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Energy security and the Energy East pipeline

Does Stephen Harper’s promise make sense? Andrew Leach explains.


 

Etienne de Malglaive/REA/Redux

During his visit to the Irving Refinery on August 8th, Prime Minister Stephen Harper stated that the Energy East pipeline was not just about moving Alberta’s energy to markets, but that the government would, make sure “that Canadians themselves benefit from these projects and from that gain in energy security.” That got me to thinking about energy security, what it means, and how we might benefit (or lose) from what it implies. In what follows, I argue that there are some potential benefits, but also some false-economies and pitfalls in terms of delivering energy security with Energy East.

When it comes to energy security, Michael Levi* at the Council on Foreign Relations is one of the world’s leading experts. In his May 2009 paper “The Canadian Oil Sands: Energy Security vs. Climate Change” (long one of my favorite sources), Levi identifies a list of six security and economic consequences of oil consumption and production and then examines how increased oil sands production and exports to the U.S. would mitigate or exacerbate these impacts. I thought it would be a useful exercise to use a modified version of Levi’s checklist to think about Energy East and its impact on Canadian energy security, so here we go:

1. Oil revenues empower exporting states whose interests often conflict with our national interests.

The trade impacts of Energy East depend on what you view as the alternative scenario, but let’s take the most likely – barrels shipped on Energy East would otherwise be shipped south or east by pipe or rail, and these barrels displace barrels which would otherwise be imported from a similar set of countries as we import from today.  At the same time, this would imply an increase in imports into the U.S. from countries other than Canada to replace the foregone barrels.  The countries from which we imported the largest volumes into Ontario, Quebec and the Atlantic provinces over the previous 12 months are shown below:

Imports to Ontario, Quebec, and the Atlantic Provinces, May 2012-April 2013. Source: Statistics Canada.

Certainly there are many points of disagreement between Canada and many countries on that list. However, if you are worried about empowering these nations, you really want to worry about whether Energy East affects their ability to sell oil much more than you want to worry about whether they are selling it to Canadians or to someone else. In that sense, the net effect on world oil demand of Energy East is what matters, and it would be negligible. If the construction of Energy East also does not put significant new supply into the world market, it will not have a material impact on the revenues collected by other oil producing nations either. So, the impact on the empowerment of rogue states is likely a wash.

2. Economic growth is hurt by oil price volatility.

Volatility in any price is costly, so its worth asking whether Energy East would reduce oil price volatility significantly. Assuming there is no further legislation affecting oil trade, Canadian firms (producers, distributors, and refiners) would remain exposed to the world’s oil markets, but that exposure would change. Energy East would allow eastern refiners to purchase oil in western Canada, increasing their market size, and allow western producers to export product from the east coast, or sell to eastern refiners, again increasing market size. It will also aid in reducing the recent disconnect between mid-continent and coastal oil prices, but that’s not really a volatility effect. For western heavy oil and bitumen producers, tidewater access may have an important stabilizing effect as it would greatly expand the market for the product, which has previously been subject to large price swings motivated by refinery or pipeline outages in the midwest. For eastern refiners, it’s not clear that access to 1.1 million barrels of oil by pipeline will have a large impact on volatility, although a wider market will always lead to some reduction in volatility. Over the past 25 years, there has been lower crude price volatility in the mid-continent regions than on the coasts (WTI vs. Brent), so there may be some improvement here, at the margin.

People often confound the heavy-light differential with oil price volatility. Canadian heavy trades at a discount to world prices largely because it is heavy oil and thus less valuable to refiners. Since Canadian light oil has also been discounted to world prices in the last couple of years, the heavy (WCS) discount has looked even larger. However, no matter what you think this pipeline will do, I can promise you that it won’t convert heavy oil to light oil.

3. Wealth transfers resulting from a lack of national infrastructure hurt economic growth.

Here, we again need an exercise of follow-the-money. Absent Energy East, assume we take a barrel of oil and sell it in the U.S. for the world price, and buy a barrel of oil for world prices on the east coast, perhaps from one of the countries listed above. In terms of wealth transfers (ignoring price differentials), that’s a wash for us and a loss for the U.S. and a gain for the country from which we buy oil on the east coast. If, instead of that trade, we ship the barrel of oil east, the U.S. still ends up out the cost of a barrel of oil which they have to purchase from the world market instead of us, the exporting country ends up with the revenue from a barrel of oil, and Canada ends up with an offsetting revenue and cost. In other words, unless there are significant price differentials, the wealth transfers avoided by Energy East will be small. The project effectively contributes to reducing its own impact here, since its existence will ensure differentials are lower than they would otherwise be. If the price differential would otherwise be larger, then Energy East eliminates a wealth transfer from Canadian producers and taxpayers to mid-western refiners. In that sense, there would be an economic growth impact from eliminating that wealth transfer.

4. Barriers to well-functioning oil markets, including but not restricted to price manipulation by OPEC or national governments, raise oil prices and hence hurt the economy.

From the perspective of Energy East, Canada is simply electing to sell oil to itself (presumably at world prices) rather than importing at world prices on the east coast and exporting at (eventually, hopefully) world prices in the west. Unless you are supposing that, with Energy East, there will be some sort of domestic consumption priority akin to the crude oil export ban in the U.S., there is no reason that Canadian crude would be sold at or below its market price to Canadian refiners. If it were, for whatever reason, that would still not constitute a gain for the economy overall, but rather an introduction of an inefficient price signal and a wealth transfer from west to east (a policy that would no doubt bring out the bumper stickers in Alberta again). If what the Prime Minister has in mind when he says energy security is a Canadian oil market isolated from the world market, it will come as a surprise to western producers and to the Irvings who have pledged to build an export terminal in Saint John, and he will need some additional legislation to make it so.

5. Canada is potentially vulnerable to supply disruptions resulting from states’ decisions to withhold oil supplies from world markets or from damage to oil supply chains by nonstate actors or natural disasters.

Economist Peter Terzakian wrote a couple of days ago about Canada’s failure to maintain oil self-sufficiency, and tells us that, “it’s naive to think that global oil disruption can’t happen again.” Sure, it’s possible that an event will lead to a very high temporary value for west-east infrastructure.  What should also be mentioned here is that insurance comes at a cost — had we decided in the 1970?s to build significant west-east oil infrastructure and ensure domestic priority, we would have lost out on a winning trade with the U.S. — for 23 out of the past 25 years, oil prices have been higher in the U.S. Midwest than at eastern Canadian ports (adjusted for quality) and the U.S. midwest is closer to Alberta. Yes, we’d have been well-prepared for an oil crisis that has yet to re-emerge, but we would have lost money month after month on insuring ourselves. We should account for any insurance value which is provided by the pipeline, but we should also remember who is underwriting that insurance. If you believe that, in times of crisis, a West-East pipeline will provide eastern refiners at oil below the world price, you are assuming that western producers will sell oil below world prices in times of crisis. That’s not preventing damage — it’s transferring damage.

6. Dependence on oil from unstable regions may necessitate military expenditures to ameliorate risk.

This isn’t as big an issue for Canada as for the U.S., and certainly not my area of expertise, so I will rely more heavily on Levi here. Levi writes that as a justification for enhancing domestic and North American oil production, “the underlying argument is weak. While U.S. commitments in the Middle East may have strong historical ties to oil, current U.S. commitments are anchored in other fundamental problems. In particular, the long-term challenges posed by transnational terrorism, by Iran’s pursuit of nuclear weapons, and by threats to Israel’s security will require strong U.S. security commitments in the Middle East regardless of whether oil is also a major regional concern.” To apply this to Energy East, you have to go back to the questions above as well. First, as Levi puts it, oil is far from the only reason for U.S. military involvement in oil producing regions. Second, Energy East is unlikely to change the amount of oil imported to North America from these regions. Insofar as our military interests remain reasonably aligned with the U.S., it’s hard to see how Energy East brings about a material change.

In a 2010 piece discussing the impact of climate change legislation on the U.S., Levi and Trevor Houser write that, “energy security is notoriously difficult to define and thus serves as the perfect weapon for attacking legislation.” It seems that is largely the case here, albeit as a weapon for supporting pipelines – if you can promise someone that the pipeline will enhance energy security, they are more likely to smile and nod than to ask you to define it, so you can get away with it as a soundbite. Canadians would be much better served to ask what it means when someone says it, especially if that someone is the prime minister.

*Since I have borrowed so heavily from Levi in this post, you may be interested in his book Power Surge. Check it out here.


 

Energy security and the Energy East pipeline

  1. //The trade impacts of Energy East depend on what you view as the alternative scenario, but let’s take the most likely – barrels shipped on Energy East would otherwise be shipped south or east by pipe or rail, and these barrels displace barrels which would otherwise be imported from a similar set of countries as we import from today. At the same time, this would imply an increase in imports into the U.S. from countries other than Canada to replace the foregone barrels. //

    This is likely not true. Hydro-fracturing technology has unlocked pretty large previously trapped oil in the United States. Western Canada is “losing” its existing midwest market as US oil production rises there.

    The oil east or oil west or oil south is really a question of where one wants the upgrading and refining jobs to be for the export of refined products from North America. And who displaces non-North American oil in the eastern seaboard of the United States.

    Do you want those jobs to be in Houston or Louisiana or do you want a greater share of those jobs to be in Prince Rupert/Kitimat/Montreal/New Brunswick.

    BC, Montreal, and New Brunswick refineries would have the strategic advantage of being closer to the end markets, the eastern seaboard of the US, Europe, and Asia than Texas and Louisiana. These are high-skilled high paying jobs. (with the associated economic multipliers).

    With Mexico opening up its oil industry to foreign partnerships, North America is poised to become oil independent, and a net oil and refined product exporter over the next generation.

    The issue is how does Canada capture the most economic benefit as North America transitions from a net oil importer to a net oil exporter over the next generation.

    The route south is into the heart of growing US oil production. It means the US gain more economic control over Canada, because they will control the flow and where the exports go.

    “Who controls the spice, controls the universe”, Frank Herbert, Dune.

    Canadian sovereignty and independence means that we really have to have oil flows other than to just the US. We need direct flows to the global markets for oil and refined products to capture the maximum economic benefit for all of Canada.

    • The plan for the west coast is 100% export in raw form. There is no plan to refine it in Kitimat or Prince Rupert. The companies say shipping raw bitumen to China is more profitable.

      • There is a BC businessman working on a refinery plan (which is not part of Northern Gateway).

        Creating a major refining industry in Prince Rupert/Kitimat would be the way BC would get value-added for the risks they are taking.

        • David Black’s plan is no where near a place where it will go. He is a newspaperman and a strong Liberal supporter. Most think the plan was floated to support the Liberal campaign. Nothing has been said since.
          Not withstanding that, if the refinery was built it would provide some benifit and solve some of the bitumen issues but not all. If it is built, it should be built in eastern BC not in Kitimat so that the bitumen is not transported across the rivers and through sensitive areas. With the gas plants going in, and the increased tanker traffic that goes with it, air quality would be a problem . The geography and weather patterns will trap the smog in the town. If it gone on the west coast, it would need to be Prince Rupert.

  2. Any time I read, see, or hear an economist opine, I yawn, scratch myself, and look for something to make better use of my time – I almost always find it right away.

    • Like posting anonymous messages on media comment boards?

      • Itchy and Scratchy…

  3. What should also be mentioned here is that insurance comes at a cost — had we decided in the 1970′s to build significant west-east oil infrastructure and ensure domestic priority, we would have lost out on a winning trade with the U.S. — for 23 out of the past 25 years, oil prices have been higher in the U.S. Midwest than at eastern Canadian ports (adjusted for quality) and the U.S. midwest is closer to Alberta.

    Not today, it doesn’t. The Energy East pipeline is projected to cost $7 /barrel to ship to St. John, NB. Gulf of Mexico Gulf Coast $6-$8/ barrel. Source: Scotiabank Commodity Price Index, July 30, 2013 page 2.

    So, it’s awash economically, and provides diversity of markets for Canadian producers, and diversity of sources for Eastern Canadian refineries.

    Security, in this situation, however you define it (I prefer the definition of having unimpeded physical access in this situation) is a bonus, economically.

  4. Another book to be read is William Marsden’s national best seller “Stupid to the Last Drop: How Alberta is bringing Environmental Armageddon to Canada (and doesn’t seem to care).
    This facts are that these tar sands are best left under the forest untouched.

    • I do not agree that it must be left untouched but it should be extracted at a lower rate and should be upgraded in Canada

      • I agree with this notion also.

        Upgraded or refined in Alberta or elsewhere in Canada.

        Just not in BC if it means oil-filled supertanker traffic in BC coastal waters.

        The railway to Alaska solves that problem and can handle/ship all types of refined oil products although the high value syncrude would be ideal.

      • Perhaps you and the others should pick up a copy of Marsden’s book before you decide.

        • I have followed the tarsands development for years and while I have always been concerned about them, it is not reasonable to shut them down. The development can be slowed and the companies can be forced to upgrade in Canada but I believe shutting them down them down would devastate the economy.

        • One persons opinion is not going to shape my opinion. I read a lot of research about this topic, including studies by environmentalists and economists. Marsden may be your primary source but he is not the only looking at the different scenarios.
          I tend towards environmental protection but not at the cost of our entire economy. There are costs to a collapsing economy that often results in desperate people becoming destructive to the environment. Look at The Amazon and Africa for examples. Scaling back is responsible but unless we can replace the economic impact of the tarsands, then doing away with them is not responsible in the short or medium terms.

    • Dear mj…x: Please provide a path and timeframe for what you and many un-pragmatic posters propose….that is: an immediate cessation to all present and future and planned production from the oil sands of Alberta and Saskatchewan.

      We are all ears for an way forward to make this happen.

      BTW, this may be a laudable goal but in the Bigger Picture is it a practical policy initiative in light of all the vested interests and knock-on consequence in the short medium term (as opposed to the 20-30 year timeline)?

      For a healthy debate about this outcome, I’d also ask:

      What’s next after you accomplish this remarkable task?

      Many would be curious about your next aspiration…

  5. Peter Tertzakian (linked to in item #5) describes the 1973 OPEC embargo and its effect on oil supplies to North America. Non G&M member link here:

    http://arcfinancial.com/research/energy-charts/the-absurd-irony-of-canadas-oil-and-gas/

    A more significant event that possibly lead to the energy rationing provisions (security of supply) in the FTA and NAFTA is documented in Guts and Guile, True Tales from the backrooms of the Pipeline Industry, pages 40-41:

    Adding to the gnawing perception that Westcoast was destined not to survive, another disaster occurred in the summer of 1973. The Beaver Creek and Pointed Mountain gas fields, operated by Amoco near the 60th Parallel, went to water. The producing gas wells reduced the reservoir pressure, which is normal. The unexpected result was migration of underground water into the reservoir and a rapidly rising water table that reached the producing level of virtually every gas well in the fields. Overnight, a supply of 300 million cubic feet per day was lost for good. Amoco spent a small fortune in remedial drilling to solve the water intrusion, but the entire field was eventually abandoned.

    This gas-field failure shocked the industry. The first call offering assistance came from Don Getty, then Alberta’s energy minister. He said he would do everything possible to arrange supplementary gas supplies. Unfortunately, physical limitations and B.C. political interference prevented any significant inflow of new Alberta gas. Accordingly, Westcoast announced that all customers would be cut back on a pro-rata basis because the winter daily demand could not be met. The two Canadian customers, particularly Inland, launched an impressive public-protest campaign that intimidated the provincial government into ordering Westcoast not to curtail any B.C. customers, thus putting the damage of the gas shortfall totally on our U.S. customers. Despite Westcoast’s objection to the British Columbia New Democratic Party government’s discriminatory ruling that resulted from Inland’s protests, the exports to the United States were curtailed by about 300 million cubic feet per day that first winter. On the coldest days, our U.S. customers received not much more than half their contract entitlement. At one point, they claimed that 150,000 people were temporarily laid off because of the shutdowns at cement plants, pulp mills and other industrial concerns lacking alternate fuel installations.

    To say that the U.S. customers, who had been so supportive in our previous predicament, were displeased would be grossly understating their grievance. An official of Washington Water Power in Spokane dramatically, if not seriously, suggested that the Marines should be called in to open the gas valves at the Sumas border crossing. It is a frightful embarrassment to acknowledge that some curtailment persisted for six winters on peak-demand days. That failure represents the blackest service record of any big-inch pipeline in North America. The provincial politicians were informed forcefully of the damage their arbitrary export curtailment had caused, yet they seemed unconcerned about the welfare of American citizens. This episode could have been on the minds of the Americans during negotiations between Canada and the United States on the Free Trade Agreement. In the energy section, FTA provisions preclude precisely this type of natural gas curtailment by Canada in the future.

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  7. With so many ‘experts’ ramping up the rhetoric on the energy dependency aspect of the pipeline east debate, it’s nice to see it put into a factual perspective. But regardless of what the figures say the Harper government will find a way to do an end run around any real environmental/economic considerations because so many Canadians will see it as a national issue that will unify the country. It will just be part and parcel of the Conservative’s much vaunted Economic Action Plan. The photo-op upon its completion will be priceless.

  8. This is a very well writen article and hits a number of myths right on the head. I have been quite mystified at the suggestion that gas prices in the East would drop with the substitution of western oil for imported oil. since the purpose of getting oil to the coast is to obtain world prices, it makes no sense to me that prices would go down, in fact, since the oil would be getting world pricing, prices in the West would actually lose the discount they currently enjoy.

  9. from my perspective, the only way that the East will see lower costs for oil is if the pipeline stops short of the coast. If, for example, it stopped in Quebec City, the price would remain pretty much the same as it is now, but once it reaches the Coast and the world can bid on it, the price will be a higher world price and every refinery in Canada will be bidding against Asia for the feedstock thus we all will be paying world prices. Companies will do better,Alberta will get more tax revenue as will the Feds. the rest of us will get higher fuel prices and carry the risk of environmental damage. As we have seen in Lac Magentic, when large disasters occur, companies leave the province and communities holding the bag while they walk away.

    • Refineries in the east already pay world prices. So how would gas prices go UP by having their inputs remain the same price?

      As for Lac Magentic, the rail company is bankrupt. You want them to hand over millions of dollars they don’t have?

      • Firstly, energy east is being sold as a way to bring lower gas prices to the east. That would not happen. Thier prices would stay pretty much what it is now, but in the west, prices would go up.
        As for Lac Magantic, the railroad did not carry he insurance it needed so walks away leaving Quebecers to clean up the mess. You ask ” you expect them to hand over millions of dollars they don’t have? ” that is my point. They leave the tax payer with the bill. Enbridge admitted they proposed the NG pipeline as a limited partnership to protect themselves from liability should an oil spill exceed the coverage of the insurance they carry. They even baulked at the boards proposal to make them keep $1,000,000,000 available to cover the cost of a spill. The point is not what I expect the railroad to do but what companies do when the cost of cleaning up exceeds their insurance. They declare bankruptcy leaving us holding the bag.

  10. after just reading #1 I realized this is a very partisan piece.

    Of course energy east will help the world supply, because the East, which includes Ontario and Quebec, use a lot of oil and gas product, and if that was supplied by ourselves, that would free up what we are using from others, so they could sell it to the world, and that whole chart, and however many barrels that represents would be added to world supply Plus, we would sell to the states south from the east, and we could sell to others off shore, adding even more supply to the world.

    Most importantly, we won’t be cut off is someone is mad, and we can use Oil as a control lever, We can buy both from Alberta and from around the world and cut back from the rest of the world when we don’t like someone. That puts us in the driver seat, not under the wheels. And people are careful if they know they will lose a contract to sell to us.

    And our trade deficit will decrease, that means a lot for our economy over all.
    #3 again confuses the whole thing, if we are selling to the USA then buying from others for the east, of course it would be a gain if we put a pipe line east because then we would have exports and no imports, What is so hard to understand about that, why would the writer try to fool with Logic.

    #4 regardless, there will be a net gain of sales in Canada because of an energy east pipeline, Alberta will take over sales that would other wise be from the middle east etc. So the money would help Alberta and equalization would then help all the provinces providing stimulus…

    #5-6. of course we have less exposure to risk because our Military is less involved, but if we want to make a difference, we cannot be worried that someone will cut us off, we have the ability to be less dependent on foreign oil, and we should be.
    We should also consider that the Pipeline build is of no loss to us because it is simply a cost to the Oil companies who only charge world prices, so, its actually stimulus to our country from international oil companies.

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