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John Engle
John Engle
Articles (240) 

Kinder Morgan Has Delivered a Serious Blow to Canada’s Government

Justin Trudeau is paying the price for letting a provincial dust-up become a national crisis

June 07, 2018 | About:

The politically fraught story of Kinder Morgan’s (NYSE:KMI) Trans Mountain expansion project came to something of a conclusion at the end of May, when the Canadian federal government moved to purchase the project from the pipeline company for 4.5 billion Canadian dollars ($3.5 billion). The government agreed to the desperate move when Kinder Morgan threatened to walk away from the project if no agreement was reached by the end of May. With the prospect of losing an economically vital infrastructure expansion, and suffering a nasty political loss to the opposition, the Liberal government of Prime Minister Justin Trudeau caved.

But it did not have to be this way. The federal government had many opportunities to prevent the conflict over the expansion project from escalating into a full-blown crisis. Unfortunately, it failed to see the danger before it was too late. While the move to buy out the project is a welcome relief to beleaguered Kinder Morgan investors, and is certainly better for Canada than having it abandoned, it is still a major blow to Trudeau and his government.

In this research note, we reflect on the crisis, what it means for Canada’s government and what it can teach investors about trading political crises.

The Trans Mountain saga

The trouble started for the Canadian pipeline project when a new minority government, led by the left-wing New Democratic Party and supported by the Greens, took power in the province of British Columbia. The province's government decided to throw out the approvals secured under the previous government, and thumbed its nose at the Canadian federal government’s constitutional prerogative of jurisdiction over inter-provincial pipeline projects. The British Columbian government proceeded to throw up regulatory and legal challenges, while galvanizing environmentalists and First Nations activists to renew their fight against a project that had already won every approval it needed.

At first, the federal government seemed to opt for a wait-and-see approach. Evidently, it expected the opposition to the expansion to fall apart fairly quickly and that the British Columbian government would strike a deal with Kinder Morgan that would allow it to proceed. Kinder Morgan made an effort at this sort of compromise, but when the company was rebuffed and slapped with a raft of legal challenges, the company went on the offensive. Even then, the federal government kept its head down, leaving the fight to the provinces and the courts. The government of Alberta, the other province affected by Trans Mountain, was eager for the project to continue. Perversely, Alberta is also led by the New Democratic Party, making the fight something of a civil war within the left-wing party.

As the months dragged on and the British Columbian government refused to yield or compromise, Kinder Morgan set a firm deadline for the end of May. It would not invest any further in the project until it got clarity. That galvanized the federal government to step in at last, but there was too little time by that stage to end the escalating crisis. And so, rather than simply have Kinder Morgan walk away, stranding a vital energy infrastructure project in the process, the federal government decided to cough up the cash to buy the project off the American company.

Political tight-rope

While ostensibly standing behind its approval of the Trans Mountain expansion, Trudeau’s government was unwilling to make a full-throated defense of the project. The reason for this tightrope walking is a product of Canada’s political system.

Trudeau’s Liberal Party holds the political center ground, which gives it the advantage of speaking for the “average Canadian voter” to a degree, but also risks it being squeezed out by the Conservatives on the right and the New Democratic Party on the left. It is a tricky balancing act, one that few leaders are able to manage for great lengths of time.

In the case of the young first-termer Trudeau, who held no government office before his elevation to the premiership in 2015, striking the correct balance has proven very difficult. Trudeau has been working to burnish his millennial credentials with intensive social liberal policies. But on the economy, it has been harder to square his environmentalist sensibilities with Canada’s strong reliance on the energy sector. The seeming animosity – or ambivalence – toward the energy sector has resulted in political consequences.  Conservatives are already starting to run neck-and-neck with the Liberals and could threaten Trudeau’s position in the next general election.

Trading politics

We had surmised, when British Columbia's government started throwing up roadblocks, that the provincial administration would cave once offered some cash and other concessions. We further foresaw the federal government stepping in relatively quickly to prevent a local conflict from turning into a national crisis. Alas, we misjudged Trudeau’s political acumen – and that of the inner circle of Liberal Party grandees who set much of the country’s policy. The federal government responded far more sluggishly than we anticipated, and British Columbia’s opposition far more hard-bitten.

Despite those miscalculations, the saga has ended on a positive note. Kinder Morgan’s share price has been buoyed, albeit only by a bit. More importantly, focus can now shift from this project that, while important, never held existential importance to the company or its future growth trajectory. Now that the dark clouds of uncertainty have been dispelled, investors can look at Kinder Morgan with clearer eyes. The company has an impressive yield and plenty of upside. And the cash payment from Canada will go a long way toward helping clean up the balance sheet.

Overall, it is a win for Kinder Morgan, but not a perfect one. As for Trudeau, it cannot be called anything other than a loss, though the endgame decision to buy out the project turned a total disaster into merely a small disaster.

Disclosure: I/We are long KMI.

About the author:

John Engle
John Engle is President of Almington Capital - Merchant Bankers. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin and an MBA from the University of Oxford.

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