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Starving the Beast: Keystone XL and the Politics of Global Warming

Prepared by: Robert Linden

December 20, 2011

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The Keystone XL pipeline odyssey has become the latest lightning rod for all manner of competing political agendas in and out of Washington, DC. The politicians and pundits have once again managed to render the issue unintelligible to the general public by making the pipeline a featured player in the many storylines competing for attention on the media stage, from Jobs, jobs, jobs to Save the planet. The underlying issues and agendas get lost in the dense fog of obfuscating rhetoric. So what is really going on here?

For the oil and gas industry, Keystone XL is a straightforward response to ongoing geographical shifts in North American crude oil supply, demand, and refining capacity. The market is out there: 200 million American drivers are counting on their next tank of fuel, and the next. North American oil demand may decline in coming decades, but the U.S. still imports half of its crude oil supply. Countering historical trends, crude production is growing rapidly in Alberta and North Dakota, straining the existing pipeline infrastructure built for other times and different purposes. Available refining capacity exists along the U.S. Gulf Coast that is capable of processing a blend of synthetic crude from Albertas oil sands and conventional sour crude production.
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A logistical bottleneck has emerged between Alberta and the Gulf.

The nexus of the bottleneck happens to be in and around Cushing, Oklahoma: more oil is coming into Cushing than can make its way to the Gulf, building local inventories and depressing local prices.

U.S. West Texas Intermediate crude (WTI), priced at Cushing, has traded at record discounts to its European counterpart, Brent crude from the North Sea, for the past year. But this is only the first haircut hitting Canadian producers: prices for their Western Canadian Sour blend has been priced an additional $20/bbl under WTI (see Exhibit 1). Therefore, within the industry, the solution is obvious: build the pipeline, relieve the bottleneck and pay for the pipeline cost with a portion of the price appreciation the capacity will deliver to the producers. Pipeline advocates note that the project will require some 20,000 full-time equivalent (FTE) jobs to build, and support services and supplies will require another 120,000 FTEs, while the pipeline itself will bring another 700,000 barrels a day or more of Canadian crude to thirsty U.S. refineries on the Gulf Coast. The pipeline crosses a portion of the Ogallala Aquifer in Nebraska a critical water resource for the region but its the safest pipeline yet built among the 21,000 miles of oil and gas pipelines now crisscrossing the aquifer. Replacing that 700,000 barrels of overland Canadian oil deliveries would be more oil tankers operating in the Gulf of Mexico, bringing imported crude from less-friendly suppliers at greater environmental risk. Case closed.

A blend known as Western Canadian Sour (WCS)

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Exhibit 1: Brent (North Sea), WTI (Cushing) and Western Canadian Sour Oil Price Trends 140.00 120.00 100.00

US$/bbl

80.00 WCS 60.00 40.00 20.00 0.00

1/1/2009 7/1/2009
11/1/2009

WTI Cushing Brent

1/1/2010

11/1/2010

Source: Bloomberg

Well, not quite. For those U.S. citizens living near the new pipeline corridor, the issue is one of very specific environmental risk versus a vague and highly diffused economic benefit. No matter how safe and reliable pipeline supporters may claim it to be, having no pipeline near the aquifer is an even safer bet. Not having trenches dug across your farmland would be better than having trenches dug across your farmland. These concerns have been extensively addressed by the pipeline developer, TransCanada, which recently agreed to reroute the pipeline around the Sandhills wetland ecosystem to eliminate that spill risk, however remote. Given the extensive pipeline infrastructure that currently exists, protestations of chastity by State of Nebraska officials at this point seem a bit lame and a bit late, so there is a deal to made here that should satisfy all parties.

If these conflicting priorities were all that was on the table, a mutually satisfactory accommodation might have already been reached. But the pipeline crosses an international border, so the U.S. federal government gets a say. Given U.S. obligations to Canada under NAFTA, the proper role for the federal government here would be to determine whether all the rules had been followed, which they apparently have. That federal power to deny TransCanada permission to cross the border, however, has been

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adopted by the many environmental NGOs aligned against the pipeline as the perfect mechanism to bring an end to The Petroleum Age. For this dedicated group of pipeline opponents, the big issue to address is carbon emissions. Since attempts to price these products of fossil fuel combustion have met with no success, lacking the needed political consensus on the cost/benefit relationship underlying a carbon tax or emissions credit (the same tax in another guise), the U.S. Administration and many state governments have gone to Plan B: regulate and restrict access to hydrocarbons and their usage wherever, whenever and by whatever means possible, from drilling permits to renewable portfolio standards to unrelated emissions restrictions. The current agenda of the EPA can be usefully viewed from this perspective. While much of the public debate over Keystone XL is about the risk of local environmental impacts, the real objective of the Obama Administration and the many well-intentioned protestors is to starve the beast: deny access to U.S. markets for Alberta synthetic crude, thereby (it is assumed) reducing global oil supply, thereby decreasing global oil demand (you cant burn what you dont have) thereby accelerating the end of all fossil fuel combustion. Presto: planet saved.

This strategy is consistent with the campaigns against offshore drilling and shale gas development. From this perspective, the threat posed by plentiful, affordably priced oil and gas is that it frustrates this zerocarbon endgame strategy. Peak Oil theories, skyrocketing energy prices and declining domestic Increasing oil and gas

production all support this alternative, indirect approach to carbon pricing. reserves and falling prices do not.

The problem with trying to artificially induce national oil shortages to alter consumer and industry behavior is that its a futile gesture in the context of global commodity markets. Blocking Keystone XL will not reduce global carbon emissions, the only relevant measure. Oil sands production will continue apace as long as it covers its cost within the global oil price structure. The Alberta oil will go to Asia, and the U.S. will buy more on the open market to meet demand. The net production and consumption of oil will be unaffected, other than by any price impact due to the unnecessary costs (and carbon emissions) of shipping Canadian oil by oil tanker to Asian markets. To the extent that anthropogenic carbon emissions pose a threat to the Earths capacity to sustain its growing human population and the biosphere on which it relies, and to the extent that the U.S., in concert with other major carbon emitters, can meaningfully alter the climatic trajectory caused by increasing greenhouse gases, efforts to reduce U.S. reliance on fossil fuels for its energy needs make sense. Manipulating the retail cost of hydrocarbon consumption is a proven way of altering consumer decisions on the next car or home purchase, or the distance one elects to travel between home and job each day,

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or the setting on ones thermostat. Blocking access to nearby fossil fuel production may increase U.S. energy costs, but to an unpredictable extent and with large collateral costs in terms of wealth transfer to often-hostile foreign suppliers and further compromised national security. At least a carbon tax or

emission fee could be applied toward covering a portion of the cost of achieving long-term reductions in carbon emissions rather than simply lining the pockets of foreign producers or paying the cost of inefficient delivery systems. Shutting down Keystone XL will not accomplish its implicit goal while exacerbating all of the downside features of reducing U.S. self-sufficiency. Asia will get our oil and we will get the oil Asia would otherwise purchase, arriving by ocean-going oil tankers posing far greater risk of environmental damage than that posed by a well-designed, routed and constructed pipeline delivery system.

Despite the passion and conviction of the many detractors of the pipeline, their success in defeating its construction would be little more than symbolic and probably pyrrhic in retrospect. The U.S. will continue to need imported oil for the foreseeable future, even during the requisite multi-decade process entailed by a sustained shift to low-carbon energy systems. The State of Nebraska and pipeline developer TransCanada should be allowed to reach a final accord on pipeline routing, and everybody else should just get out of the way.

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