The Keystone Quandary

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Includes: ENB, TRP
by: Kent Moors

The U.S. State Department yesterday announced it would spend more than a year studying the route for the proposed Keystone XL oil pipeline, which means a delay in what some have considered a vital access to sourcing from Alberta's vast oil sands.

Where the current plan actually puts the pipeline has become the single most contentious issue.

Environmentalists are already hailing the decision to postpone the pipeline, which would cut through Nebraska's Sand Hills, considered an ecologically sensitive area. And there is a corollary concern over maintaining the quality of drinking water throughout the region.

The prevailing argument these days is the volume available from the oil sands would sufficiently ease American reliance on crude from volatile regions of the world.

Yet that position avails nothing if that volume cannot make it into the lower 48.

The State Department has jurisdiction over Keystone because the pipeline would cross an international border into the U.S., pushing that volume from Canada, some 1,700 miles to the Gulf of Mexico.

As the U.S. also faces a temporary shortfall in domestic production – resulting from the decline in greenfield development and the uncertainty over Bakken and other basin ramp-ups – the delay in making a final decision on the Keystone XL will only add to the volatility of oil pricing.

The Rising Importance of Heavier Oil

Globally, more reliance is being put on heavier oil as a rising component of the raw material base because it is a larger part of the crude coming available.

But this crude cannot be refined without extensive refurbishments to refineries. Its viscosity (resistance to flow), weight, and other properties make it unacceptable for the production of retail oil products such as gasoline, diesel, and low sulfur heating oil.

U.S. refineries along the proposed Keystone XL route have already spent billions on upgrades to handle the heavier oil. What's more, they're already processing heavier crude being cut from places like Mexico, and Venezuela.

While many see the Williston basin in North Dakota, and Montana, as a new American source for such a grade of oil, such areas have their own production and transport problems.

Politics aside (and there is much of that surrounding the State Department decision, or lack of a decision, as we move into an election cycle), the delay puts the crude oil balance in question.

Absorbing the Impact

The primary concern moving forward is what the delay does to refinery usage and crude availability.

Major processors have already indicated this will create problems in planning for adequate crude oil consignments in the medium-term, when overall oil pricing is expected to be spiking anyway.

The primary immediate impact is on TransCanada Corp. (NYSE:TRP), the company responsible for building the pipeline, and Enbridge Inc. (NYSE:ENB), the U.S. division of the trans-border company with the primary responsibility of moving supply across the border.

TRP had previously said, rather categorically, that any revision in the pipeline route would be tantamount to cancelling the project.

TRP CEO Russ Girling said yesterday afternoon that he still believed the original route would be approved.

But the overall impact of the delay may well be felt before the State Department even votes the project up or down.

This is all about perceptions of the future crude sourcing balance.

Refineries are understandably concerned over what this does to refinery margins. This is the difference between the cost of refining and sale prices; the main source of processing profit.

Main end users of the products coming from the refineries are in a limbo over what costs will do to their bottom lines.

However, two things seem rather clear as we trudge through all of this.

First, the longer the indecision continues, the greater the pressure on Canadian unconventional oil production.

And second, this is likely to increase the overall price of crude.

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