Checking the math on Energy East - Macleans.ca

Checking the math on Energy East

Our in-house economist finds higher minimum savings and lower maximum savings than recent reports suggest

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Daniel Acker / Bloomberg / Getty Images

One of the main selling points of TransCanada’s Energy East Pipeline is that it presents a potential win-win whereby eastern refiners would be able to pay less for crude than they otherwise would, while paying more for Alberta crude than Alberta producers would otherwise receive. Yesterday, TransCanada announced the results from a study on the economic benefits of Energy East. One of the lines that caught my eye in that detailed report, authored by Deloitte, (PDF) was a statement that the pipeline would provide, “a supply of domestic crude oil sources for eastern refineries, which is expected to result in an annual feedstock cost savings of between $1.55 and $11.49 per barrel.” Now, $11.49 per barrel seemed awfully high, so I dug into the assumptions a little. I then re-estimated the potential savings, using Deloitte’s assumptions, and found $3 to 6.04 per barrel in savings for eastern refiners.

The Deloitte analysis lays out two scenarios. In the first one, the price eastern refiners pay for oil transported on Energy East is based on Brent, a north sea oil price benchmark. In the second scenario, the price they pay for Alberta oil is linked to how much it would cost to ship that oil to Europe via the Gulf Coast. These are defensible, though not the only, potential outcomes of the North American oil market with Energy East in service.

Eastern refineries currently use crude for which they pay world (or Brent) prices, and also have to pay the transportation costs (assumed in the analysis to be $1.50 per barrel to Saint John and $2.80 per barrel to Quebec) to get that oil to their refineries.* In the first scenario explored by Deloitte, the Energy East pipeline would, effectively, reverse this relationship. Oil would be flowing outward to the coast, so the price of a barrel of oil at the port of Saint John would be Brent less the price of transportation to Europe, representing a savings to refiners that is equal to double the current transportation cost. This suggests that the price at St John would go from Brent + $1.50 to Brent – $1.50, a savings of $3 per barrel relative to today’s costs. Similarly, in Quebec, you would see oil being worth Saint John prices net the toll to ship to Saint John, so Brent prices – $2.75 per barrel using the assumptions in the Deloitte analysis, a savings of $5.35 per barrel relative to current pricing. For this scenario, it appears the TransCanada’s report may have under-estimated potential crude savings (assuming the marginal barrel is moving out by export), perhaps by missing the double-impact of the crude transport cost premium being reversed.

Just so you are clear that my math works, you can make this argument from the producers’ perspective as well. If a producer can ship oil from Alberta to Saint John for $8.25 per barrel, and then to Europe for $1.50 more, they will not accept a price less than Brent – $9.75 per barrel from a domestic refiner as long as exports are permitted. So, let’s assume that the refiner buys oil in Alberta at Brent – $9.75, and pays $8.25 to ship the oil to Saint John — they’ve obtained oil at Brent prices less $1.50 per barrel, a cost savings of $3 per barrel over their previous crude prices.

Looking at the high-end of savings estimate, the Deloitte analysis again relies on assumptions as to the marginal barrel leaving Alberta. The analysis lays out a scenario where the best alternative for an Alberta producer is to ship via other pipelines to the Gulf Coast and on to Europe, and they calculate that, “the Quebec refinery savings would be equivalent to the cost to ship crude oil from western Canada to alternative markets.” The Deloitte analysis calculates this savings at $10.24 per barrel in Quebec and $11.49 per barrel in Saint John.

The calculation leading to these large potential savings seems flawed to me. Yes, it’s true that if the marginal barrel is leaving Hardisty, Alta., via Cushing and the Gulf Coast, we would expect, using  their toll assumptions, for the price of oil at Hardisty to be Brent – $10.24 per barrel. However, in order to benefit from these depressed prices via Energy East, refiners with firm service access on the pipeline would still have to pay pipeline tolls (producers aren’t going to sell at an even larger discount to cover tolls to eastern markets). If this shipping toll is $7 per barrel to Quebec, then you would see their cost of Alberta oil of Hardisty prices + $7 per barrel, or Brent prices minus $3.24 per barrel. This would amount to savings of $6.04 per barrel relative to their assumed current option of paying Brent + $2.80.

For Saint John, the high-side calculation is similar.  Using a pipeline toll of $8.25, and a Hardisty oil price of Brent less 10.24 per barrel, the price of Alberta oil delivered to Saint John via Energy East would be Brent less $1.99 per barrel, a savings of $3.49 per barrel relative to their current pricing of Brent + $1.50.

So, using the assumptions laid out in the report, I’d calculate potential savings of $5.35 to $6.04 per barrel for a Quebec refinery and and of $3 to $3.49 per barrel in Saint John.  These results have higher minimum savings and lower maximum savings than those reported by TransCanada and Deloitte.

*As an aside, it previous writings on the issue, I’ve made the assumption that eastern refineries are paying Brent prices and have ignored the transportation cost premium paid relative to Brent.  As the analysis above shows, this transportation cost premium, and its potential reversal, plays a very important role in determining the potential cost savings from the pipeline project, so I am happy to correct that previous oversight.