Compensation from producers of C$30.4 million (US$29.2 million) is being sought for natural gas reserves and drilling disappointments offshore Nova Scotia by Maritimes & Northeast Pipeline (MNP).

In the wake of a decision by the owners of the Sable Offshore Energy Project (SOEP) against trying further exploration, MNP is seeking the cash as a 2010 toll surcharge generated by a risk management provision of its construction financing. ExxonMobil Corp. in mid-July said it had decided not to extend the life of the SOEP (see Daily GPI, July 12).

When MNP was built in 1999 "the biggest risk to lenders was gas reserve risk," according to written testimony by banker Cliff Inskip, CIBC World Markets Inc.'s project finance director, in an application to collect the money filed July 26 with Canada's National Energy Board (NEB).

"As it turned out the risk was real," Inskip adds. "The expected gas reserves and new firm service agreements (to extend and expand deliveries on the pipeline) didn't materialize."

The risk management provision of the project's financing required MNP to set aside equity earnings distributions to its owners in an escrow account, earmarked for payment to bondholders, if SOEP failed a gas supply test eight years after production began.

By the time the test deadline rolled around in 2007, the offshore production platform's owners disclosed that its gas supply base was severely disappointing. SOEP partners Shell Canada and Pengrowth Energy Trust cut reserves estimates by 60%, down to 1.4 Tcf from initial projections of 3.5 Tcf.

The downgrade drew no quarrels from the other participants in the production project consortium: senior and operating partner ExxonMobil, its majority-owned Imperial Oil and Mosbacher Operating Ltd. A formal reserves and production projection by the Calgary engineering and geology consulting house of Gilbert Laustsen Jung Associates confirmed that the SOEP group cannot guarantee keeping the 580 MMcf/d pipeline open.

Since the financial risk management provision kicked in, the loan repayment escrow account has accumulated about C$161 million. The total will increase to C$190 million by the end of this year and keep on growing to C$263 million as of mid-2012. At that level, the account will cover all principal owing to holders of MNP construction bonds, says the application to the NEB.

The pipeline's owners -- led by Spectra Energy with 77.5% -- say the money swept away from their anticipated returns amounts to additional equity in the project. All toll revenues exceeding operating expenses and bank debt servicing have been going into the risk management account since Nov. 30, 2007, MNP reports.

The C$30.4 million (US$29.2 million) 2010 toll surcharge sought by the NEB application was calculated as an 11.8% return on the equity represented by the escrow account, a rate that MNP says is in step with current market conditions.

The application follows a clear signal that the SOEP consortium has no intention of making further attempts to shore up or extend its output after its current gas reserves are depleted.

An opportunity to add supplies with fresh drilling was provided starting last December when the Canada-Nova Scotia Offshore Petroleum Board posted shallow-water exploration rights for sale near the production platform. When the deadline for receiving bids rolled around this June 24 no takers stepped forward, and the SOEP group indicated further drilling in the area is now regarded as uneconomic.

SOEP production continues at a rate of about 350 MMcf/d, or 40% below MNP's capacity. Use of the pipeline, built primarily for exports to the northeastern United States, will revive by the end of this year, when Encana Corp. will start production by its Deep Panuke project near the SOEP site 250 kilometers (160 miles) offshore of Halifax. Encana's agenda calls for initial Panuke output of 200 MMcf/d to rise eventually to 300 MMcf/d, with all the gas being bought by Spanish international energy trading house Repsol YPF S.A. for resale as part of its North American growth program.

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