Last month, it seemed the Keystone XL pipeline was nearing approval, but as with most things surrounding the project, things weren't as they seemed. A US state department report reviewed the Alberta, Canada-Nebraska pipeline and indicated the project was unlikely to have a significant impact on climate change. This seemed like a significant positive step for the pipeline, but within the details of the report were critical comments from the Environmental Protection Agency.
Environmental concerns have been the most publicized aspects of the pipeline, with opponents arguing that the project could accelerate climate change by enabling increased production from the oil sands of Alberta, which creates 17% higher greenhouse gas emissions than the average crude used in the US. President Obama will make the final decision on the pipeline, and given his campaign to battle climate change, it is difficult to imagine him defying the EPA and his core Democrat base, especially with midterms later this year. Then again, labor unions will be angered if he blocks the pipeline and the thousands of potential jobs it could create. It is not surprising that he has taken so long to make a decision.
TransCanada (NYSE:TRP) first proposed the project seven years ago, and a lot has changed since then. Back in 2007, there were still concerns that "peak oil" was imminent, and demand for energy was booming in the pre-financial crisis environment. The pipeline was initially viewed by many as a much-needed tool to bring down oil from Canada and ease supply concerns. But now the US is apparently nearing energy independence, and the Keystone project is seen as an environmentally unsafe method of transferring oil to major refiners in the Texas Gulf (via Nebraska).
But oil companies have not been sitting idly during the prolonged approval process, and have been working on other methods of getting the oil from Canada. The refiner, Valero (NYSE:VLO) signed on to receive oil from the Keystone pipeline early in the project and has spent billions upgrading its equipment to handle the type of heavier crude produced in Canada. So to make good on its investment, the company has invested in rail terminals at its refineries to help get the oil in. Last month, Exxon Mobil (NYSE:XOM) announced the construction of a rail facility in Alberta that will be completed early next year.
Oil-by-rail has attracted scrutiny following a series of recent accidents, most notably a crash in Quebec last year that killed 47 people. This might bring additional regulation, such as railcar modifications, but such developments will only result in a short-term slowdown in the rail expansion. Companies will continue to aggressively pursue this transportation method as long as the Keystone XL pipeline remains in limbo.
The economic impact of the pipeline has also generated much debate, but despite heated arguments from both sides, its effect is unclear. TransCanada claims Keystone XL will support approximately 42,100 direct, indirect and induced jobs in the US, and will provide a substantial increase in tax revenues for local counties along the pipeline route, with 17 of 27 counties expected to see revenues increase by 10% or more. It added that the project will result in "spending $7 billion stimulating the local economy."
These claims are countered by the Cornell Global Labor Institute, which says the project budget that has a direct impact on US employment is between $3 and $4 billion. Moreover, any jobs created would be temporary, and between 85%-90% of the people hired to do the work would be non-local or from out of state. It also warned of the economic risks from possible pipeline spills, pollution and the rising costs of climate change. But there is no way of quantifying these risks.
Another argument revolves around the possible impact on oil prices. Intuition would say that the more oil that comes into the US, the cheaper prices will become. But the market isn't so straightforward. Since 2011, refineries in the Midwest have benefited from a glut of oil produced in the region and Canada, which has been easily accessible thanks to an array of pipelines that were granted approval. This has seen US WTI crude oil trade up to $20 less than the global benchmark, Brent, over the last year. The spread was about $8 last week.
However, if the Keystone XL pipeline enables the efficient transport of oil from Canada to the Gulf, then more refiners will be bidding for the oil. It is feared that increased competition for the Midwest oil glut will see an increase in prices.
Yet, just like predicting anything in financial markets, there is no certainty about future prices. Nobody knows where how much oil will cost next year, but the logical policy is to create the most efficient oil transportation network so that supplies can be maximized, thus lessening the impact of a price shock brought about by unexpected events.
Efficiency involves the full development of the Keystone pipeline. Even if Obama rejects the proposal, companies will pursue other methods of transporting oil from Canada, and as has been evidenced, oil-by-rail is not a risk-free alternative. Rejecting Keystone XL won't reduce the production of heavy oil in Alberta. That will only happen when better energy alternatives are promoted.