Andreoli on Oil & Fuel: What will the Keystone XL decision mean to your transportation budget?

Rare is the news day that passes without mention of the proposed Keystone XL (KXL) pipeline. In fact, just as I was about to send this article to the Logistics Management editors, news broke that President Obama rejected the proposed route for the KXL. Of course, this is not the last we will hear of the project. The route will be revised and resubmitted for review, and we will soon revisit the issues surrounding the KXL.

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Rare is the news day that passes without mention of the proposed Keystone XL (KXL) pipeline. In fact, just as I was about to send this article to the Logistics Management editors, news broke that President Obama rejected the proposed route for the KXL. Of course, this is not the last we will hear of the project. The route will be revised and resubmitted for review, and we will soon revisit the issues surrounding the KXL.

Labeling tar sands as the dirtiest and most carbon-intensive source of liquid fuels, environmentalists have galvanized around opposition to the proposed pipeline, which will connect Hardisty—the collection point for Athabascan syncrude—to Cushing, Okla., and on to Houston and Port Arthur, Texas.

Opponents hope that by pressuring government, the U.S. will refrain from granting permits, and, as a result, Athabascan syncrude will remain stranded. While the former may be true, the latter does not necessarily follow.

The pushback against the KXL is intense, but the pipeline is staunchly supported by many people who are motivated by energy security and the promise of jobs creation.

TransCanada, the firm that has proposed the KXL, claims that construction will create 20,000 jobs and help the U.S. become more energy secure; however, a Cornell University study claims that “construction of the KXL will create far fewer jobs in the U.S. than its proponents have claimed and may actually destroy more jobs than it generates.”

Of course, both the TransCanada-funded study and the Cornell study are politically motivated, but even more importantly, political motives underlie how the media frames the findings. As Mark Twain put it: “If you don’t read the newspaper you are uninformed. If you do read the newspaper you are misinformed.” 

There are three reasons why the cancellation of the KXL will not likely have any impact on global greenhouse emissions. First, there is more than one way to skin a cat, and more than one way to get syncrude out of Athabasca. Another pipeline company, Enbridge, is currently seeking approval to construct a pipeline connecting Bruderheim (a town just east of Edmonton, Alberta) to Kitimat, British Columbia, where syncrude can be loaded into oil tankers and shipped to Asia.

Alternatively, syncrude could be loaded onto rail tank cars—in fact, this is starting to occur. With a capacity of 600 barrels each, it would take roughly 10 unit trains to equal the volume that the KXL is designed to transport (just over 800,000 barrels per day). While this is a lot of rail cars, a bit of envelope math suggests that 80 to 100 unit trains of far less valuable coal leave Wyoming every day.

Though trains are a more costly option, they offer a distinct advantage in that they can go to tight markets where the same barrel of oil will sell for a premium, which may be greater than the transport cost differential.

But even in the unlikely event that Canadian syncrude does become stranded, Canadian syncrude may simply be substituted by heavy oil sourced from Venezuelan tar sands. Currently the expansion plans for heavy oil production from the Orinoco Belt (a tar sands deposit similar in composition and size to Canada’s tar sands) far outpace Canda’s expansion plans.

The bottom line is that U.S. refineries will either operate at capacity or shut down. If the KXL is constructed, Canadian syncrude will supply them. If the KXL is not constructed, one or more refineries will either be shuttered, thereby causing fuel prices to increase, or these U.S. refineries will be forced to purchase oil on the open market, which means that the U.S. may source dirty heavy oil from Venezuela.

While there is no guarantee that the diesel produced in U.S. Gulf Coast refineries will be sold to U.S. consumers (in December we exported 22 percent of the diesel we produced), construction of the KXL would further lock in the U.S. as the most economical destination for Canadian syncrude—and from a price perspective this is certainly a good thing.

As I’ve explained before, the relative over-supply has suppressed the price for crude delivered to Cushing and regional refineries served from there. This relative glut, which is due to the increased output of Canadian syncrude and Bakken shale oil, underlies the divergence in price between West Texas Intermediate and Brent crude streams. These savings have been passed on to the consumer, and this is why diesel has been somewhat less expensive in the Midwest than elsewhere in the U.S.

Though Canada exports oil to countries other than the U.S., the U.S. consumes the majority of Canada’s oil production. This is in part due to the configuration of the current pipeline infrastructure, but it also results from the NAFTA “proportionality clause.”

The proportionality clause states that Canada must make available for U.S. purchase an amount of oil and gas proportional to the average of Canada’s oil exports to the U.S. over the previous three years.

The three-year rolling average of Canada’s U.S. exports as a percentage of production through 2010 was 60 percent. Assuming that it remains at this level, if Canada produces 3.6 million barrels per day (mbd) next year, by NAFTA convention, they must sell 2.16 mbd to the U.S., but only if the U.S. demands this amount. If, however, the U.S. only purchases 1.8 mbd, the 3-year average will drop and Canada will no longer be beholden to selling 60 percent of its oil to the U.S. in the future.

In short, the world oil market is far from perfect, and as it stands now, the U.S. benefits from the proportionality clause. If we choose not to approve any version of the KXL, we may inadvertently lose the price advantage and security that the proportionality clause currently ensures.

While environmental concerns over tar sands production are justified, refusing to build the KXL pipeline will not meet environmentalists’ primary goal to reduce greenhouse gas emissions, but will instead simply push production and emissions around the globe.

Canada’s tar sands will be produced unless production itself is disallowed or becomes uneconomical. The question that the KXL helps answer is whether the U.S. or China will be the end consumer of Canadian syncrude. And if the U.S. is not consuming Canadian syncrude, we may very well substitute Venzuelan heavy oil because there aren’t many options left.

There are no ideal solutions to the current situation, but some choices are clearly better than others. Failing to permit the KXL will most likely cause U.S. imports of Canadian oil to decline, and over time the proportion guaranteed through the proportionality clause will erode. Through the proportionality effects, failure to approve the KXL will likely make the U.S. less energy secure and will most likely result in higher domestic fuel prices.

About the Author

Derik Andreoli
Derik Andreoli, Ph.D.c. is the Senior Analyst at Mercator International, LLC. He welcomes any comments or questions, and can be contacted at [email protected]

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Article Topics

February 2012 · Oil · Transportation · All Topics
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