Economic Implications Of The Keystone XL Pipeline

by: Capital One

Contrary to popular belief, when it comes to oil and gas, the laws of supply and demand are a little more complex than usual. What consumers want to believe is that the opening of the Keystone XL pipeline will open up the tar sands supply to the international market and drive prices down on a global scale. However, this is not the present case due to a pre-existing capacity problem with natural resource transportation in North America. The immediate permitting of the Keystone pipeline would in effect lower the volatility of North American oil but also a rise in oil prices in certain regions.

The major beneficiaries of the Keystone pipeline are not the end-consumers at the pump but rather the oil producers that are currently facing dangerously low prices because of the low quantity of customers that comes with the inability to transport the oil cross-border efficiently and cost-effectively. The most dramatic increase would be in regions where purchase of Canadian and American Midwestern oil is high. The availability of new markets for these Canadian and American Midwestern producers decreases buying power for pre-existing customers and would drive prices up in these areas. This effect will also have horizontal spillover into other commodity markets where the commodity-by-rail transportation system is prevalent. However, the difference here is that these prices will fall simply because of an increased quantity of the commodity in the system. We can see this effect in commodities like grain, potash, and maybe even iron and steel where producers (farmers) are sitting on high storage quantities.

Beyond this, the Keystone pipeline will have a drastic normalizing effect on the price of oil throughout North America. In the past, domestic gas prices have been heavily correlated to the supply of oil in the Middle East. During times of immense political or economic turmoil in the Middle East, we observe significant amounts of volatility and upward movement in oil prices.

The above graph shows how closely the black line (U.S. purchase price of crude) tracks the red line (World purchase price of crude). With the opening of the Keystone pipeline and the subsequent accessibility to the tar sands in Alberta / Midwest, even when the international supply of oil is in crisis the domestic supply will be able to keep prices afloat or stable.

However, one key consideration is that the majority of the oil will likely not remain in North America. The final destination for products travelling through the Keystone is likely the Gulf Coast, which acts as a hub for international exports. As a result, even though there will likely be an observable domestic effect in special situations, the effect will generally be mitigated through the broad range of dispersion for tar sands oil. This is by no means an encompassing representation of the economic implications of the Keystone Pipeline. In fact, it is safe to say that there will be a significant increase in short-term elasticity in all commodity markets that are currently facing the transportation bottleneck until the market returns to the steady state.

Disclosure: None