By: John Auers and Ryan M. Couture
After seven long years, the continuing soap opera around the Keystone XL (KXL) approval process seems to have finally come to an end; or has it? On Friday morning, citing a “recommendation” from U.S. Secretary of State John Kerry, President Obama formally announced his rejection of the application for the KXL pipeline. To explain his decision, the President stated that the pipeline would neither lower oil prices nor improve America’s energy security. The announcement comes on the heels of a flurry of news earlier in the week, first with TransCanada requesting a delay in the State Department permit review until it could finalize plans for the pipeline’s path through Nebraska (the final state needing approval), followed by the subsequent denial of that request. The rejection by President Obama comes ahead of a major UN climate conference scheduled to begin at the end of this month in Paris, and surprised no one, based on previous comments from the administration. Stating it would “undercut America’s leadership” on the environment, the denial of a permit for KXL is meant to boost Obama’s legacy and “bonafides” in the war against climate change. While this move certainly gives the President a soapbox to stand on, the real impact is unlikely to be as earth-shattering as either he or anti-KXL environmentalists had hoped. What’s more, TransCanada’s decision to essentially withdraw its application certainly put the Administration on the defensive, and makes the rejection seem both reactionary and political. It also, in our opinion, provides an opportunity to potentially resurrect the project at a more opportune time, depending on 2016 election results and future crude oil supply/demand developments.
“This pipeline would neither be a silver bullet for the economy, as was promised by some, nor the express lane to climate disaster proclaimed by others.” – President Obama
We actually agree with the general substance of the quote above from the President as he made his rejection announcement (although we do see tangible economic plusses in both the short and long term). Despite this, there is little doubt it was not either the real economic benefits or even the potential environmental risks which played the overriding role in the KXL permit denial, but rather the political agenda of the Obama Administration. For our part, let’s look beyond the politics and one-upmanship and instead examine the facts. One of the primary driving forces for the construction of KXL was the rapid growth of crude oil production from Western Canada’s oil sands. The decline in oil prices over the past year, coupled with a shift of politics in both Alberta and at the national level in Canada, makes the future growth rate of this production less clear. Already, companies have cut back investment, including Shell’s recent announcement that they were abandoning the Carmen Creek project. The $2bn write down for Shell is just the latest in a series of setbacks for the oil sands, after Total, Statoil and several other major Canadian companies have halted plans for new projects or expansions within the last year. This begs the question on whether production growth will continue and as a result, what is the real need for KXL.
Forecasts for Western Canada production varied significantly even before the drop in crude prices. As they have continued to decline, the forecasts have become even more uncertain. From current levels of 3.7 MMBPD this year, the Canadian Association of Petroleum Producers (CAPP) had forecast that production would rise to 4.6 MMBPD by 2020 and to 5.6 MMBPD by 2025 in their June 2014 annual publication. A year later, having seen oil prices drop by over 60%, they have dropped that forecast to 4.4 MMBPD in 2020 (a decrease of 0.2 MMBPD) and 4.8 MMBPD in 2025 (a decrease of 0.8 MMBPD). TransCanada itself has publicly revealed a more conservative forecast, estimating that production will only grow by 500 MBPD through 2020, about 0.2 MMBPD below the most recent CAPP forecast. There are more optimistic forecasts; Platts quoted a Bentek Energy forecast in a November 4th article calling for Western Canadian Production to increase to as much as 5.8 MMBPD by 2025.
We recently completed a study in conjunction with Schlumberger Business Consulting which examined worldwide crude supply and demand fundamentals. The regional crude production forecasts which were developed in this study (The Evolving New World Order) are based on relative production costs and the crude price necessary to achieve equilibrium between supply and demand on a global basis. Our forecast for Western Canadian production (which is shown in Figure 1, below) is more conservative than either CAPP or TransCanada, with production only growing by 400 MBPD by 2020 (to 4.1 MMBPD) and 600 MBPD by 2025 (to 4.3 MMBPD).
If You Build it They Will Come (and Crude Will Flow)
All along the assumption (by both proponents and opponents) has been that KXL was necessary to move growing crude production out of Western Canada, and if it wasn’t built, the crude would stay in the ground. However, in addition to the lower expected growth rate of production due to the change in the price environment, the logistical landscape has changed as well, as the KXL permit process dragged out. Others, most notably Enbridge, have stepped into the breach, completing projects that have actually provided excess pipeline capacity out of the region, making the need and even utility of KXL in doubt, at least until production growth accelerates again.
Today, nearly 3.5 MMBPD of pipeline capacity exists to move production out of Western Canada. When you factor in rail capacity, which sits at around 550 MBPD, alongside the 400 MBPD of refining capacity in Alberta, the total is greater than current production levels. Canadian producers and midstream operators have gotten creative, using a combination of rail and the repurposing existing pipeline infrastructure to move crude to market. Looking at projections of capacity out of the region, there is ample to satisfy the production rates for the next several years, even if some projects, such as the controversial Energy East, never come to fruition.
The benefit of KXL was not only having a large capacity line, but that it took a more direct route to access Gulf Coast refiners. Existing pipeline routes go through Wisconsin and down through the Midwest. KXL drew a near straight line from Edmonton down to Steele City, NE, where it would have linked in with the existing Keystone pipeline. Along its route, it also passed through Eastern Montana, where it would pick up a portion of Bakken crude oil as well. Without Keystone, crude is forced to take a longer route through Wisconsin and Illinois, before making its way to Cushing and ultimately the USGC. While KXL was continually delayed, Enbridge was able to expand capacity through their existing system to move increasing volumes down. Expansions of the Mainline System (Line 61 and Line 67) increased capacity from 450 MBPD to 800 MBPD from Edmonton into Superior, WI, and by up to 1.2 MMBPD from Superior, WI, to Flanagan, IL. With the construction of the Flanagan South pipeline running parallel to the existing Spearhead pipeline, an additional 600 MBPD of crude can be moved from Flanagan, IL, to Cushing, OK (a total of 775 MBPD of combined capacity). While not as direct of a route as KXL, it ultimately gets the crude into Cushing and onto the USGC.
The reversal of Line 9, which is scheduled to be completed in the coming weeks after receiving final regulatory approval this fall, will allow for up to 300 MBPD of crude, including bitumen, to reach the Eastern Canadian refiners. This will help increase demand; something producers are hoping will help the currently depressed prices for WCS, while allowing for domestic refiners more crude optionality. The two Quebec refiners, Valero and Suncor, have both anxiously awaited the ability to access oil sands crude. Valero has invested $200M in their refinery and terminal in anticipation of the pipeline’s ultimate approval.
The denial of KXL does not mean the project will never get built. While it is certain the project will not see a reversal of fortunes soon, TransCanada has several potential options moving forward. The most likely is to wait for the outcome of the next U.S. election. Should a Republican win the election, it is near certain they would have a much easier time getting approval with a second application. A second, more brazen (and less likely) option, would be to sue the U.S. for violating NAFTA. A third option would be to work some political solution between the U.S. and Canada, although that may be an increasingly more challenging proposition. The elections in Canada this year marked a shakeup, which have sent some of the pro-industry candidates packing. Both in Alberta and Ottawa, elections marked a shift away from the Conservative mindset of ex-PM Stephen Harper. While the new PM, Justin Trudeau expressed disappointment at the denial of the KXL pipeline permit, it is unlikely this administration will be as critical of the Obama administration as was the last. Regardless of the path forward, TransCanada still owns the right-of-ways, and maintains the ability to construct pipeline along the routes approved by the individual states.
Conclusion
While the rejection of the KXL permit is certainly a setback for TransCanada, it is hardly a devastating blow to the industry at large, or even the final word on KXL. The drop in prices over the last year has and will have a far more significant impact on the oil sands, triggering numerous setbacks as companies pull back on plans for new projects or expansions. The long lead time for oil sands projects mean these setbacks will ultimately delay the need for KXL. While KXL was being delayed, multiple alternate pipeline options to move oil sands to refining centers have been developed and others are moving forward. There is little doubt that when oil prices again rise, the oil sands in Canada, some of the most prolific petroleum deposits on earth, will be further developed. The question remains as to whether the U.S. will ultimately want to allow for Canadian bitumen to be efficiently transported to domestic refiners who are held to some of the highest environmental standards in the world, or see it exported to the growing markets in Asia, where it may not face the same scrutiny.
Turner, Mason & Company is continually monitoring developments in the global petroleum markets and assessing how they will impact the industry. We utilize this analysis to assist both individual clients and also to develop reports and studies which we provide on a multi-client basis. In our most recent study, we teamed with Schlumberger Business Consulting to develop a comprehensive assessment and forecast of what can be expected in global markets and what those trends will mean for production levels, demand, prices, differentials and other key parameters. Earlier in this blog, we referenced the Western Canadian production forecasts from this study, The Evolving New World Order: Rebalancing Oil Supply in the Next Decade. The study contains significant detail and analysis of crude production and flows for all regions of the world. For more information about this publication or studies and other consulting services TM&C can provide, please visit our website or give us a call.