Why Keystone XL is more important to Canada than the U.S.

Refineries along the Gulf Coast have plenty of access to foreign crude


None of Canada’s hardships will appreciably affect the U.S. energy market — hence why Obama has not prioritized Keystone XL’s approval.


By

Stratforanalysts

Approval of Keystone XL, the controversial pipeline that would move heavy Canadian crude to the U.S. Gulf Coast, has been stalled ever since it was first proposed in 2008. And it appears as though the oil industry may have to wait longer still.

The Republican-controlled Congress will vote on a bill approving the pipeline’s construction Jan. 9, but President Barack Obama has threatened to veto the bill if it passes.

Washington can afford to wait. U.S. oil production has risen by nearly 4 million barrels per day since 2010, and refineries along the Gulf Coast have plenty of access to foreign crude. But Canada is not so fortunate. Transportation bottlenecks have kept local oil prices much lower than international ones. With so many questions surrounding the Keystone project, Ottawa must continue to look for alternate routes to export its crude — something that will likely galvanize voters ahead of Canada’s federal election in October.

Most of Canada’s oil production is found in the landlocked province of Alberta, and nearly half of the United States’ refining capacity is located in the Gulf Coast. Both countries have wanted a better connection between the two for some time. From 2009 to 2013, Canada exported only 125,000 bpd; the rest of its production went to the Great Lakes region. With such poor market access, West Canada Select, the Canadian heavy oil benchmark, has traded far below international prices for several years. (Currently, it trades for $33 per barrel.)

The Keystone project was meant to solve this problem in four phases. The first phase connects Alberta to the oil terminal in Patoka, Ill., via Steele City, Neb. The second and third phases bring oil from Steele City to Cushing, Okla., and then to Houston. All three entered service between 2010 and 2014. The fourth phase, Keystone XL, is the portion that would send high volumes of crude from Canada to Steele City, where it would link up with the second and third phases of the pipeline.

Plenty of obstacles stand in the way of Keystone XL’s construction. Congress has to approve the bill, and it would have to overrule Obama’s veto if he does, in fact, veto the bill. In addition, the project is still undergoing a U.S. State Department review, which issued an environmental study last January. Also complicating the issue is state approvals. The Nebraska Supreme Court on Friday allowed the pipeline’s construction to proceed. But South Dakota’s construction permit expired in June 2014. So if TransCanada TRP, +0.58% the company in charge of the project, has to wait for a potentially more friendly U.S. administration, it could delay the project until after the U.S. presidential election in 2016.

Alternate routes

With Keystone XL apparently unavailable for now, Canada has had to consider other transport options. Transporting oil to the United States makes the most sense for Canadian companies because it faces less political, environmental and social domestic opposition.

One pipeline, the Flanagan South, which entered service in December 2014, connects the Great Lakes to Cushing, creating some market competition among refiners. However, that link has the same problem as the Keystone project: Getting crude oil across the U.S.-Canadian border to feed it. To bring more Canadian oil to the Midwest, energy company Enbridge wants to expand another pipeline, the Alberta Clipper, which connects Alberta to Superior, Wisc., from 450,000 bpd to 800,000 bpd. But because it is a transnational pipeline, it must go through the same approval process as Keystone XL.

Of course, Canada could build more options to ship oil to non-U.S. markets. The most direct routes would be from the Canadian Rockies to the Pacific Coast — in fact, three proposed routes already exist — but British Columbia has strongly opposed those routes. The Energy East pipeline, which would send 1.1 million bpd to eastern Canada and then onward to foreign markets through the Atlantic, has incurred comparatively less opposition, though it is not universally supported.

The only other realistic option would be to expand crude-by-rail deliveries. But transporting oil by train is more expensive than by pipeline, and companies are loath to use trains even when oil prices are high.

Beholden to Washington

Still, alternate modes of transportation can only do so much. Canada produces roughly 4 million bpd, but Ottawa wants to increase production to 6.5 million bpd by 2030. To reach that target, Canada must bring more oil from Alberta to foreign markets, so any delays on pipelines like Keystone XL and Alberta Clipper will necessarily delay production growth.

Production growth will come primarily from oil sands production, increasing from about 2.5 million bpd in 2014 to about 6 million bpd by 2030 (which includes synthetic sweet crude oil). In a study released by the Canadian Energy Research Institute in mid-2014, the estimated production costs per barrel for oil sands were as low as $50 Canadian dollars (about US$42) and as high as $107 Canadian dollars, depending on which extraction method is used.

These costs put a lot of pressure on expansion projects. If oil prices remain as low as they are currently, profit margins will be small, so production growth will likely never materialize until oil prices rise or technology gains continue to drop prices. This need for growth makes minimizing transportation costs a key issue.

Notably, none of Canada’s hardships will appreciably affect the U.S. energy market — hence why Obama has not prioritized Keystone XL’s approval. In fact, currently the United States is effectively the only country to which Canada can export oil from Alberta. But slowed production growth in Canada creates stronger demand from other heavy oil exporters, including Venezuela, Mexico, Colombia and Ecuador. However, if Canada builds alternate pipelines, U.S. oil refiners that receive discounted Canadian oil may have to buy at higher prices, possibly undermining the advantage the U.S. economy has over other countries with higher energy costs.

The Keystone XL will be hotly contested in Canada ahead of federal elections in October. Prime Minister Stephen Harper of the Conservative Party has been a staunch supporter of Keystone XL and other similar Canada-based pipelines. He has tried to fashion Canada as a global energy superpower, but he has come under heavy pressure from the Liberal Party and its leader, Justin Trudeau. Trudeau favors Keystone XL, but he does not approve of some Canadian-based options for non-U.S. exports, such as the Northern Gateway Pipeline. The Liberals have fared better in the polls for much of the past two years, but more recently the Conservatives have narrowed the lead.

Canada knows that sharing a border with United States can be economically beneficial, but sharing its geographic position, so far removed from the rest of the world, can be detrimental. Ottawa may have its own goals, sometimes distinct from its southern neighbor’s, but it is often beholden to the political machinations of Washington.