Prime Minister Justin Trudeau’s bid to press ahead with construction of the Trans Mountain pipeline suffered a major setback after a Canadian court nullified approval of the project.

The Federal Court of Appeal ruled Thursday that the regulatory review of the pipeline expansion was “impermissibly flawed” because it excluded project-related tanker traffic. In addition, the court found the government failed to fulfill its legal duty to consult indigenous people.

The decision effectively halts construction of the conduit, which has been seen as a key project for Canadian oil-sands producers suffering through lower relative prices for their crude due mainly to a lack of pipelines.

It’s also a major headache for Trudeau, whose government is purchasing the $4.5 billionpipeline from Kinder Morgan Inc. in order to ensure its construction. About half an hour after the court issued its ruling, Kinder Morgan Canada shareholders, meeting in Calgary, voted almost unanimously to proceed with the sale.

“Within the industry, there’s frustration,” said Allan Fogwill, chief executive officer of the Canadian Energy Research Institute. “It’s not clear to most proponents and customers of the pipelines: when is the approval of a project final and what more has to be done?”

Today I spoke with Premier @RachelNotley - and reassured her that the federal government stands by the TMX expansion project and will ensure it moves forward in the right way. — Justin Trudeau (@JustinTrudeau) August 30, 2018

Market Reaction

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Shares of Canadian oil companies plunged on the prospect the pipeline shortages that have weighed on the price of their crude will continue. The S&P/TSX energy index dropped as much as 1.1 per cent following the ruling, and was trading 0.2 per cent lower at 1:45 p.m. in Toronto. Among the top decliners were oil-sands companies like MEG Energy Corp., which slid as much as 8.6 per cent, and Cenovus Energy Inc., which dropped as much as 5.6 per cent. Kinder Morgan Canada shares rose 0.9 per cent to $17.

Finance Minister Bill Morneau, speaking on BNN Bloomberg television after the ruling, said the government remains committed to getting the pipeline built, arguing it’s needed to diversify exports and ease the price discount that comes from being so reliant on the U.S. market.

“We are going to be here as long as it takes to make sure the project gets done,” Morneau said. He declined to comment on how much of a delay the court ruling would cause.

Ian Anderson, president of Kinder Morgan Canada, was similarly undaunted. “We remain committed to building this project in consideration of communities and the environment, with meaningful consultation with indigenous peoples and for the benefit of Canadians,” he said in a statement.

Canadian heavy oil prices fell to a US$31 a barrel discount to West Texas Intermediate futures this year, the biggest discount since 2013. Three projects that could support prices aren’t scheduled to be fully operational until the next decade, including Trans Mountain, Enbridge Inc.’s Line 3 and TransCanada Corp.’s Keystone XL.

“We have seen the issue this year: deep discounts and that’s affecting the pace companies are sanctioning projects,” Kevin Birn, a director on the North American crude oil markets team at IHS Markit, said in a phone interview. “We have got three pipes in the race right now. You need at least two of them to resolve the current issues.”

In addition to faulting the National Energy Board report on which the government based its approval, the court said Canada “fell well short of the minimum requirements imposed by the case law of the Supreme Court” at the last stage of the consultations with indigenous people.

Thursday’s unanimous decision indicates the court is advocating for an expanded project review scope. The three judges note the National Energy Board should have included tanker traffic in its review and took issue with how the government made its decision based on the regulator’s recommendation -- something Fogwill said he doesn’t believe has been brought up in previous cases.

The Trans Mountain expansion would nearly triple the capacity of the six-decade old line, helping carry almost 600,000 more barrels of oil and fuels a day to the Pacific Coast, where they could be loaded onto tankers and shipped to markets in Asia.

Political Fallout

The legal challenge had been brought by First Nations, the City of Vancouver and others. The government can appeal the decision but Morneau gave no indication it would, saying it was still reviewing the 250-plus-page decision.

British Columbia Premier John Horgan, who was elected in part on his opposition to the project and whose provincial government has filed a separate legal challenge, hailed the decision. “It’s a great day,” he told reporters in Victoria, adding “our coast wasn’t considered by the National Energy Board.”

A revamped approval process could make the project an issue in the next federal election, currently scheduled for October 2019. Trudeau’s political foes were already sharpening their knives.

“What a total mess Justin Trudeau has made,” Andrew Scheer, leader of the opposition Conservative Party, said on Twitter. “Canadians are paying, literally, for his utter failure to champion the cleanest, most ethical, environmentally-friendly energy in the world. This has to change.”

Today’s ruling is a victory for First Nations rights and for all those who have long held that Trans Mountain’s approval was not based on sound evidence. My full statement: https://t.co/dGi2Wl8erb #bcpoli — Andrew Weaver (@AJWVictoriaBC) August 30, 2018

The double-whammy decision against the #KinderMorgan pipeline validates the strong concerns of #Vancouver & many others that Indigenous peoples were not adequately consulted - and marine impacts of oil tankers were ignored - in the federal review & pipeline approval. — Gregor Robertson (@MayorGregor) August 30, 2018