What if Congress threw a Keystone XL party and nobody came?

RMI

The energy gods relish ironic humor. Drilling in the Arctic National Wildlife Refuge is an economic and national-security loser, craved by Alaskan politicians but by no major oil company. Higher oil prices and better technologies only made it relatively less attractive. Yet whenever Congress nonetheless gets close to approving this political project, it seems that the oil industry obligingly suffers an Exxon Valdez or BP Macondo disaster. Maybe we should expect another, now that Congress wants to revisit Refuge drilling even as oil prices swoon and easier Arctic prospects get shelved.

Similarly, whenever nuclear reactor sales tank, a Three Mile Island or Fukushima adds emphatic punctuation. Boosters then mythologize those accidents into the cause of the market collapse that had already occurred, and cheerily call them a semicolon when basic uncompetitiveness really wrote a right parenthesis.

Now the gods may be preparing yet another jest: just as the Keystone XL (KXL) pipeline battle comes to a political head, its business rationale may have vanished.

KXL’s Alberta-to-Nebraska northern leg (shortcutting other sections already built or being built) was meant to give Canadian tar sands, lately rebranded “oil sands,” a cheaper, simpler, and safer route to market than railcars. But which market? That depends on whom you ask. Promoters say American consumers, and refer only to crude oil. Opponents worry mainly about refined products, which Gulf Coast refineries sell wherever they’ll fetch the best price net of delivery costs. Thus if KXL’s oil cut domestic products much below the world price, they’d be exported instead.

The Canadian oil industry’s ambition is to more than double current tar-sands output from two-odd million barrels per day (Mbbl/d) to 4.8 by 2030. It considers KXL the cheapest, least uncertain way to ship the first third of that extra oil. Prime Minister Harper, who mirrors the industry’s views, is pressing very hard for consent.

Cheaper shipping from Alberta to processing and markets raises producers’ profits, and were meant to make marginal production economic that otherwise might not be—at the old oil prices. Albertan tar sands’ basic challenge is cost. Heating them yields not light, sweet crude oil but a heavy, higher-sulfur tar called bitumen. Warmed, it has the consistency of peanut butter; cooled to 50˚F, that of a hockey puck. Fort McMurray, the tar-sands epicenter, averages 32˚F and has dropped to –59˚F, so extracting bitumen takes much energy, water, and money. Shipping it, upgrading it to synthetic crude oil, and refining that into saleable products (typically far from Alberta) takes more. And in between comes the need for shipment.

Shipping bitumen in new heated railcars is costly and needs special facilities at both ends. Mixing with a costly hydrocarbon solvent to form diluted bitumen (“dilbit”), then pumping it through a new pipeline a yard in diameter, costs about $8 billion plus pumping energy and solvent, but costs less overall than new railcars. Owners of tar-sand acreage, from big Canadian and global oil companies to the Koch brothers, thought all these costs were justified when oil sold for $100+ a barrel. Now they might just break even, not robustly, if world oil sold for around $60/bbl and carbon emissions cost zero. Without KXL, the bar would be far higher—but oil is below $50.

The 36-inch-diameter, 1,179-mile KXL pipeline supposedly takes the least difficult route. Rather than cros­sing the Rockies and British Columbia, where environmental and First Nations opposition is strong, KXL would traverse more oil-friendly, politically pliable, and climate-skeptical U.S. states to existing Gulf refineries attached to major ports that routinely import and export oil worldwide in vast quantities, opening more marketing options.

The industry was surprised when conservative Nebraska farmers turned out to care about risks to their groundwater, and lucky that citizens’ challenge to the constitutionality of the enabling law was accepted for hearing by only four, not the required five, of seven state Supreme Court judges. That decision may not end siting disputes in Nebraska, and won’t elsewhere. Some landowners are asking how a Canadian cor­poration can seize their land by eminent domain as if it were an American public utility or common carrier. The President of the sovereign Rosebud Sioux Nation, which like other Sioux bands opposes KXL, considers last November’s House approval vote an “act of war” and vows to bar the pipeline’s cross-Reservation route. Even if resolved now, such thorny issues would presumably recur in another four years. That’s two years (normal pipeline-construction lead time) before Canadian producers project that tar-sands growth will again outrun shipping capacity in 2021.

What benefits of KXL are said to justify these hassles? First, secure supplies from a friendly, familiar, and relatively stable neighbor. Yet tar-sand operations gush red ink whenever high world oil prices dip, so they seem less likely to stay economically viable than far cheaper resources elsewhere. KXL would concentrate control over Midwest and Gulf crude sources, giving Canadian producers more market power whose exercise might end up increasing U.S. imports from Middle Eastern and other OPEC countries. In essence, Canada is asking American consumers to pay billions of dollars a year for oil-interruption insurance already bought by the Strategic Petroleum Reserve, diversification, more-efficient use, biofuels, and other means.

Next come potential economic savings from cheaper oil. At first this might seem obvious, because KXL would deliver more oil into a shrinking U.S. market: since 2007, GDP grew 10% but gasoline use fell 4% and total oil use fell 19%. Meanwhile, diligent drilling by over half the world’s rigs outside the former Soviet Union is now fracking an extra two million barrels per day (2 Mbbl/d) of new supply. Result: the lowest U.S. net oil imports in 29 years. This might look like a recipe for cheaper oil, but it’s not the only oil on offer. North Dakota and Montana’s 1 Mbbl/d of currently fracked, higher-quality oil compete directly with Alberta tar sands for U.S. demand —and, in part, for any new pipeline capacity to the Gulf Coast. (An eighth of KXL’s 0.83 Mbbl/d capacity would actually carry that fracked U.S. oil, three-fourths of which now leaves by rail with valuable flexibility but only enough capacity for another year or two of growth.)

Yet paradoxically, increasing already-abundant oil supplies may not drop prices, for reasons that get complex. Oil companies are in business to make money, and the less competition they face, the more money they can make. Owners of U.S. petroleum infrastructure may exploit bottle­necks to raise prices. Even if they don’t, getting higher prices for Alberta’s bitumen is promoter Trans-Canada’s main motive for KXL. Shifting oil deliveries from nearly saturated Midwestern markets to immense, export-capable Gulf Coast refineries with direct access to world markets could help tar-sands output compete against Mexico’s similarly heavy Maya bench­mark crude. Gulf refineries also produce more diesel and Midwest ones more gasoline, so making Midwest gasoline scarcer should raise its price. Going around an Oklahoma bottleneck could even switch bitumen pricing to a more favorable benchmark crude. When pitching KXL to the Canadian government, TransCanada hoped such effects would lift heavy-crude prices, and hence Alberta producers’ profits, by billions of dollars a year at the expense of American consumers. That remains KXL’s core purpose.

Of course, tar sands’ meager or perverse security and price benefits could be drowned out by constant repetition of exaggerated claims about jobs and economic stimulus. Climate skeptics from Congressional leaders to Prime Minister Harper, too, could ignore the foolhardiness of expanding the use of an especially carbon-inten­sive resource that science and economics say is not rationally burnable.

Yet one more decision­maker (besides the President) shouldn’t be overlooked. Investors of the half-trillion dollars sought to build out Alberta’s tar-sands industry can’t prudently ignore the special risks of combining extra carbon intensity with marginal costs that lie at the upper end of the top quartile of world oil resources.

That’s the wrong end of the supply curve. Of course, costs depend on site-specific con­di­tions, extraction methods, etc., and indeed there’s one small project costing only about $50–55/bbl. But despite continuing technical improvements, Goldman Sachs noted in April 2013 that no new tar-sands projects in the previous two years had total costs below $70/bbl, and most cost $80–100/bbl. Typicalindustry analy­ses reckon that breakeven oil prices average around $75 without contingency allow­ance. Even oilfield service leader Schlumberger pegs the industry-consensus range at $50–90/bbl—similar to fracked oil, whose $50–80 the Saudis are currently trying to drive out of business.

No wonder Citibank, back in September 2012,listed tar sands among the resources at most risk of being written down or written off as unprofitable to produce if oil prices fell. Then prices fell by 55% and are still falling. In November 2014, as that drop accelerated, analysts warned that the tar-sands expansion KXL was meant to serve looked increasingly like a bubble. Carbon Tracker Initiative’s oil-industry financial analysts found

“…ninety percent of future oil sands projects at risk from eroding oil price. Investors in Canadian oil sands are at a heightened risk of wasting $271 billion of funding on projects in the next decade that need high oil prices of more than $95 a barrel to be profitable.”

Now world oil prices below $50 may have burst that bubble. At anywhere near today’s oil prices, Alberta’s 167 billion barrels of tar-sands oil are no longer even “reserves”—resources profitably producible at current technology and prices—so Canada should lose its recent promotion to the world’s #3 holder of oil reserves, after Saudi Arabia and Venezuela. Don’t expect this, though: the classifiers, and Canada, took credit for higher oil prices but will probably ignore lower ones as long as possible.

Most operating tar-sands projects were built early when labor and infrastructure cost less, so they break even at an average oil price around $60–65/bbl. However, many can run at oil prices down to perhaps $30–35/bbl, and most within a $25–45 range, depending on whether the aim is to cover just cash operating costs or some capital costs too. But capital-project costs in Alberta’s oilpatch are now several times 2005 forecasts, so even at 2013’s high oil prices, only three of ten major and two of eight junior tar-sands companies had positive free cashflow. Of all tar-sands output proposed to 2030, including those now being built, leading analysts reckon 44% requires a $80/bbl world oil price to break even, hence $95 to be investable using a prudent $15/bbl contingency margin. That is, the projects being built to ship via KXL were predicated on oil prices around $80–100.

At today’s halved oil prices, many mostly-built projects may be completed despite dismal or no returns to capital: the remaining investments to finish them, plus bare operating costs (typically in the low $20s/bbl), let owners hang on until prices rebound. If that actually happens, this survival strategy substitutes misery for outright loss. But producers also say that by around 2017, when KXL could come on­line if approved this year, old projects’ output will be starting to dwindle and growth will increasingly require new projects now in discovery phase. Roughly 99% of those projects need $100–130/bbl oil prices. And all this assumes no future Federal or Alberta government will ever make the operators thoroughly clean up their mess.

Even before the oil-price collapse began in mid-2014, Shell, Total, Statoil, Suncor, and others had shelved high-cost tar-sands projects. Last November, prices fell further, so many new projects didn’t pencil out and at least one major pipeline wouldn’t be needed. Oil prices then plummeted further. The bloodbath intensifies. Oil majors must even wonder if they could make more profit by abandoning tar-sands projects, which are a small fraction of their supply, and thereby lifting the world price for their entire global production.

To be sure, oil prices have been fluctuating since 1859, and investors do, or should, take their volatility into account. Some knowingly bet that sub-$50 oil prices will rebound to $100+ and stay there for decades. But the smartest oil companies should love to have competitors who believe that. With increasing competition from efficiency, some renewable mobility fuels, and cheaper batteries and smarter, more-efficient electrified automobiles, a bet on high-priced oil needs a hefty risk appetite. For example, Reinventing Fire found the total cost of getting U.S. automobiles completely off oil is around $18/bbl, and for all U.S. mobility, about $25/bbl. Those costs are now even lower and heading down. The technologies for getting off oil are rapidly fungible in hypercompetitive global vehicle markets. Costly tar-sands oil may never find a durable market: it’ll be obsolete before it can be extracted and sold.

In mid-December, The Los Angeles Times reported, quoting industry analysts:

“Amid the shouting on Capitol Hill, the wads of campaign cash and the activist careers shaped around the Keystone XL pipeline, the project at the flashpoint of America’s energy debate now confronts a problem bigger than politics.

It may no longer pencil out.

As Congress’ six-year obsession with Keystone nears a climax, plunging oil prices have industry analysts questioning whether the plan to link Canadian tar sands with Gulf Coast refineries still makes economic sense.”

Not only investors wonder if expected returns on KXL are at risk. On 11 January, Fox Business pointed out, plunging oil prices “raise critical questions about whether the Keystone XL oil pipeline is still needed or even makes financial sense.” And Rupert Murdoch, noting one kind of competition (though not the ones that can shed our fossil-fuel addiction), tweeted: “Is Keystone Pipeline really good idea? Bringing lots of heavy, dirty oil across country, when fracked, cheaper, cleaner energy available.”

Of course markets, like Newtonian mechanics, have equal and opposite reactions: less tar-sand or fracked oil reduces supply, raising prices, stimulating production and efficiency, reducing prices, and so on. Major oil exporters like Saudi Arabia steer oil prices to meet their budget needs (currently at around $90/bbl). Periodically they also “sweat the market” by opening the taps, just as John D. Rockefeller did, to bankrupt competitors. At otherwise high prices, they create an incentive to stop using oil so its price gyratations can’t hurt you. That’s where smart countries and companies are going, and that’s what the global energy revolution is partly about.

The Congressional KXL Circus will open anyway, because as Dr. Michael Levi at the Council on Foreign Relation notes, in the grand scheme of things “The costs are small. The benefits are small. It’s the politics that are big.” So a bill may pass. The promised veto may stand. If it doesn’t, and if investors’ doubts don’t scuttle the project, KXL might even get built.

But be careful what you wish for. Wouldn’t it be ironic if TransCanada built its pipeline just in time for tar-sands companies to be too weakened and uncompetitive to fill it? The energy gods would chortle again: Such fools these mortals be.

Source: RMI. Reproduced with permission.