COTW: Is the Price Right for Keystone XL?

[source: Oil & Gas Financial Journal]

The Keystone XL pipeline is being sold to uninformed Americans as a relatively painless way to insure a future domestic oil supply free of the insecurities of Middle East politics. But US Person knows the actual driver of the proposal, as is commonly the case in matters corporate, short-term profit margins. The chart shows the discount Western Canadian Select (WCS) heavy crude (a blend of 19 different Canadian conventional and bitumen crudes with diluents) is selling compared to the West Texas Intermediate (WTI) benchmark. One can see that although the discount varies, it is substantial. That is because there is a glut of heavy crude oil reaching midwest refineries. Canadian heavy crude is not as valuable as lighter viscosity oils that can be refined into more petroleum products. Canadian dilbit is known in the trade as a "dumbell crude" because middle distillates are reduced in amount. Middle distillates may account for 30% of the products distilled from lighter oils compared to the sulfur rich and super heavy Canadian dilbit. Another factor in the pricing of Western Canadian heavy is the number of nearby US refineries that can cook the gunky stuff. The US midwest market is already saturated with it. Inventory at the Cushing, OK terminus are at record levels now. A Chicago area refinery capable of refining dilbit is slated to come back on-line in the latter part of 2013 but its capacity is 400 Mb/d, while Canadian dilbit is expected to reach 1MMb/d in the next three years.

[source: RBN Energy]

The answer the Canadians have come up with to low prices and excess supply is to build another high capacity pipeline directly to Gulf Coast refineries that can handle heavy oil and thereby reach international markets*. The Gulf Coast is the largest market in the world for heavy crude refining. It already refines heavy crudes from Venezuela and Mexico and has about 2.38 MMb/d of capacity. However in the second quarter of 2012 only 90Mb/d of Canadian crude was reaching Gulf Coast refineries. The only other choice they have is to ship it to Asia from their Pacific Coast, but that means building expensive, and ecologically controversial pipelines over the Great Divide and a deep water port at Kitimat, BC. Two such projects are in the works, Kinder Morgan's Trans Mountain project and Enbridge's Northern Gateway. However, there is significant opposition to both projects from Canadian environmentalists and First Nations. Unless Canadian heavy crude producers find a way to international markets they will have to reduce production levels and that is bad for business [chart] Canadians can expect their dilbit to sell for as much as $28 per barrel on average more on the US Gulf Coast than the price they receive in Alberta. But this price analysis is not guaranteed because it depends on volatile price differentials between WTI, WCS and Maya crudes and changing transportation costs.

One viable alternative that the US State Department failed to compare to the Keystone XL proposal because it was too busy rolling over for the Koch Brothers, et al, is the transportation of dilbit by railcar. Rail transport of bitumen is going on right now and its economic aspect makes it increasingly likely more rail transportation will be used. Heating bitumen in steam coil equipped rail tankers obviates the need for dilution thereby reducing costs and making rail transportation almost as cheap as pipelines by some estimates. One refiner announced at a recent Houston oil conference that it was buying 1600 coil tankers with the intention of running unit trains from Alberta to its east cost refineries. Rail transportation is not without accidents, but is arguably safer than a high capacity pipeline that may rupture in people's front yards as it did in Mayflower, AK.

*Of course WCS will have to compete with other heavy crudes in the Gulf Coast market like Maya from Mexico which trades at a premium to Canada's product.