blocks tendered in offshore eastern Canada: regulator,” Platts Commodity News, 15 May 2014, via Factiva, © 2014 Platts.

5 Financing the future energy landscape, EY, December 2013, ©2014EYGMLimited,ey.com/oilandgas/financingthefuture

6 “Request for expressions of interest for implementing a safety and environment oversight management system (SEOMS) in the C-NLOPB region,” Canada-Newfoundland and Labrador Offshore Petroleum Board, C-NLOPB news release, 22 May 2014, ©

7 “Canada looms large in ExxonMobil’s global growth plans,” Daily Oil Bulletin, 12 March 2014, via Factiva, © 2014 Junewarren-Nickle’s Energy Group.

Contact usOur Atlantic Canada Oil & Gas team consists of 189 people in St. John’s, Halifax, Moncton and Saint John. We bring you deep technical knowledge, global experience and a local perspective. We’re part of EY’s global network of 190,000 professionals, working together to share our knowledge, resources and integrated technology. This global reach means we can coordinate a team to address your oil and gas needs anywhere in the world.

For more information about our team or East Coast Offshore, please visit ey.com/ca/oilandgas or contact one of the following professionals:

Darrell Bontes Halifax, Nova Scotia +1 902 421 6263 darrell.bontes@ca.ey.com

Richard Harrison Halifax, Nova Scotia +1 902 421 6244 richard.harrison@ca.ey.com

Scott Howell St. John’s, Newfoundland and Labrador +1 709 570 8267 scott.r.howell@ca.ey.com

Dan LeBlanc Moncton, New Brunswick +1 506 388 7728 dan.leblanc@ca.ey.com

Matthew Lewis St. John’s, Newfoundland and Labrador +1 709 570 8214 matthew.lewis@ca.ey.com

Keith Mercer St. John’s, Newfoundland and Labrador +1 709 570 8276 keith.c.mercer@ca.ey.com

Dean Mullin Saint John, New Brunswick +1 506 634 2134 dean.mullin@ca.ey.com

Troy Stanley St. John’s, Newfoundland and Labrador +1 709 570 8290 troy.a.stanley@ca.ey.com

David Steele St. John’s, Newfoundland and Labrador +1 709 570 8264 david.steele@ca.ey.com

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