Will you be paying more at the pump now that the Obama Administration has rejected plans to build the Keystone XL crude pipeline? At issue is whether the US would allow TransCanada, a large Canadian energy company, to build a massive pipeline that would transport crude oil from Canada and parts of the US, all the way down to the US refining center around Houston, Texas. Those for and against the pipeline have peppered the media with dozens of reasons why the pipeline should, or should not, be built.
Here are a few issues worth considering when assessing the impact of the pipeline on your wallet.
The Pro-Pipeline Argument.
The pro-pipeline advocates say the project is desperately needed because there is not enough takeaway capacity available to fulfill Canadian crude production. They fear lots of Canadian crude could be shut in the ground with nowhere to go if this pipeline isn’t built quickly. In addition, they say the few pipelines that do connect Canada’s oil production region to the US currently flow where refining capacity is limited. This means less gasoline for your tank. Connecting Canada with the big refineries in Texas, they say, would solve both problems, as it increases takeaway capacity and refining capacity. The result would mean more supply for US consumers, and therefore, lower gasoline prices.
The Anti-Pipeline Argument.
The anti-pipeline advocates say the project will just serve the interest of big oil corporations that want to make more money and it would do nothing to improve the supply picture in the US. They are concerned that the oil flowing to Texas will not go to the US market, but will instead be refined and shipped via Houston’s massive port to other parts of the world. They cite a TransCanada study that estimates Canadian crude could fetch as much as $4 billion more per year if the pipeline is built because the pipeline would open up new markets to them.
For now, Canadian crude destined for export has only been able to flow to the US Mid-Continent. This has allowed refiners there to lower prices for the oil, as they were the only player in town. Building this pipeline, they argue, upsets that dynamic and would force refiners to pay more for Canadian crude, which would translate to higher prices at the pump.
When would it affect prices at the pump?
Both sides present compelling arguments on the economic angle of this story but there are a few things you should know. First, as you may have noticed, oil prices did not move radically last week after the administration failed to give the project the green light. That’s because the oil price quoted today is for delivery in a month. The pipeline is not expected to be completed until 2015 and a lot can happen between now and then. So, for now, oil traders have just stored this information in the back of their minds.
The major variable.
Second, oil is a relatively fungible commodity, which means a barrel of oil sold in Canada is capable of mutual substitution with most other barrels of oil from around the globe, plus or minus a few dollars, based on how easily the crude can be refined into gasoline and other products. It shouldn’t matter too much where the barrel of oil is sold or consumed, as it should be relatively the same price, minus transportation costs, across the globe. The US receives much of its oil from Canada, a strong ally, as well as from Venezuela, where its relationship is problematic, because both are close by. The only real variable to be considered here is the shipping cost and that is determined by the distance and ease of transport of the crude.
The crude export market.
Bearing this in mind, it seems clear why supporters believe adding more export capacity will help world oil markets. If Canadian crude is shut in and cannot get to an export market, then the price of crude around the world should rise. Currently, there is enough export capacity to deliver all available Canadian crude to an export market and the US Mid-Continent for at least the next four to five years. There is around 1 million barrels a day of spare capacity available on current lines.
Is the export market the best place for the crude?
There is an export market but is that market the best place for the crude? There probably won’t be more demand for much more crude in the Mid-Continent as its refineries reach peak capacity, which means Canadian crude could be de-facto shut in. Eventually, that crude needs to reach other export markets to impact world supply. Texas is perhaps the best place for the crude, as it has the ability to refine heavy Canadian crude in large quantities.
Currently, there is just one large pipeline, the Seaway pipeline, linking the US Mid-Continent to Houston but the pipeline is flowing refined products up north and not receiving crude. The pipeline was recently sold and the new owner said they would reverse the flow to send crude down to Houston next year. This is expected to erase much of the differential that Mid-Continent refiners enjoyed by being Canada’s only export market.
Is the US the only export market for Canadian crude?
Does the US have to be the only export market for Canadian crude? Canada could upgrade its own pipelines to take more of its own crude to its refining center in Ontario. It could also build a pipeline west to facilitate export to China and beyond. While it would cost more money to ship oil to China than to the US, it is better than crude being shut in the ground. Both alternative solutions are in the planning stages, so neither is far-fetched.
The Bottom Line
At the end of the day, it is widely believed that the excess Canadian crude will find an export market. The largest differential seems to be the price of shipping extra oil to either Texas by the Keystone XL pipeline, versus somewhere else. Given how massive the world oil market is, that differential in cost will likely be small and should have limited, if any, impact on the price you’ll pay at the pump.
Cyrus Sanati is a frelance financial journalist whose work has appeared in dozens of leading publications, including The New York Times, BreakingViews.com, and WSJ.com. Follow Cyrus on Twitter @csanati