Keystone XL: Cornerstone or Tombstone?

How does the pipeline project fit into the larger North American energy puzzle? By Stephen Blank and Monica Gattinger.
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November 17, 2014
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The Republicans have won control of the U.S. Senate! What’s the magic word in Ottawa? Keystone!

The U.S. House of Representatives passed legislation on Friday approving the pipeline project. The lame-duck Senate, still Democratic, may finally vote on Keystone, but the outcome remains uncertain. When the new Republican Senate convenes in January, the outcome will be clear and the new Senate will approve Keystone legislation.

But will President Obama then veto the bill?

Republican National Committee Chairman Reince Priebus was optimistic earlier this month, saying that passing a Keystone approval bill would be the second item on the Republican agenda, after a budget. "I actually think the President will sign the bill on the Keystone pipeline because I think the pressure — he’s going to be boxed in on that, and I think it's going to happen," Priebus said.

Well, maybe. It’s not at all clear what President Obama will do if he receives a bill from the Senate (and there may not be enough pro-Keystone votes to override his veto).

But before leaping to Keystone conclusions, it’s essential to examine the rapid transformations underway in North America’s energy picture. How important Keystone will — or won’t — be to North America’s energy future depends on the outcome of fundamental changes afoot in North American energy markets and politics.

First, the remarkable fall in oil prices. How does this affect the oil sands?

In the last few days, as the global oil supply has increased and demand has weakened, oil prices have been driven down to below $80 a barrel, a drop of more than 25 percent since June. Prices recently fell to a three-year low.  No one thinks this will last, but no one thinks it will end soon either.

There is much speculation about the impact of this on oil producers — Russia, Saudi Arabia, Venezuela — but not much on Canada. (See this Economist article and note that Canada is not in the chart.)

Clearly, Alberta oil sands have always been sensitive to world oil prices. The price line below which it is no longer profitable to work the Alberta fields has fallen because of new technology, but there is some point at which investment will fall off. A recent report from the Canadian Energy and Mines Ministers’ Conference (August 2014) finds that U.S. shale oil production remains economical at $50/barrel while Albertan in situ production (deep extraction) is economical until $65/barrel. Mining ceases to be economical at $85/barrel.

Second, U.S. oil production and imports.

Domestic production in the U.S. of light oil from the Bakken Shale and other formations is surging, pushing total U.S. production to levels not seen since the 1970s. At the same time, rising high gasoline costs (until recently), more fuel efficient cars, and the 2008 recession have driven down national oil consumption. As a result, U.S. oil imports are expected to fall to just 21 percent of total domestic consumption in 2015, representing a 39 percent decrease over the past decade.

Third, Canadian oil exports to the United States.

Even as oil prices are falling and U.S. imports of crude oil are down, Canadian crude oil exports to the United States have grown. In early October, Canadian oil exports exceeded 3 million barrels per day for the first time — up almost 20 percent from the previous week and up 35 percent from the same period a year earlier.

This occurred without oil from a Keystone pipeline. The bulk of crude exports is shipped south on Enbridge’s 2.5 million-barrel-per-day Mainline system (now undergoing an expansion program, according to the Financial Post “to deal with frequent congestion as oil sands supply outpaces pipeline capacity”). And a lot of oil sands crude is moving by rail as well. According to Canada’s National Energy Board, Canada exported 163,000 bpd of crude by rail in the second quarter of 2014, 22 percent more than a year earlier. The Canadian Association of Petroleum Producers estimates current rail loading capacity is much higher at around 800,000 bpd and could hit 1.4 million bpd in 2016.

Why are Canadian oil exports to U.S. increasing? Will exports continue to increase?

Alberta’s heavy crude is welcome at America’s Gulf Coast refineries which are not suited for the lighter, sweeter crude coming from the new domestic sources like Eagle Ford and Bakkan.

Exports of crude oil produced in the U.S. are largely banned, but crude shipped from Canada can be re-exported. As Canadian production increases and U.S. demand stabilizes, more oil from Canada is expected to move through the U.S. to other markets. This process works, but shaves profit margins. Even so, exports of Canadian oil from U.S. Gulf ports which now amount to 25,000 barrels a day could grow to 500,000 barrels a day in the next two years, says FirstEnergy Capital Corp., a Calgary-based investment bank.

Albertan crude is being exported out of Montreal as hopes for the Northern Gateway pipeline to Pacific ports bog down. Kinder Morgan’s Trans Mountain pipeline expansion to the west coast is also encountering stiff opposition, and TransCanada’s Energy East project to move oil sands crude to refineries in eastern Canada also looks set for a bumpy ride.

If these domestic projects don’t come to fruition, would Keystone become central to growing Canadian exports to international markets beyond the U.S. — rather than for supplying U.S. markets?

Fourth, increasing U.S. oil exports to Canada.

Exporting crude oil from the U.S. has been tightly controlled. But U.S. crude can be shipped to Canada, with authorization, and U.S. exports of crude oil to Canada have reached their highest level in many years as production of shale oil surged. This means that heavy crude oil from Alberta now competes with lighter, cheaper oil from the U.S.

The Globe and Mail recently noted, that this new pattern “has dramatically altered Quebec’s diet of crude, replacing such traditional supply sources as Algeria:

So far this year, about 51 per cent of the province’s oil imports have come from the U.S., according to Statistics Canada data. That has translated into lower gasoline prices for consumers in the province compared with the rest of Canada, generating $280-million in savings for Quebec households from January to August, according to National Bank research.

Note that the crude oil that caused so much damage in Lac-Mégantic came from the Bakken fields in North Dakota.

Fifth, will pipeline politics continue to stymie infrastructure development?

Keystone XL has unwittingly become the poster child for opposition to oil sands development and fundamentalist opposition to developing hydrocarbons. No matter that multiple credible studies have found that the project will not lead to a substantial increase in greenhouse gas emissions and that oil sands oil is no more corrosive to pipelines than conventional crude, the project remains a lightning rod for climate change activism.

But it’s not the only project facing this challenge. Northern Gateway (Enbridge), Trans Mountain (Kinder Morgan) and Energy East (TransCanada) are likewise encountering fierce and vocal opposition. The old world of energy development is behind us. We have entered Naomi Klein’s world of Blockadia: climate activists fighting the development of fossil fuels in toto. This moves us well beyond NIMBYism (Not In My Back Yard) to BANANA (Build Absolutely Nothing Anywhere Near Anyone) and NOPE (Not On Planet Earth).

Increasingly, the fate of pipeline projects ultimately rests more on political support than it does on market fundamentals or regulatory approvals. Independent expert-based regulatory decisions are increasingly viewed with skepticism – or even outright rejected – by projects’ political opponents. We’ve seen this in spades in Canada with reaction to the Joint Review Panel’s decision on the Northern Gateway pipeline.

How political leaders respond to contemporary pipeline politics is pivotal. Will they enforce regulatory decisions or will they whither in the face of opposition — no matter the merits of a project?

And finally, what’s going to happen in Mexico?

Will Mexican President Enrique Peña Nieto’s reforms to open up the energy sector to greater involvement of private firms expand Mexican oil production? If so, how will this affect refinery appetite in the Gulf Coast for oil sands product? Will Canadian crude find itself on the losing end of competition with Mexican heavy crudes?

In brief, there are many moving parts to the emerging energy picture in North America that will have a decisive impact on the ultimate importance of the Keystone XL pipeline. All told, it is only one project in the context of a much broader energy transformation underway in North America.

Rather than cheerleading or slinging mud at a single project, we should examine how Keystone fits into North America’s emerging energy architecture. This involves changes in patterns of production, imports and exports in all three North American nations, changes in patterns of demand, as well as changes in pipeline, rail and refinery capacities.

Does Keystone represent a new opportunity for Canada to export Albertan oil to other countries? If other pipelines can be built to take oil sands crude to Canada’s east or west coasts, will Keystone become less essential? If Mexico’s energy reforms revitalize oil production in the country, will it find its product itself increasingly shut out of Gulf Coast refineries?

These are the big questions raised by Keystone. Grappling with them sooner not later will help us discern whether Keystone becomes a cornerstone — or tombstone — in North America’s energy architecture.