27

Energy East pipeline: Fact and fiction

Lower oil prices? Nope.


 

The Enbridge Norman Wells pipeline.

It’s been a week since TransCanada announced that it had secured sufficient commercial commitments and would be proceeding with the Energy East project. Their announcement included a few surprises — a larger-than-expected capacity of 1.1 million barrels per day, and a $300 million marine terminal in Saint John, N.B. What follows is a Q&A addressing some of the fact and fiction that’s been tossed around this week.

Is this pipeline a done deal?

Not even close. Securing commercial commitments is an important step, but there remains a long process ahead. The project will still face at least National Energy Board approval, but more likely a federal joint review panel including both the Canadian Environmental Assessment Agency and the National Energy Board, similar to the proceedings currently underway for the Northern Gateway Pipeline. There will also be consultations with First Nations, negotiations with landowners with respect to the new sections of pipeline, as well as dealings with the six provincial governments affected by this project among other requirements. Provinces do not have to approve energy pipelines in order for them to be granted a Certificate of Public Convenience and Necessity by the National Energy Board, but the process will be much smoother for the proponent if the respective provinces are on side.

Will Energy East lead to lower gas prices?

The answer to this comes in two parts. First you need to ask how Energy East will impact crude costs for refineries across Canada, and then you need to ask whether such a change will alter gasoline prices at the pump.

Energy East will serve as a link between Eastern Canadian refineries and the western crude oil market, where crude oil had been discounted significantly since mid-2010 until these price differentials converged rapidly over the last couple of months. By providing this link, the pipeline will alter future differentials from what they would otherwise be. If we assume that the marginal barrel out of Western Canada is still moving by rail, then you would expect western Canadian oil to be priced at approximately $12-15 below prevailing prices at the coast, reflecting the cost of rail transport. In such a scenario, a refiner who owned firm shipping capacity on Energy East could purchase oil at Edmonton and deliver it to Montreal, Quebec, or Saint John at a lower cost than that at which they would otherwise be able to obtain oil. Refiners without their own firm shipping capacity on Energy East (or Enbridge’s Line 9) will continue to pay world prices for oil, regardless of whether that oil is Canadian or imported. If the marginal barrel is moving by pipeline, the difference between oil in Alberta and oil on the east coast is likely to be comparable to the shipping tolls on Energy East, and so running Canadian oil would not save refiners any money at all relative to running imported crude.

There is some evidence that recent crude oil discounts in Western Canada have been partially passed through to consumers through lower gas prices. Statistics Canada reported in The Daily in November that, “gasoline prices have increased at a slightly faster pace in the central and eastern provinces than in the west, resulting in a spread between some provincial gasoline indices…associated with the dual crude oil market in Canada and the recent price differential between crude oil benchmarks.” The image below shows that this pattern has continued for the last six months since the Statistics Canada report.

Source: Statistics Canada.

However, you need to keep in mind that we are not talking about a systematic lowering of crude oil costs in eastern North America—we are talking about an increase in crude costs in Western Canada, combined with a potential small decrease in costs for some eastern refineries. As a result, you may see a small increase in refining margins for those refiners with firm shipping capacity on Energy East, along with a decrease in refining margins for in-land refineries in Alberta. If you’re going to see a change at the pump as a result of this project, I’d expect to see an increase in Western Canada rather than a decrease in Eastern Canada.

Will Energy East increase oil sands development?

As with the question above, this question should really be followed with an alternative scenario. If you evaluate Energy East against an alternative scenario where no other pipelines out of Alberta are ever built and no existing pipes are expanded, you could expect a marginal impact on future oil sands development. I say marginal because you simply can’t look at it as enabling 1.1 million barrels per day of new production which would otherwise not occur—you have to look at the impact on profitability between the two scenarios and ask whether that impact is sufficient to have an influence on the pace of development. For a bitumen project, the difference between pipeline and rail is small, once diluent transport is factored in. In order to ship a barrel of bitumen by pipeline, you’d need to ship 1.4 barrels of diluted bitumen, so if your pipeline heavy oil toll is $7/bbl, it is going to cost you $9.80 to get a barrel of bitumen from Alberta to Saint John. You can ship bitumen by rail with little or no diluent added, so the rail vs. pipe trade-off is likely to be only $3-5 lower netback per barrel. That type of decrease in expected profit certainly matters, but it’s not likely to reduce oil sands production by 1.1 million barrels per day.

You might argue that the rail system will, at some point, reach a capacity constraint. That’s possible, but unlikely. Despite all the attention to oil-by-rail increases, crude and fuel oil still only accounted for less than 5% of Canadian rail car loadings in May, 2013. Nickel, iron-ore, coal, and potash each accounted for more rail car loadings than crude oil. Access to pipelines matters, but given the alternative of oil-by-rail, the profitability impact is not as large as some have made it out to be and that’s what will drive development.

Should we have built this pipeline a long time ago?

There’s a strong nationalist element which seems to think we’d be somehow better off had we not been importing oil on the east coast while exporting oil from western Canada to the U.S. Midwest. That sentiment ignores the market reality for much of the last 25 years. Here’s an admittedly simple simulation using crude oil prices since 1987. Assume you could have built a pipeline and put it in service from Alberta to an eastern refinery center, with a pipeline toll of $7/bbl in today’s dollars, adjusted for inflation (the toll would have been $3.89/bbl in 1987).  Assume that your alternative project would have been the Keystone Pipeline to Cushing, OK, with tolls equivalent to today’s tolls on that line to Cushing, again adjusted for inflation. Now, here’s your choice—you can either ship your oil to Cushing, and sell it there and use the revenues to buy oil on the east coast, or you can ship your oil all the way to the east coast, and sell it (assumed price of Brent +$1.50).  (The simple part of this simulation is that I’ve assumed that prices in Cushing and in eastern Canada are not affected by your choice). The Figure below shows how much you would have lost on every barrel if you chose the Canadian option.

From 1987 to 2010, you’d have been better off in every single month making the trade we have been making—exporting to the U.S. Midwest and importing on the east coast. In fact, the from May 1987 to May 2013, the average loss from shipping 1 million barrels per day of oil east rather than south would have been about $250 million per month in today’s dollars. If you assume you could have moved it east for free, you’d have still lost money, although not much of it.

The oil market in North America has certainly changed, and the expectation is that the marginal barrel will be moving to the coasts, so oil in the mid-continent will no longer trade at a premium as it has. As a result, the economics of Energy East are likely better today than they would have been at almost any point in the last couple of decades. It’s certainly the case that perfect foresight would have led to more pipelines being built to the coasts instead of to the Midwest in the late 2000s, but not before that.

Have more questions about this project? Post them in the Comments section and I’ll take some of them on next time.


 

Energy East pipeline: Fact and fiction

  1. If the oil at the end of the pipe is priced the same as imported, adjusted for quality, it will displace imports and lower the import price since they will need to find new markets.

  2. Oh, where do I start? How about here:

    For a bitumen project, the difference between pipeline and rail is small, once diluent transport is factored in. In order to ship a barrel of bitumen by pipeline, you’d need to ship 1.4 barrels of diluted bitumen, so if your pipeline heavy oil toll is $7/bbl, it is going to cost you $9.80 to get a barrel of bitumen from Alberta to Saint John. You can ship bitumen by rail with little or no diluent added, so the rail vs. pipe trade-off is likely to be only $3-5 lower netback per barrel.

    You’re comparing orange pulp with orange juice. Or old lumpy flour thickened gravy, kept in the freezer, with au jus served from the cooking tray.

    Has anyone yet tried to ship undiluted bitumen,by rail, multiple days in the dead of the winter, from Edmonton to St. John? Even if you had an insulated rail car, with heating coils, the logistics would be challenging especially at the unloading end. This website from Pulsar suggests hours of heating (rather than days) with their technology.

    http://www.pulsair.com/applications/railcar-mixing.php

    I also think your “historical losses” analysis is too simplistic, but won’t bother elaborating.

    • “However, unlike pipelines, rail cars do not necessarily require diluent for moving oil sands.” IHS CERA

      “Bitumen can also be transported by rail in a form known as “railbit” using 15 – 20 percent diluent or in its raw form with no diluent at all.” RBN Energy

      “By late 2014 there will be enough insulated rail cars to transport about 800,000 bbls per day of bitumen with little or no diluent, equivalent to just over one million bbls per day of dilbit, according to a market analysis included in the Draft Supplementary Environmental Impact Statement for Keystone XL.” Oilsands Review on State Department EIS

      But don’t worry, I am sure they will all change their tune once they read your comments in Macleans, Derek.

      Also, are you referring to the historical losses analysis which I stated was an, “admittedly simple simulation?” If so, thanks for your comment that it’s too simplistic. Much appreciated.

      • Andrew, you are making the same assumption that Nathan VanderKlippe of the G&M has made in the past: assuming that shipping undiluted bitumen south to warm Gulf states would be the same as shipping to Prince Rupert or an alternate location in Alaska.

        The report addresses alternates to Keystone moving bitumen south. This blog, I assumed, was looking at shipping bitumen east to St. John. Not the same.

        Also, are you referring to the historical losses analysis which I stated was an, “admittedly simple simulation?”

        So, why bother, unless you are trying to make some larger point? For example, why pick Cushing, OK, and not Gulf of Mexico, the termination point of Keystone? Then you would be comparing two tide water ports – the difference, theoretically, would then just be difference in pipeline tolls? Consistent with the argument I thought you were making as to why gas prices will not see relief on east coast with Energy East?

        • Keystone terminates in Cushing. That’s why I chose Cushing. Keystone XL is slated to reach the Gulf Coast when combined with the Gulf Coast pipeline project. Anything else?

          • So, are the prices different in Cushing vs Gulf Coast, net of additional tolls (I know they are the last couple of years). And if WTI at Gulf Coast is different than Brent, why is that (this seems to be the biggest factor in your analysis – difference between Brent and WTI)?

          • WTI doesn’t trade at the Gulf Coast. It trades at Cushing. That’s why I used Cushing.

          • Well, fair enough. I may be being a bit too picky for a high level study. You larger point that it was uneconomic in the past still stands. Personally, I would be shy of quoting the number of $250 million/month.

            Thanks for the replies.

          • Professor Leach,

            I think you may be shortchanging TCPL. Keystone South (aka Gulf Coast Pipeline) was originally part of the rejected application by TCPL for the complete Hardisty AB to Gulf Coast. It was partitioned off in 2012 and is currently under construction.

            Regards

          • TCPLs,

            Thanks for reading. Indeed, the Gulf Coast Pipeline was initially part of Keystone XL, but was built as a separate project after the initial rejection of that pipeline. The original Keystone line serves Wood River, Patoka, and Cushing from Hardisty, and is already in service. I used toll schedules for that line in compiling my simplistic simulation exercise.

          • Prof Leach,

            Thank you for that acknowledgement. Before rushing out to buy some railroad stock, I thought I would run your article past my stock broker. I was trying to understand marginals.

            He told me that it would be difficult to buy stock in that American railroad, you know the one that caused all that trouble in Quebec, because it had declared it would no longer carry oil before declaring bankruptcy.

            He also thought shipping 1.1 million barrels/d to the east coast of Canada was “optimistic”. According to him, this would involve 22 trains per day of the same size as the one that derailed, or 1500 tanker cars. And then double that for the ones returning empty. Never mind the extra wait times for rail crossings etc through Ontario and Quebec cities.

            He wondered if you had CN or CP stock? :)

            I feel a bit embarrassed to ask, but for us unsophisticated investors, would you mind revealing if you have any stock, financial interests, associations with railway lines, oil sands companies, pipelines etc. like they do on BNN.

            You seem to be new here, haven’t seen you before, so if you do, would you mind divulging that in your posts in the future, similar to Paul Wells on the Sun TV thing.

            Regards,

          • I have no idea why you would see this as an endorsement of railroad stock. I you want to know what stocks I hold, feel free to have a look here. http://andrewleach.ca/conflict-of-interest-disclosure/ Of relevance to this post, no TRP, but I do hold both Enbridge and Interpipeline. No railroads.

          • Professor Leach,

            I was thinking that if Energy East was delayed, or didn’t go through, all of the oil would be shipped by train. I thought that was the point you were making. A natural hedge, I think he called it.

            No green company stock, heavily weighted on oil and gas? Interesting.

            Thanks again.

            Regards,

          • Thanks for reading.

          • Professor Leach,

            I just came from lunch with my son. He did a google and sees that you are sponsored by Enbridge, a TCPL competitor. As a retired Sask farmer, with a fixed income, this makes me mad.

            Are you allowed to do this?

            Regards,

          • Allowed to do what? By whom? Sorry if I have angered you.

          • Oh, I don’t want to say, without my son present.

            When is the next Enbridge Annual meeting? I feel like buying a couple of shares and attending.

          • I am sure you can find out from Enbridge.

  3. I have a new idea for pipeline construction, that while adding to the overall costs, will mitigate the effect of costly spills/cleanup/environmental degradation, and allow for easier access and faster response times for crews assigned to all aspects of general pipeline maintenance.

    • If you’re attempting to sell it in the comments section of a blog, I’m pretty sure your idea’s already a failure.

  4. How will eastern Canada cope if the mid east blows up. Why is all the discussion about economics instead of security?

    • If your concern is that oil prices will be high in that event, then they will also be high in Western Canada. If your question is whether we should be insulated from the world oil market, then I would say no.

      • About the only difference is how much shale oil there is around the world. Whether we are talking about Australia, Great Britain, you can be sure that the trolls who are anti-pipeline, they will be on the receiving end of deaf ears and blind eyes.

  5. In all honesty, having more options to sell oil to – what is the downside to this?

    • More options are better. More costly options not necessarily so.

      • If they were all priced the same, they wouldn’t be options.

Sign in to comment.