Illustration by Nous Vous
On Keystone, Environmentalists Lose by Winning
TransCanada Corp. (TRP)’s proposed $7.6 billion Keystone pipeline system, which would take crude from Alberta’s tar sands down through the Midwest and on to Texas and the Gulf Coast refineries, could be scuttled because of concerns about its potential impact on a major aquifer in Nebraska.
President Barack Obama has blocked the project application, citing the need for further review. TransCanada intends to reapply, but a decision won’t be made until after the U.S. presidential election.
Yet environmentalists could find that an apparent victory over Keystone will do more harm than good. The U.S. economy, meanwhile, is set to learn a hard lesson.
If the aim of opponents was to keep TransCanada from building the 1,600-mile Keystone line, then they have accomplished their mission. But if the objective was to fight global carbon emissions by hindering the expansion of Alberta’s tar-sands production, then little has changed. What’s more, a win for Nebraska’s farmers has now dramatically increased the risk to the pristine rainforests along the coast of British Columbia.
Output from Canada’s tar sands, currently about 1.5 million barrels a day, is forecast to double by 2020. Until Keystone was tripped up by the Nebraska aquifer, the project looked like the best option for getting new production to world markets. In the long run, several new pipelines will be needed to handle the extra volume from the tar sands. But in the short term, the competition to build a new line looks like a horse race. Keystone had the inside track, but the political delay has created an opening for a competitor, Enbridge Inc. (ENB)’s $5.5 billion Northern Gateway that could ship about 525,000 barrels of oil a day from Alberta to a terminus in Kitimat, British Columbia. Regardless of which pipeline gets the nod, once construction begins, the necessity for oil-sands producers to build the other line will be alleviated.
Right now, Canadian oil companies have a huge incentive to fast-track another pipeline out of Alberta. The bulk of the province’s tar-sands output currently ends up in refineries clustered throughout the U.S. Midwest. An increase in volume from the tar sands, combined with prolific production from so- called Bakken shales, a new oil play being exploited in North Dakota and Montana, has created a supply glut at those refineries.
As it stands, Canadian oil makes it only as far south as Cushing, Oklahoma, the terminal point for the pipeline system. The plan for Keystone would extend the system another 435 miles to the Gulf Coast, effectively connecting landlocked Cushing to world oil markets. Gulf Coast refineries also hold more spare capacity than those of any other refining region in the U.S.
A surplus of oil backing up at Cushing has turned into a sweet deal for Midwest refiners, and explains why West Texas Intermediate crude traded more than $20 a barrel lower than benchmark world oil prices for most of 2011. Without a new pipeline, Midwest refiners will get to keep paying a discounted price for Canadian oil.
Considering that Canada exports more than 2 million barrels of oil a day to the U.S., getting shortchanged by $20 on every barrel sold is no trifling matter. It works out to about $40 million a day or roughly $1.25 billion a month in forgone petrodollars. And it’s not just Canadian oil producers that take a hit. The royalties collected by Alberta’s provincial government also shrink with the corporate taxes collected by Canada’s federal government.
What exactly happens to that missing $20 a barrel? U.S. motorists don’t get a break at the pumps. The big winners are the oil companies that own the Midwest refineries, which have been pocketing huge profits on the back of abundant supplies from Canada.
In the refining business, the difference between the cost of feedstock, such as bitumen from Alberta’s tar sands, and the price charged for end products, such as gasoline and diesel, is known as the crack spread. A wide crack spread means refiners are making a lot of cash. In Cushing, crack spreads have been as much as five times wider than margins for refineries in other parts of the U.S. On the Gulf Coast, for example, refineries pay the going rate for Light Louisiana Sweet crude, which trades close to the same price as Brent crude, the benchmark world oil price. The story is much the same for refineries on the Pacific and Atlantic coasts.
Refineries in the Midwest, in contrast, get to fatten up at the expense of Canadian oil exporters. Keystone would have changed that game. Until a major new pipeline is constructed, crack spreads in the Midwest will remain wide open. But it’s unlikely that oil will keep flowing to places where it gets sold at a discount.
If Obama finds the flow of oil from Canada’s tar sands too hot to handle, the Chinese will certainly have no qualms about taking it off his hands. In the event that Enbridge gains approval from Canada’s National Energy Board to build Northern Gateway, a zero-sum world will only tilt that much further in China’s direction. Once oil tankers load up at Kitimat and hit the high seas, their cargoes will go to the highest bidder. That probably means China. Before building a new pipeline, companies such as Enbridge secure commercial agreements to make sure the pipe will be filled with product. It’s an open secret in Canada’s oil patch that representatives of the Asian market are part of the group that has already secured space on a potential new line to the Pacific coast.
Five or six years ago, the idea of Alberta oil heading directly to China would have been unthinkable. Why ship oil across an ocean when the world’s best customer lives next door?
Times have changed. In 2010, China’s state-owned refining company, China Petroleum & Chemical Corp. (600028), or Sinopec, paid $4.65 billion for a 9 percent stake in Syncrude Canada Ltd., which runs the largest of Alberta’s four tar-sands mines. It was the first time a Chinese company took a direct position in a producing tar-sands asset; it won’t be the last.
Before that deal, Chinese companies had already picked up stakes in a number of early-stage projects that have yet to reach commercial production. A year earlier, PetroChina Co. (857), one of the country’s state-owned exploration companies, spent $1.9 billion for a 60 percent share of a project being developed by Athabasca Oil Corp. (ATH), and it paid an additional $680 million for the remaining stake in early 2012. Prior to that, Sinopec and China National Offshore Oil Corp. (883), another state-run company, each picked up ownership positions in smaller players with big plans on the drawing board.
And China’s interest in Canada’s oil patch isn’t limited to the tar sands. Late last year, Sinopec paid $2.9 billion for Daylight Energy, a midsized exploration and production company with operations in Alberta and British Columbia.
China’s deep pockets have also made an impression on the Alberta government. That’s not hard to do when you are willing to pay world oil prices that are as much as $20 a barrel higher than Canada’s one-time favorite customer to the south. The pull of the Chinese market is also being felt in Canada’s capital, Ottawa, where politicians are taking a long look at the merits of giving the go-ahead to Northern Gateway. Shortly after Obama’s pronouncement on Keystone, Canada’s minister of natural resources, Joe Oliver, said he wanted a regulatory decision on Northern Gateway by 2013, a full year ahead of the previous schedule.
It’s tough to refute the benefits of opening new markets for Canadian oil, which is currently being held hostage by U.S. refiners. If officials in Washington continue to drag their feet on Keystone, expect to see Canadian politicians shift their focus from winning U.S. congressional support to fast-tracking a pipeline to the Pacific.
Of course, this doesn’t ensure that Northern Gateway will be built. The pipeline faces fierce opposition from conservationists who are worried about what the project will mean for the ecosystems on the Pacific coast. It faces an even stiffer test in convincing members of the First Nations that a new pipeline is in their best interests. The pipe will cut across lands that are traditionally claimed by First Nations groups, and these unresolved land claims are a potential quagmire that could derail the project.
That said, oil is Canada’s No. 1 export. At current prices, pipeline economics make for a powerful political force. Northern Gateway would increase the revenues of Canadian oil companies by billions of dollars. More cash flow means more profits, which means more money in government coffers.
The government in Ottawa has the incentive to do everything it can to make one of the proposed pipelines a reality as soon as possible. If Northern Gateway goes ahead, the big loser will be the U.S. economy, which needs as much Canadian oil as it can get. And America’s loss could turn into China’s gain.
There is, however, one ray of hope: the end of growth. The triple-digit oil prices that will bring Chinese tankers halfway around the world to fill up on oil extracted from tar could also deep-six the global economy. If China stops growing at its current clip, maybe it won’t need to import oil from the tar sands.
That’s one of the silver linings of a static economy. A new world of slower growth will certainly usher in painful changes, but it also might save one of the largest remaining temperate rainforests in the northern hemisphere.
(Jeff Rubin, a former chief economist and chief strategist at CIBC World Markets Inc., is the author of “Why Your World Is About to Get a Whole Lot Smaller.” This is the third of four excerpts from his new book, “The Big Flatline: Oil and the No- Growth Economy,” which will be published Oct. 16 by Palgrave Macmillan. The opinions expressed are his own. Read Part 1 and Part 2.)
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