Photographs by Getty Images; Illustration by Devin Rochford

Blame Canada’s Kyoto Snub for Keystone Trouble

a | A

(Corrects spelling of Phelps in 11th paragraph. For a Bloomberg View daily news alert: {SALT VIEW <GO>}.)

Dec. 19 (Bloomberg) -- At midnight on Dec. 14, you might have heard the pop of champagne corks at some tables in Calgary and Ottawa. That was the moment Canada’s withdrawal from the Kyoto Protocol on climate change took effect.

It’s easy to see how the bubbly may have seemed in order. In announcing Canada’s withdrawal a year ago, Conservative Environment Minister Peter Kent said he was saving Canadians $14 billion in compliance costs.

In response, several commentators and members of opposition parties raised the flip side of the same coin, that is, the costs associated with not playing along with Kyoto’s carbon-reduction game. These include the increased risks of future climate-related disasters, Canada’s tarnished international reputation and influence, and missing out on the competitive advantages arising from a cleaner-energy economy.

But there’s another, potentially larger price that isn’t talked about much. To find it, one must look inside the esoteric world of the oil market.

Crude from Canada’s oil sands in Alberta is sold under the Western Canadian Select contract, which trades at a discount to the benchmark West Texas Intermediate contract. The discount now stands at more than $30 a barrel.

Given oil production of at least 2.5 million barrels a day, that difference implies $75 million a day, or $28 billion a year, of lost revenue.

Ask any analyst what they think is the biggest determinant of this discount and they will give you the same answer: insufficient pipeline capacity. Ron Liepert, Alberta’s former energy minister and its current finance minister, has a less technical term for it: “landlocked in bitumen.”

Keystone Denial

President Barack Obama’s temporary denial in early 2012 of a permit for the Keystone XL pipeline, designed to carry oil-sands crude to the U.S. Gulf Coast, epitomizes the problems Canada faces expanding pipeline capacity. But Keystone’s challenges are collateral damage from Canada’s climate policy.

To understand the connection, flash back to 2010. This was a demoralizing year for the environmental movement. The United Nations jamboree in Copenhagen at the end of 2009 had failed to produce a strong agreement, and a cap-and-trade bill had died in the U.S. Senate. Environmentalists were looking for a new, easier target. Enter Canada.

Since taking office in 2006, the Conservative government of Prime Minister Stephen Harper made it clear that Canada would not meet its Kyoto commitments.

Programs established by the erstwhile Liberal government to reduce carbon emissions were dismantled. Internationally, Canada amassed a collection of “Fossil of the Day” awards rivaling swimmer Michael Phelps’s Olympic medal count. For environmentalists in search of a new target, Canada was a serendipitous moose painted with a bulls-eye.

And so the wars over the oil sands and their pipelines entered high gear and continue to this day. Environmentalists are planning yet another demonstration at the White House on Presidents Day in February 2013, calling Obama’s continued rejection of the Keystone XL pipeline their “one big ask.”

For Canada, this poses a real risk that the discount of Canadian oil to the West Texas Intermediate benchmark will persist.

Did it have to be this way? Is oil-sands development inimical to carbon-reduction initiatives like the Kyoto Protocol? The answer is no. In fact, Kyoto could have helped save Keystone.

Cleanup Costs

Despite the label “dirty oil,” the Canadian oil sands are not all that much dirtier than conventional crude. The oil industry estimates that, considering its entire well-to-wheels existence, a barrel of oil derived from oil sands spews 5 percent to 15 percent more carbon into the atmosphere than does a barrel of conventional crude.

All the additional emissions accrue in the production process. The trouble is that the main technology option to reduce those emissions, carbon capture and storage, is expensive. Shell Canada thinks it could accomplish the job for about $70 a metric ton of CO2 reduced. Government estimates have gone as high as $200 a metric ton.

The Liberal government of Jean Chretien that negotiated and ratified the Kyoto Protocol wanted to develop the oil-sands asset just as much as the Conservatives do now. But unlike the Conservatives, the Liberals knew they had to address the oil sands’ carbon emissions and they needed to do it cheaply. So they pressed for a provision in the Kyoto Protocol called the Clean Development Mechanism.

Rather than the expensive process of carbon capture in the oil sands, this mechanism would allow companies to invest in projects in developing countries that reduced emissions in sectors with much lower abatement costs.

In return, the companies would obtain carbon credits that could be used to offset emissions at home. During the Kyoto compliance period, the price of these credits has averaged about 10 euros ($13) a metric ton of CO2, or a fifth to a fifteenth of the potential cost of carbon capture.

Imagine if Canada had stayed in Kyoto -- perhaps not meeting the target, but taking a best-efforts approach under the agreement. It would have implemented a cap-and-trade system that, with the use of carbon offsets and a price on carbon, would have cost-effectively driven oil-sands emissions down to conventional levels.

In this alternative history, the credibility of the argument against “dirty oil” would have been greatly diminished. Environmentalists might have left Canada alone and focused on the greater problem of China’s increasing emissions from coal-fired power generation.

Today’s reality is instead pipeline protests and active campaigns for divestment in oil-sands assets. Today’s reality is billions a year in lost revenue for oil-sands producers, their shareholders and the tax and royalty base.

Time will tell whether Obama finally approves the Keystone XL pipeline. Regardless of his decision, opposition to oil-sands development is unlikely to fade. Maybe Canadian policy makers should pause before swilling any more bubbly over Canada’s withdrawal from the Kyoto Protocol.

(Chris R. McDermott, who was from 1998 to 2006 a Canadian federal negotiator on the Kyoto Protocol, works in private investment in oil and gas, renewable energy and carbon trading. The opinions expressed are his own.)

To contact the writer of this article: Christopher McDermott at

To contact the editor responsible for this article: Mary Duenwald at