Transportation – Alberta Tar Sands Achilles Heel

by Glenn Gilchrist
Credit: Greenpeace Creative Commons

Credit: Greenpeace Creative Commons

In much the same way as the Bond Market can take down an entire economy by making interest rates too high to support additional borrowing, so too can the price of Alberta oil on the International Oil Market take down the entire Tar Sands project. The price of oil is determined daily by the market and is contingent upon a number of factors, one of the most significant being the cost and reliability of oil transportation. Without extensive transcontinental oil transportation capability, using a combination of pipeline, ship and rail, the long term, multi-trillion dollar expansion plans for the Alberta Oil Sands project are effectively dead on arrival. Keystone XL is just one piece of the bigger puzzle, but helps us understand the full context of the problem both Big Oil and the Canadian Government are facing, and how significant our direct actions can be in not only delaying their progress, but rendering their efforts useless. The irony here is that the “Market”, so revered by corporate and political America, can, through risk induced discounted pricing render the Tar Sands project unprofitable, and its expansion, dead. To understand why requires that we look at the way oil is bought and sold worldwide and how oil prices are established. It is commonly believed that oil companies set the price for oil, but this is not the case. Oil is bought and sold globally through commodity exchanges. Because oil comes in many forms, varying in weight, sulphur content and similar factors, you don’t just buy “Oil” on the global market, you buy a type of oil. A number of types of oil have been defined to facilitate this process (called Benchmarks) and to assure that when a buyer purchases an oil contract (1000 barrels) on an exchange, for delivery of oil by a certain date, the buyer knows exactly what kind of oil they are buying and can be confident that it will arrive on the agreed upon date. These Benchmarks are set up based on the quality and make up of the oil, such as its sulfur content and include consideration for the cost and reliability of transportation. One of these Benchmark oils is West Texas Intermediate (WTI) which currently trades at $90-100 per barrel. To purchase WTI for example, a buyer places a bid on an exchange for one or more contracts (1000 barrels each) that have a promised delivery date at some specific time in the future – usually a few months away, at a specific location. This is how other commodities such as corn and pork bellies are traded and not any more difficult than telling a stock broker to buy a specific stock at a certain price. Daily supply and demand considerations cause the actual trading price to move up and down. If the price offered is at or above the trading price, the purchase will be confirmed. It is important to repeat here that Oil Companies and government controlled producers do not set the price of oil. The best they can do is modify how much supply is available and hope to influence the price in that way. But in the end, the markets set the price every hour of every day through the dynamics of supply and demand, and always in the context of perceived risks. Tar Sands oil is traded under the name Western Canadian Select (WCS), and its price is measured against WTI, so theoretically should command the roughly the same $90-100 per barrel less a slight discount that allows for additional refining requirements. But it does not. It trades at a fairly significant discount to Texan WTI and this is of great concern to the oil companies who see their profits diminished, and to the National, Municipal and Provincial governments of Canada whose royalties are adversely affected. A significant portion of the price difference, which grew to over $40 per barrel at times last year, is due to insufficient capability to transport the oil out of Canada and then past the US Midwest, reliably and economically. Tar Sands oil cannot be shipped easily and reliably to customers around the world, to Asia and Africa, for example. Right now the delivery location for tar sands oils is Hardisty, Alberta and they are awash in oil because production is outpacing their ability to ship using existing pipelines, rail and trucking options. Consequently, Alberta Tar Sands oil pricing is based almost exclusively on North American demand and that demand is declining and will continue to decline well into the future as the United States presses forward with its own aggressive drilling and fracking program. It follows then, that to increase oil sands profitability and fund future expansion, oil companies will have to find ways to make their product readily available to a wider, global market. And that means one thing – more and more transportation alternatives. Complicating matters more is the fact that even within North America, tar sands oil delivery is unreliable due to insufficient pipeline and refining capacity at current production levels. Any disruption in pipeline flow, whether caused by routine maintenance or civic action, causes large decreases in the trading price, significantly reducing revenue, profits and royalties. This problem elevated to crisis proportions as recently as January, 2013 when the price of WCS dropped to $35 below Texas WTI. Said another way, while oil drilled in Texas sold for $95 per barrel on the world market, oil collected in Alberta sold for just $60. Most of the difference can be traced to problems with transportation. So, what does all of this mean? Let’s do the math. Let’s consider the effect of transportation caused pricing discounts on the Oil Sands Industry. Using current oil sands production levels of about two million barrels per day and a modest $25 discount associated with transport and other risks, calculates to be a loss of $50million per day in revenue, all of which falls to the corporate bottom line (as reduced profits). That represents a loss of about $18billion per year at current oil sands production levels, not to mention the corresponding loss of royalty dollars paid to government. Many industry experts are also comparing the Alberta tars sands oil to a Mexican oil called Maya. Energy media giant Argus states: “WCS at 3.5pc sulphur and 20 API is nearly identical in quality to Mexico’s Maya crude, but its inability to reach the US Gulf coast forced WCS to sell at discounts of up to $40/bl to Maya early this year. Its discount to the Argus Sour Crude Index which represents a lighter blend of coastal sour crudes, reached $50/bl.

As a result, moving crude to the US Gulf has been a long-term goal of western Canadian producers.”

The impact of market induced price discounting has been deeply felt by Alberta Provincial government who seem to have overestimated 2012 oil royalties and now find themselves struggling with a large budget deficit. This is particularly painful when you consider that originally they had forecast surpluses of as much as $3billion per year going forward. The Calgary Herald, reporting on Premier Alison Redford’s statement in her State of the Province address earlier this year quote her as saying “This bitumen bubble means the Alberta government will collect about $6 billion less in revenue this year alone…To put that into context, that’s the equivalent to all our government’s spending on education each year. So as we prepare for this year’s budget, it means we have to make some very difficult choices.” Oil companies and Canadian Municipal and Provincial governments are expecting to see tar sands production increase to over 5 million barrels per day in the years to come, with development costs funded by current profits. Those profits will be significantly reduced however, if oil interests cannot find economical and reliable ways to make this oil available to world markets – specifically Asia and Africa, where, according to Exxon-Mobil’s “The Outlook for Energy: A View to 2040” is where the growth markets will be. If those profits are reduced, so too will be their motivation and ability to expand the tar sands even further. So this issue is not just about Keystone XL. And this issue is not just about pipelines. It is about transportation. It is about many pipelines, it is about shipping on the Great Lakes and it is about transport by truck and rail across the North American continent. And that is where the battles will be fought. This, from a report paid for by the Saskatchewan government earlier this year, underscores the significance of this issue: If pipeline project proposals such as Trans Mountain, Keystone XL and Northern Gateway don’t move forward, Canada will be foregoing $1.3 trillion in economic output, 7.4 million person-years of employment and $281 billion in tax revenue between now and 2035,” said Michael Holden, the foundation’s senior economist and author of the report. Depriving Canada of revenue may seem harsh, but balance this against the other cost, greenhouse gas emissions. From Scientific American: “As it stands, the oil sands industry has greenhouse gas emissions greater than New Zealand and Kenya—combined. If all the bitumen in those sands could be burned, another 240 billion metric tons of carbon would be added to the atmosphere and, even if just the oil sands recoverable with today’s technology get burned, 22 billion metric tons of carbon would reach the sky. And reserves usually expand over time as technology develops, otherwise the world would have run out of recoverable oil long ago. “ Big Oil has determined that the fastest and least expensive way to solve these problems is to start with more pipelines. Pipelines provide the least expensive transportation method available today. A few pipeline conversions have been completed and many more are underway. Note that this problem is much bigger than Keystone XL alone, and in fact, if Keystone were to be rejected, the pressure by the oil industry to press on with all the others would be magnified proportionally. Proposed Pipeline Projects Keystone XL Enbridge Canadian Mainline Enbridge Line 9′ reversal (Trailbreaker system) Enbridge Line 9B reversal (Trailbreaker system) Alberta Clipper (completed) Portland Montreal Pipeline reversal (Trailbreaker system) Enbridge Line 67 Great Lakes Enbridge Trailbreaker – will move Alberta crude from Enbridge Northern Gateway to Western Canada Trans Mountain Recently Completed Pipeline Projects Southern Lights transports diluent from Chicago to Edmunton Alberta and was a reversal of an existing pipeline Seaway completed in 2012 carries oil from Cushing, Oklahoma to Texas and was a reversal of an existing pipeline Every pipeline ends somewhere. Some end at refineries – such as those on the Gulf Coast, where more refined products can then be loaded onto ships and sent overseas. Others end at ports on the Great Lakes and the Pacific Ocean that can transport dirty tar sands oil around the world. And still others end at the rail yards of North America. It should be obvious that if the pipelines are blocked, then shipping cannot happen. And if the shipping is blocked, then the pipelines are irrelevant. Big Oil, and the Canadian government see transportation as the pivotal issue that threatens not just the profitability of the Alberta tar sands, but the very existence of their exploitation plans. Climate change science proves that tar sands oil needs to remain underground and this critical transport vulnerability can provide the means to make that happen. Any direct action that introduces doubt about future transportation reliability and capacity can lower the market price for Alberta tar sands oil, and thus oil company revenues. Any action, legislative or otherwise that increases the cost of moving this oil will further erode corporate profits. Forcing shipments to be made by rail and truck instead of by pipeline is the most significant example. Together these will diminish the capital required for future expansion of the Alberta tar sands project.

Glenn Gilchrist