Thursday, March 28, 2013

The Ultimate Relief

How the controversial, critical, market-making Keystone XL pipeline is edging closer to fruition.
This article appears in the April issue of Oilsands Review

By Peter McKenzie-Brown
Oil pipeline construction in North America began in the 19th century. There are now a couple of dozen major lines on this continent alone, and they are supplemented by thousands of gathering and distribution lines. During the 100 years after building began, the major issues surrounding development were the terms between landowner and pipeline operator. The secondary issue was the speed with which the operator could clean up and remediate rights-of-way after a spill. Put another way, pipelines were seen as necessary infrastructure that contributed to the economy and, therefore, to the public good.

This article argues that the economic realities behind pipeline construction haven’t changed, and that North America’s long record of safe pipeline operations will contribute to momentum for approval of the Keystone XL pipeline. There are economic imbalances in global oil markets and continental labour markets that need to be rebalanced. Keystone will be a key part of the rebalancing act.

Proxy Battleground
There would be little need for this discussion if environmentalism hadn’t become such a powerful force. The level of hyperbole in the discussion has been extraordinary, with articles by environmentalists bearing such headlines as “‘Game Over’ For Planet If XL Oil Pipeline Is Built to Tap Alberta Tar Sands.”  So heated has the debate been that the Obama administration found it politically expedient to postpone a decision on Keystone until after the recent election.

Canada West Foundation’s senior economist, Michael Holden, recently released a study that analyzed what he calls the “vilification” of the oilsands. Holden says, “We wanted to look at the overarching narrative, the main issues, both positive and negative,”  and continues, “What we found is that there is a battle between the perceived economic benefits and perceived economic risks associated with oilsands development. They were a number of issues that came out of that, (one of which is that) pipelines have become a proxy battleground for the whole discussion about oilsands development.”
Although he believes Keystone is likely to get approval, he won’t gainsay the effectiveness of the environmental movement. “The track record of the people opposing the oilsands speaks for itself. They got the pipeline route changed, the project delayed and even now there’s no guarantee that the project will pass the State Department. The delay is all the evidence we need.”

Price differentials can become a powerful force for change. Burgeoning production from Canada’s oilsands has driven down the price of North American crude oil, especially relative to international oils like Brent and other light products. That same sunny outlook for Canadian oil production has multiplied the number of options aimed at finding international markets to ease gluts in oil supply.

The underlying reality, though, is that the US and Canada are responding to growing production by finding alternative pipeline, rail and barge systems to take Canadian and American oil to coastal markets and to Eastern Canada. Neither government nor the petroleum industry itself wants oil differentials to continue, and the billions of dollars at stake can motivate quite a bit of change. A web of oilsands pipelines is spreading from Canada’s oil hub at Hardisty, Alberta into American markets. Three years ago, TransCanada’s new Keystone Pipeline began delivering 435,000 barrels of oil to refining centres in Illinois, while Enbridge’s Alberta Clipper began delivering 450,000 barrels per day to Superior, Wisconsin. Those lines are a metaphor for the industry-driven activity taking place across North America.

Governments are also driving innovation. After TransCanada proposed converting one of its eastward-bound gas lines into a pipeline for bitumen, New Brunswick Premier David Alward took the idea a step further. He has suggested that the company should also link that line to refinery systems in Quebec and to New Brunswick. The Irving Oil Refinery (Canada’s biggest, and now reliant on expensive imported oil) is located near New Brunswick’s great deep-water port at St. John, and could be modified to refine bitumen. Such an extension could even provide diluted bitumen with access to tidewater.

In the proxy battleground Holden described, Keystone XL illustrates a conflict between old issues and new ones.

Old Issues and New
The old issues are technical and economic. The barrel of oil is blackening everywhere as supplies of light, sweet oil decline, and global demand is rising. Oilsands production is increasingly available and needs markets. The world’s big refining centres need feedstock and have the capacity to refine bitumen; pipelines are efficient and safe. The proposed pipelines are mega-projects that will provide jobs and economic stimulus. Oil-importing countries around the world want to develop secure, longer-term supplies, and they are paying much higher prices than Canadian producers – price-takers rather than price-makers – receive. According to Holden, “Once the oil is sold to a refinery in the Gulf coast you automatically are getting international prices. Once you get to the coast the actual market is virtually secondary.”

The new issues are soft and environmental. Some environmental groups are aggressive against hydrocarbons, especially bitumen. They have successfully painted the oilsands black and want to further punish Canada’s merchants of dirty oil. Citizens wanting a greener world worry that the pipelines may lead to industrial accidents that spoil the environment. “It’s important for the oilsands industry to improve on its environmental records,” says Holden, “and for pipelines to be built as safely as possible.”

Poster Child
In addition to displacing offshore imports of crude oil into the U.S. with oil from its closest trading partner, Keystone XL also would help reduce U.S. imports by delivering increased domestic crude oil production from the Dakotas and Montana to U.S. refineries. By moving domestic production from the area in the U.S. that is seeing the greatest growth, it would be an effective response to the need for additional pipeline capacity from America’s northern plains.

America’s Department of State will make the final decision on the Keystone Expansion. Although most of the smart money still seems to be betting that the US government will buy the energy security argument, in his inaugural speech, president Obama said “we will respond to the threat of climate change, knowing that the failure to do so would betray our children and future generations” – a sentiment he repeated during his state of the union address. These comments created a lot of concern within the gas, oil sands and coal industries. He then appointed a climate hawk, Senator John Kerry, as his new secretary of state, and reaffirmed in his state of the union address that “for the sake of our children and our future, we must do more to combat climate change.”

What does all this mean for the oilsands sector? “Our high level view is that the Congressional/international dynamics remain unfavorable for a big cap and trade or carbon tax push by Obama,” according to Robert Johnston, the director of energy and natural resources for Eurasia Group, a New York-based enterprise that bills itself as “the world’s leading global political risk research and consulting firm.”

Johnston thinks there is a “65% likelihood of (Keystone XL) approval by summer.” If environmental groups persuade the State Department to commission an update of a key study – released in 2010 – on the project’s GHG impacts, a common view is that the result will be lower oil sands investment because of the weaker outlook for Gateway and congestion in the midcontinent and Gulf Coast pipelines. Johnston’s view is the exact opposite. “The fact that Alberta’s realized prices are low and that there is a risk of an investment slowdown…means that the US market is less likely to get the security benefits of the oil sands without [Keystone XL], due to the lack of easy alternatives.”

“For climate change to truly be his legacy, Obama would probably need to secure a victory on climate legislation in Congress,” he added. “At present, this is not realistic, given that Republicans control the House and that even moderate Democrats in the Senate are opposed to climate legislation. Congress is still leery of climate legislation after a grueling effort to pass a cap-and-trade bill in 2009-2010 and there is little appetite to resurrect this fight. There could potentially be more support for a less contentious clean energy standard, but it is still too early to say how much backing such a bill could muster. Obama is…likely to push for renewable energy subsidies as part of budget negotiations.”

“If America cannot produce all its own hydrocarbons, many would settle for North American self-sufficiency,” The Economist, a British magazine, argues in an article on energy independence for the continent. “This would require more imports of Canadian oil. That in turn would depend on building Keystone XL, a pipeline that would bring oil from the northern neighbour and reassure Canada that its hydrocarbons are wanted down south. Keystone XL is likely to go ahead in some form after the election but the political controversy over the plan may encourage Canada instead to build pipelines to its west coast to take its oil and gas to the fast-growing markets of Asia.”

Michael Holden also believes the decision on Keystone will favour Canada. “I would be surprised if Keystone didn’t go ahead,” he says, although he’s not a believer in the west coast pipeline option. “In the case of Northern Gateway, I’d be surprised if it did.”

“It’s important for the oilsands industry to improve on its environmental records, and for pipelines to be built as safely as possible,” he adds, so “scrutiny from environmental groups isn’t a bad thing. But these groups are underestimating the economic impact of the oilsands.” He sounds puzzled when he asks, rhetorically, “What is it about the oilsands that makes them a poster child for the environmental movement?”

Other Proposals
As these projects go through the approval mill, inventive companies and people will continue to propose innovative ways to get Canada’s oil to “tidewater” – code for “international markets and prices.” For example, pipeline giant Kinder Morgan is seeking approval for a $4.1 billion expansion of the TransMountain pipeline to BC’s lower mainland. This would involve twinning the existing pipeline, adding new pumping stations, increasing the number of storage facilities and expanding a marine terminal in Vancouver Harbour. This would increase Canada’s ability to ship blended bitumen overseas.

More recently, Enbridge proposed transporting Canadian and North Dakota crude to Gulf Coast refiners with a $3.4-billion conversion of another natural-gas pipeline system. A joint venture with a Texas-based limited partnership, this scheme would involve reversing 1,100 kilometres of an existing natural-gas trunk line to transport 660,000 barrels of oil a day from Illinois to Louisiana. If this system gets regulatory approval, it could be in operation by 2015.

With so many ideas snapping at Keystone’s heels, there are risks in the longer-term timeframe. How soon will Keystone XL be approved, and then how long to bring it to completion? Price differentials are holding back oilsands investment in Canada, and providing “crack-spread” advantages mostly to American refineries in the western states.

The same concerns apply to New Brunswick Premier David Alward’s ambitious ideas about transforming part of the TransCanada gas pipeline into a bitumen conduit to Ontario, and then linking it to Quebec and Atlantic Canada. Is that feasible from the point of view of economics and regulatory approval? Could it be done in the medium term?

Although the timelines are vague, economic forces are clearly promoting change. Increasingly, the outlines of those changes are becoming clear.

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