Tuesday, March 18, 2014

Pipeline Troubles

There have been lots of pipeline stories in the newspapers lately, and they almost all include commentary that suggests that it is very much in this nation's interests to have these pipelines built. Mr Harper is determined that Mr Obama will approve the Keystone XL pipeline from Alberta to Oklahoma, while others in government and industry are equally determined that there shall be an oil pipeline from Alberta to the Pacific Ocean, and another group wants an oil pipeline from Alberta to Saint John, NB (with an extension to Port Hawksbury, NS). And then there is the pipeline to bring natural gas to Guysborough County where it will be liquefied and exported.

The common element in all of these proposals is this: our energy resources are stranded in the centre of the country, and if we can only get them to tidewater we can sell them at world price.

The world price of oil is generally considered to be the Brent price, which is a basket of crude oils tied to the benchmark created around the Brent fields on the North Sea. These are light, sweet crudes with little sulphur (which makes them sour) and lots of components useful for distilling out gasoline and diesel fuel. (Diesel fuel, kerosene, aviation fuel and home heating oil are essentially the same product.) The current Brent price is about $110 US per barrel. Most of the Middle East oil is sold at either a slight premium or discount from Brent price. And interestingly, our Nova Scotia gasoline price is set off the New York Harbour wholesale gasoline price, which is set off the Brent price.

Another standard is West Texas Intermediate (WTI), which is based upon another light sweet crude commonly found in the centre of continental United States. This crude sells for less than Brent world price because it is generally landlocked in the centre of the continent. This price is usually quoted at Cushing, Oklahoma, a small town whose principal claim to fame is that almost all of the western pipelines meet there, and they have many huge tank farms capable of storing millions of barrels of crude oil. (It's worth looking at this town in Google Earth!) For most of the past few years WTI has traded at about $20 below Brent price. All of the fracked oil from the Dakotas is priced at a discount off WTI.

Alberta oil is commonly traded as Western Canada Select (WCS), and this benchmark is a blend of Alberta crude oil and bitumen upgraded from the oil sands in northern Alberta. This oil is also landlocked, and in the past few years it has been supplanted by the fracked crude oil from the shale plays in the Dakotas. Shale oil is very light, almost like natural gasoline, which is why it exploded so spectacularly in Lac Megantic, Quebec last summer. WCS is much heavier, with less light gasoline-like components and more of the heavier fuel oil components. For much of the past few years WCS has traded at $10 to $20 or more below WTI, which has traded $20 below Brent, the world price.

Most of the Middle East crude oil is light and sweet, and many of the world's refineries have been designed and built to handle that grade of crude oil. It is very difficult for these refineries to process heavy or sour crude. (Saudi Arabia claims that they have excess pumping capacity but the extra is mostly heavy crudes which are not in demand.) Many of the refineries along the Gulf of Mexico coast in the USA have been built to handle heavy crude from Venezuela, but that oil is not as available now as their political instability reduces exports. The Gulf Coast refineries are awash in light crude from the Dakotas, which they do not process efficiently. They would love to have our heavy Alberta crude but the Keystone XL pipeline has not been built so they have trouble getting our Canadian supplies at a good price. (Lots of heavy Alberta crude goes south by train but that is much more expensive than by pipeline: $10 or more per barrel as compared to less than $5 by pipeline.)

So here are the issues: Alberta crude oil sells for very much less than the world price, and in fact it is backing up at Hardisty, AB where many pipelines meet. If it can be moved to the Gulf Coast they will get at least $20 per barrel more. If it can be moved to the West Coast on tidewater it can be sold to Asia for perhaps $30 more.

The Irving refinery in Saint John NB can process 290,000 barrels of crude per day and it can refine heavy oil, like Alberta's. And so they indulge in arbitrage, which is exploiting different prices for the same commodity in different markets. The Irving refinery sells gasoline and diesel/heating fuels in Atlantic Canada and down the Eastern Seaboard of the United States, and they are able to price their refined products off the New York Harbour price, which is based upon Brent or world price.

In December 2012 Bloomberg News reported that Irving was using 90,000 barrels per day of Alberta and North Dakota oil. According to the story, the Saint John refinery is picking up western oil piped to the Hudson River and bringing it north by barge. They are also bringing crude oil in by train, and it was oil destined for Saint John that exploded in Quebec. WCS was trading at $56.38 per barrel while Brent was trading at $111.00 per barrel. Before additional transport costs Irving was saving $54 per barrel, multiplied by 90,000 barrels per day. And then there are the usual refining profits. What's not to like?

That spread of $54 was unusual, but discounts for WCS of $40 off the world price are not uncommon. And this is why the Alberta and federal politicians are so frantic to get these pipelines built. Royalties are based upon price, so when Irving Oil buys a barrel of Alberta oil for $56 the royalties that producers paid to the Alberta government are based upon that $56. If the oil sold for world price, Alberta's royalties might double. This is what so annoys the governments: monies that should be royalties are instead arbitrage profits for the refiners.

The Keystone XL pipeline proposal has some very interesting elements. There are already lots of pipelines crossing the border carrying oil and gas south and some crude oil and refined products north. The southern part of the pipeline from Cushing to the Gulf Coast is already complete and in operation. The northern part is stalled because it crosses an international boundary and so must be approved by the executive of the US Government, which means Mr Obama. Activists do not want the pipeline built on the grounds that it will encourage increased production from the oil sands, and those activists currently have Mr Obama on edge.

The other interesting element is that the Keystone pipeline may allow Canadian producers to export their oil to Asia, by way of the Gulf of Mexico. Since 1970 US laws have prohibited the export of crude oil from  the USA, except to Canada (a small amount comes here for refining, usually because it is convenient for the refiners). But if the oil is in fact Canadian oil, can it be exported from American ports to foreign countries?  At world prices? These are not small stakes.

Another proposed pipeline would bring Alberta crude to Ontario, Quebec and Saint John (and possibly Port Hawksbury). Some would be refined in the regions but the big plans are for export terminals in Quebec and Saint John to ship oil to as far away as India. There are reports that refiners in that country are already building plants capable of refining Western Canada Select oil.

It is quite possible that having western oil flow to Eastern Canada will improve our energy security, and there may be some extra jobs in the terminals, but it certainly won't lower the price of gasoline. The whole idea behind getting the oil to the ocean is so that it can be sold for export at world price. Which is what we pay now. That won't change.

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