Written by Steve Kretzmann and Lorne Stockman
Last week, the Obama Administration announced that it would “examine in depth alternative routes” for the Keystone XL pipeline and that this process “could be completed as early as the first quarter of 2013”.
The Administration pledged to consider “all the relevant issues together”, including climate change, energy security, and economic impacts.
This delay is clearly not a denial, but it is a blow to the tar sands industry and its aggressive growth plans. More substantively, based on TransCanada’s own statements and an examination of the Keystone XL contracts, there is good reason to believe that this delay may kill Keystone XL, at least in its current form.
Keystone XL’s business model
Generally, pipelines operate by shipping oil on what is known as the “spot market”— selling space to whatever oil company is willing to pay the most in a “cost of service” model. Keystone XL was going to be different. It was planned to operate on a business model of long-term contracts with very few shippers.
In 2009, TransCanada identified the six shippers, or customers, who had signed confidential long-term binding agreements. They were two tar sands producers (Canadian Natural Resources and Cenovus/Encana), three refiners (Shell, Total and Valero) and one international oil trading firm (Trafigura). It is possible additional contracts have been signed since, but TransCanada treats this information as confidential.
During TransCanada’s third quarter results call in early November, CEO Russ Girling told analysts that “(s)hipping contracts have sunset clauses that could be triggered by a long delay… if the administration delays the project long enough that it becomes a low probability that they will ever get it through in a time frame that meets their needs, they are not going to support us anymore.”
Another TransCanada executive told a court in Nebraska last month that, “TransCanada has a significant interest in being able to satisfy existing contractual obligations to its shippers on the Keystone XL pipeline.”
Analysis by Oil Change International indicates that the contracts signed between TransCanada and its customers are potentially invalidated if oil is not flowing by the end of 2013. With two years needed for construction, work would need to start in early 2012 to stand a chance of meeting these contractual agreements.
Thus, the Administration’s decision puts TransCanada in a highly vulnerable position.
Emerging options for heavy oil refiners
This delay means that those refiners who have signed contracts with TransCanada will likely have the option to cancel or renegotiate them. Might Valero and Shell (to name just two) renegotiate and stay with Keystone/TransCanada? Yes, they might – but it appears to us that there might be quicker and more certain routes for them to obtain the heavy sour crude that they need to refine into diesel for export.
In anticipation of receiving large amounts of heavy oil, many Gulf Coast refiners have undertaken expensive retrofits to allow their refineries to most efficiently and profitably process the heavy oil. They are unlikely to just wait for TransCanada. They are much more likely to find alternative sources of supply in the meantime.
These alternative sources were not as numerous when Keystone XL was originally proposed and those contracts were signed. In short, the market for heavy oil on the U.S. Gulf Coast has changed substantively in the last three years, and TransCanada’s competition just got a leg up.
Enbridge’s proposed Wrangler Pipeline would run from Cushing, Oklahoma to Port Arthur, Texas. Because it doesn’t cross the border, it doesn’t need a Presidential permit, neither does it facilitate the same level of tar sands production growth that Keystone XL would have. It would help to get some of the tar sands crude that is now backing up in the Midwest for lack of customers to Texas. But its capacity to carry new tar sands production out of Alberta is limited by its connections to existing infrastructure that has limited spare capacity. It also will not be a dedicated tar sands pipeline. Tar sands crude will have to compete for space with the booming tight oil production coming out of North Dakota.
Last Wednesday, the day before Keystone was delayed, Enbridge’s CEO said that it had secured enough shippers and were moving forward towards a mid-2013 delivery date. Keystone XL now has no chance of competing with that timeline.
Worldwide Heavy Oil Boom
Since the Keystone XL pipeline was conceived the heavy oil market has changed. Canada is not the only country growing its production. Brazil, Colombia and Peru, to name a few, are all expected to substantially grow heavy oil production over the coming decade and Gulf Coast refiners may well prefer to augment the supply from Wrangler with these supplies. Doing so does not require a contractual commitment to a pipeline that may never get built.
Hart Energy wrote in a recent report on the heavy oil market that if Keystone XL is not built, “there are ample supplies of heavy crude oil on the export market to supply Gulf Coast refineries.”
Tar Sands’ March to the Sea: is it inevitable?
Tar sands producers are desperate to get their product to a coast in order to access international markets. The glut of tar sands oil in the US Midwest is a barrier to growth and they will need to go truly international to grow. Keystone XL would have provided that access as Gulf Coast refiners are increasingly exporting refined products into the international market. This would have provided some of the growth potential needed for tar sands in spite of declining U.S. oil demand.
The Canadian Association of Petroleum Producers was quick to point to its other options. “Other alternatives are being pursued to ensure market access over the medium term,” CAPP president David Collyer said. “Delaying Keystone XL will motivate exploration of other markets for Canadian crude oil products,”
In particular, there are two projects that could move tar sands oil west and one that might go east. All of them face stiff opposition from tar sands opponents and land owners.
The Northern Gateway pipeline is a (CAD)$5.5 billion proposal to build 1,100 mile twin pipelines to carry tar sands oil west and diluent east through the British Columbian mountains to the coast at Kitimat. The westward line would carry 525,000 b/d of dilbit and the eastward line would carry 193,000 b/d of diluent. The oil would then be loaded onto tankers to service markets from the U.S. West Coast to Asia. Enbridge is targeting late 2016 for startup.
If Keystone XL is any guide, and if the level of opposition at this early stage of the government review process is an indication, the timeline is highly ambitious. The route through the mountainous British Columbian terrain poses a number of significant risks and challenges but probably the most formidable challenge will be gaining land easement rights from around 100 First Nation communities who are determined to keep the project off their land.
This opposition is particularly powerful in British Columbia because of the lack of land treaties in the province. In the words of Jim Prentice, former federal minister of Indian Affairs and Northern Development, “the reality on the ground is that the constitutional and legal position of the first nations is very strong”.
The strength of opposition is impressive. The first nation groups have turned down a $1 billion benefits package offered by Enbridge and over 4,000 people and groups have registered to testify at the upcoming regulatory hearings. This number far exceeds (558) that which participated in another long delayed pipeline proposal in Canada, the Mackenzie Valley Pipeline. The Yinka Dene Alliance controls around a quarter of the pipeline route and has stated that, “the pipeline isn’t happening, period.”
Opposition is not just confined to the communities along the pipeline route. There are many communities on the coast, along the potential shipping lane that will be taken by oil tankers, who are also vehemently opposed.
Enbridge recently announced shipping agreements for the pipeline and is expressing confidence about the process. But the facts on the ground are certainly not conducive to speedy and smooth approval.
Kinder Morgan’s Trans Mountain Pipeline Expansion
The Kinder Morgan Trans Mountain Pipeline is currently the only outlet for Western Canadian oil to a Canadian port. It currently delivers about 80,000 b/d of tar sands derived crude. An expansion of this line’s capacity is perceived as a cheaper, quicker and less controversial option to Enbridge’s Northern Gateway proposal. However it is certainly not without its own controversy and opposition.
The proposal involves increasing the size and quadrupling the frequency of tanker shipments in and out of the port of Vancouver and through the ecologically valued Georgia Strait and Gulf Islands. This is not popular in the city that claims to be the birthplace of Canada’s environmental movement. The area is part of a legally designated critical habitat of southern resident killer whales which are listed as “endangered” under Canadian law. Kinder Morgan’s application has been opposed by a number of local and national environmental groups.
This project involves the reversal of an existing line that links Sarnia, Ontario to Montreal, Quebec within Canada and then Montreal with Portland, Maine. Currently the line brings imported oil into Canada to the refining centers in Montreal and Sarnia.
This project was shelved in 2009 but has recently reemerged following moves by Enbridge to begin line reversal on a section of the line. Following Enbridge’s request to the National Energy Board (NEB) to reverse flow on a section from Sarnia to Westover, Ontario, a group of Canadian and U.S. environmental organizations asked the NEB to deny the request. They asserted that for the NEB to consider the project in phases “precludes the ability of the NEB to carry out its mandate to adequately assess the economic, technical and financial feasibility of the project and its environmental and socioeconomic impacts, many of which have cumulative dimensions”.
The NEB has since written to Enbridge asking it to clarify whether the proposal is part of a bigger plan to export crude from Portland, Maine. Once again it appears that it will not be straightforward or quick for Enbridge to open up a new export route for Western Canadian crude.
The fight goes on
The delay of Keystone XL may not be an outright victory for tar sands opponents but it is significant. It is a slap in the face for an industry that generally gets its way in North America. It is a clear signal to the industry that its social license is increasingly fragile. Opponents can place barriers in its way and that is a major threat to the industry’s growth.
If British Columbian First Nations and other tar sands opponents defeat or even delay Northern Gateway or any of the other proposals, the ambitious growth targets of the industry will be curtailed.