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A "Fair Price" for Canada's Oil Is a Slippery Slope

Posted: 01/11/2014 4:51 am

It's a phrase that has wafted up from the oil sands to the airwaves. It pops up in speeches by politicians and editorials by journalists: A "fair price" for Canadian oil. The key to this, we are told, is pipeline access to "tidewater" (another marketing term adopted by media and government).

The basic argument goes like this: A barrel of oil sands crude currently trades at a lower price than other global oil benchmarks. That price gap means Canadians are losing money on every barrel sold. Access to world markets will fetch higher prices, elevating our collective prosperity.

It's a persuasive story, tickling the part of the brain associated with loss aversion. No one wants to bleed money day after day. At the same time it paints a picture of one nation, our fortunes rising and falling in unity. It's good politics. But the reality is more complex. As individuals and businesses calculate whether the risks of these pipelines outweigh the rewards, three broad trends should be kept in mind.

First, what kinds of energy do those global markets want? Second, who can get it there at the lowest price? And most importantly, who wins and who loses if the price of Canadian oil climbs? The answers point to 2014 as a crucial year in the pipeline battle. That's because the window in which these projects are viable may be closing faster than we think.

Comparing apples

If an apple is light and sweet, an orange is more heavy and sour. That's the difference between Western Canada Select (WCS), blended out of oil sands bitumen, and West Texas Intermediate (WTI), the benchmark often cited on the news as "the price of oil." They're not the same product.

As the National Energy Board website explains, "all crude oil is not valued equally. Light oil that is low in sulphur (sweet) is more valuable to refiners than heavy oil with higher sulphur content (sour)." In a chemical sense, oil containing more carbon and less hydrogen delivers less energy -- unless refiners inject more hydrogen molecules, which costs them money. So the price gap is partly due to geography, and partly due to a difference in quality.

University of Alberta environmental economist Andrew Leach explains it this way: "People could say, 'Oh, this hotel owner in Red Deer is really getting ripped off. He only charges $120 a night, versus New York, where it costs $500 a night. If only he could get world prices for his hotel room.' But that's not how it works."

Leach, who was appointed last year as the Enbridge Professor of Energy Policy at the Alberta School of Business, says "as far as the world price for Canada's oil, there's a lot of confusion created in general. People mix up geographic discount versus quality discount." Pipelines can help with one, but not the other.

The business case for a pipeline depends on what margins it can create for its clients, the companies shipping oil. The longer the pipeline and the more it costs to build, the more shippers pay to use it. Northern Gateway, for example, has jumped from a $5.5 billion project to $7.9 billion -- money Enbridge will have to make back from its customers. On top of that, those producers are factoring in the costs of mining bitumen and diluting it for transport. The bottom line is the price of other countries' crude, against which, in a global market, Canadian oil must compete.

Maya, Brent, meet Barack.

Refineries equipped to handle light, sweet crude must be retooled at considerable expense if they're going to switch to heavy, high-sulphur oil -- and vice versa. The argument for the Keystone XL pipeline is that it would carry Canadian crude to refineries on the U.S. Gulf Coast that are currently set up for heavy oil. But those refineries have another supplier, just a short tanker ride away.

Mexico's heavy crude, priced on the Maya benchmark, is chemically closer to WCS and arguably a better comparison for oil sands crude than WTI. Either way, Mexican producers are gunning for the same heavy-oil refineries. "Mexico is recovering from depressed oil outputs, in part due to low investment," says Werner Antweiler, Chair in International Trade Policy at UBC's Sauder School of Business. That's because last month, the country's new president broke a 75-year state monopoly on oil production, opening up underproducing fields to the world's energy giants.

"The shortest path is to refineries on the southern coast of the United States, meaning there could be even more of a glut in the North American market, driving down prices," says Antweiler. Meanwhile, thanks to hydraulic fracturing, the U.S. itself is in the middle of a oil-drilling renaissance. Pipelines and refineries are suddenly awash in lighter crude, from the Bakken formation.

With the U.S. lumbering toward energy independence, some lawmakers argue the country should focus on refining its domestic riches. Others say it's time to break a decades-old ban on exporting crude oil. That's right: Canada, which has no such law against exporting unrefined bitumen, could find itself competing with output from both Mexico and the United States.

Antweiler also points to Venezuela, another heavy-oil producer opening up markets after the death of Hugo Chavez, and even Iran -- which could further add to global oil supply as sanctions lift. "These markets change, and they can change quite rapidly," says the economist. "When you speculate on these price gaps persisting, others see that too. Everybody is trying to go after these margins." As easier, higher-quality sources of crude come online, Antweiler is doubtful that prices for Canadian oil will climb for long. "Put it this way. The people who forecast oil markets have gotten it wrong more often than they've gotten it right."

Either way, the long-term trend starts to flatten. The International Energy Agency forecasts slowing growth in the demand for oil as climate change forces the adoption of more natural gas, renewables, and nuclear power.

Winners and losers

Still, what if the best-case scenario described by politicians comes to pass? The pipelines reach salt water, tankers reach overseas customers, and suddenly the price of Canadian oil jumps. Who benefits then? Oil producers, says Andrew Leach, and government treasuries. But that money will not flow to all parts of Canada equally. "Oil sands royalties are ridiculously complicated," he warns. But the end result is predictably skewed. "Pretty much any way you model the benefit flows, it's all in Alberta. And though I loathe economic impact analysis, if you look at GDP or employment, a lot of it is still in Alberta."

That would be presumably help the province's long-governing Progressive Conservatives, who have drained the Alberta Heritage Savings Trust Fund and racked up a $2.8 billion dollar deficit, which they blame on the bitumen price gap -- and massive floods last June.

As for federal taxes, Leach says "I can probably weave you an example where the federal government is better off either way, pipeline or no pipeline." He compares it to suddenly banning wheat exports. "Farmers would be mad and pasta producers would be overjoyed. Would that change the world price for pasta? Probably not. But you would see a transfer of wealth from the food producing sector to processing."

In other words, pipelines giveth jobs, but they also taketh away -- in particular, at Canadian refineries. That's why unionized refinery workers pledge to employ civil disobedience if pipeline construction ever proceeds.

Who else loses? Former CIBC World Markets chief economist Jeff Rubin says everyday consumers. As Rubin wrote in the Globe and Mail, "connecting land-locked oil to an ocean is a great outcome for the Suncors, Shells, and Imperial Oils of the world, but what does it do for Canadians filling up at the pumps?" Rubin argues that "as more Alberta oil ends up on the high seas, the more Canadian oil prices will mirror the higher prices paid in the rest of the world. When the price of oil rises, clearly, the cost of gas at your neighbourhood station goes up as well."

Other economists, including Leach and Antweiler, say it's not that simple. However, most can agree on one result: as the price goes up, oil sands operations will expand. Bitumen is complicated and costly to extract. When the price of a barrel falls too far, the product is not worth mining. A report published in December by two former Deutsche Bank analysts calculates that break-even minimum at $65 per barrel. Werner Antweiler says even below $80, most deeper reserves are effectively locked away. But new export pipelines would prompt a surge in new production -- at least until the next supply glut.

The Showdown

Last month Bloomberg Businessweek magazine called Canada's oil sands a "shaky investment." State-owned Chinese oil companies are frustrated with the slow pace of pipeline approval, voiced most memorably by CNOOC executive Chen Weidong: "It's the same situation as the leftover single women. It will be the same for the oil sands, they will be outdated." That was more than a year ago. If Chen was right, perhaps the window is already closing.

Certainly a sense of urgency is gripping both camps. On the one side are those with the most to gain from a hypothetical spike in WCS prices: foreign and Canadian-owned oil producers, pipeline companies, and Alberta politicians. On the other side are those who bear the most risk: First Nations, refinery workers, B.C. municipalities, the B.C. government, and citizens concerned about oil spills or climate change. Whether the pipelines are worthwhile depends on one's personal situation.

The proponents spend impressive sums to fund think tanks, ad campaigns, and lobbying -- all of which helps push their language into the mainstream. Like a "fair price" for Canadian crude. But in a free market, fairness is determined by the buyer, not the seller. It's curious that journalists and government officials would feel bitumen needs their help to sell. The fact is, if crossing B.C. is not an option, the product will find buyers in other directions. Or it won't.

- Kai Nagata, DeSmog Canada

Loading Slideshow...
  • Syncrude's Mildred Lake Upgrader, part of The Syncrude Project complex for oil sands processing, is pictured Monday, March 8, 2006 in Fort McMurray, Alberta, Canada.

  • The Syncrude oil sands extraction facility is reflected in a lake reclaimed from an old mine near the town of Fort McMurray in Alberta, Canada on October 22, 2009.

  • A disused mining machine on display in front of the Syncrude oil sands extraction facility near the town of Fort McMurray in Alberta on October 22, 2009.

  • Mountains of sulphur, a waste byproduct of mining, stand at a Syncrude Canada Ltd. mining site near Fort McMurray, Alberta, Canada, on Tuesday, Aug. 13, 2013.

  • The Suncor oilsands operation uses trucks that are 3 stories tall, weigh one million pounds, and cost 7 million dollars each.

  • Oil sits on the surface at a Suncor Energy Inc. oilsands mining operation near Fort McMurray, Alberta, Canada, on Tuesday, Aug. 13, 2013. Photographer:

  • An aerial view of a tailings pond at the Suncor oil sands mine near the town of Fort McMurray in Alberta in 2009.

  • Mining trucks carry loads of oil laden sand at the Albian Sands oils sands project in Ft. McMurray, Alberta, Canada, on Friday, August 5, 2005

  • A large oil refinery along the Athabasca River in Alberta's Oilsands. Fort McMurray, Alberta.

  • Oils mixes with water at a tailings pond at a Suncor Energy Inc. oil sands mining operation near Fort McMurray in 2013.

  • Fort McMurray is in the heart of the world's biggest single oil deposit - the Athabasca Oil Sands, and the oil is extracted by surface mining and refined in the region. The oil production is at the heart of the economy.

  • Oil is seen at the ground's surface near Royal Dutch Shell Plc's Albian Sands mine near Fort McMurray, Alberta, Canada, on Tuesday, Aug. 13, 2013.

  • In this Aug. 5, 2005 file photo, the Syncrude upgrader spreads out towards the horizon at the company's oil sands project in Ft. McMurray, Alberta, Canada.

  • The Mildred Lake upgrader, on the grounds of The Syncrude Project in Fort McMurray, Alberta, Canada is pictured from the air Monday, March 6, 2006.

  • This Tuesday, July 10, 2012 aerial photo shows a Nexen oil sands facility near Fort McMurray, Alberta, Canada.

  • This Sept. 19, 2011 aerial photo shows an oilsands facility near Fort McMurray, in Alberta, Canada.

  • This Sept. 19, 2011 aerial photo shows an oilsands tailings pond at a mine facility near Fort McMurray, in Alberta, Canada.

  • This Sept. 19, 2011 aerial photo shows an oilsands tailings pond at a mine facility near Fort McMurray, in Alberta, Canada.

  • The Syncrude extraction facility in the northern Alberta oil sand fields is reflected in the pool of water being recycled for re-use.

  • A night view of the Syncrude oil sands extraction facility near the town of Fort McMurray in Alberta Province, Canada on October 22, 2009.

  • Aerial view of a lake and forests in the vicinity of oil sands extraction facilities near the town of Fort McMurray in Alberta, Canada on October 23, 2009.

  • Workers use heavy machinery in the tailings pond at the Syncrude oil sands extraction facility near the town of Fort McMurray in Alberta , Canada on October 25, 2009.

  • Fort McMurray is in the heart of the world's biggest single oil deposit - the Athabasca Oil Sands, and the oil is extracted by surface mining and refined in the region. The oil production is at the heart of the economy.

  • A large oil refinery in Alberta's Oilsands project. Fort McMurray, Alberta.

  • Next: Alberta Oil Spills

  • CFB Cold Lake, CNRL

    A bitumen leak was reported at a Canadian Natural Resources oilsands operation in the weapons range part of the RCAF base in June 2013.

  • CFB Cold Lake, CNRL

    Company officials said the leak - at what it calls its Primrose operation - was caused by faulty machinery at one of the wells, affected an area of approximately 13.5 hectares and released as much as 3,200 litres of bitumen each day.

  • CFB Cold Lake, CNRL

    Preliminary tallies put the death toll from the leak at 16 birds, seven small mammals and 38 amphibians. Dozen were rescued and taken to an Edmonton centre for rehabilitation.

  • CFB Cold Lake

    As of early August 2013, more than 1.1 million litres of bitumen had been pulled from marshlands, bushes and waterways.

  • CFB Cold Lake, CNRL

    Although CNRL could not say when the leak may finally be stopped, it estimates it will likely cost more than $40 million to clean up.

  • <em>Click through for other recent spill in Alberta</em>

  • Plains Midstream

    Little Buffalo band member Melina Laboucan-Massimo scoops up July 13, 2012 what appears to oil from the pond shoreline near the site of a 4.5 million-litre Plains Midstream pipeline leak detected April 29, 2011. Photos taken at the site and released by Greenpeace of Alberta's second-worst pipeline spill suggest at least part of the site remains heavily contaminated despite company suggestions that the cleanup is complete.

  • Plains Midstream Canada

    A boat passes by a boom stretching out to contain a pipeline leak on the Gleniffer reservoir near Innisfail, Alta., Tuesday, June 12, 2012. Plains Midstream Canada says one of their non-functioning pipelines leaked between 1,000-3,000 barrels of sour crude near Sundre, Alberta, on June 7 and flowed downstream in the Red Deer river to the reservoir.

  • Plains Midstream Canada

    Debris pushes up against a boom as it stretches out to contain a pipeline leak on the Gleniffer reservoir near Innisfail, Alta., Tuesday, June 12, 2012.

  • Plains Midstream Canada

    A boom stretches out to contain a pipeline leak on the Gleniffer reservoir near Innisfail, Alta., Tuesday, June 12, 2012. Plains Midstream Canada says one of their non-functioning pipelines leaked between 1,000-3,000 barrels of sour crude near Sundre, Alberta, on June 7 and flowed downstream in the Red Deer river to the reservoir.

  • Plains Midstream

    A boom stretches out to contain a pipeline leak on the Gleniffer reservoir near Innisfail, Alta., Tuesday, June 12, 2012. Plains Midstream Canada says one of their non-functioning pipelines leaked between 1,000-3,000 barrels of sour crude near Sundre, Alberta, on June 7 and flowed downstream in the Red Deer river to the reservoir.

  • Plains Midstream Canada

    A photographer snaps a boom stretching out to contain a pipeline leak on the Gleniffer reservoir near Innisfail, Alta., Tuesday, June 12, 2012. Plains Midstream Canada says one of their non-functioning pipelines leaked between 1,000-3,000 barrels of sour crude near Sundre, Alberta, on June 7 and flowed downstream in the Red Deer river to the reservoir.

  • Plains Midstream Canada

    A boom stretches out to contain a pipeline leak on the Gleniffer reservoir near Innisfail, Alta., Tuesday, June 12, 2012. Plains Midstream Canada says one of their non-functioning pipelines leaked between 1,000-3,000 barrels of sour crude near Sundre, Alberta, on June 7 and flowed downstream in the Red Deer river to the reservoir.

  • Plains Midstream Canada

    A worker slows traffic while a boom stretches out to contain a pipeline leak on the Gleniffer reservoir near Innisfail, Alta., Tuesday, June 12, 2012. Plains Midstream Canada says one of their non-functioning pipelines leaked between 1,000-3,000 barrels of sour crude near Sundre, Alberta, on June 7 and flowed downstream in the Red Deer river to the reservoir.

  • Plains Midstream Canada

    A no swimming sign along the banks of the Gleniffer reservoir while a boom stretches out to contain a pipeline leak on the lake near Innisfail, Alta., Friday, June 12, 2012. Plains Midstream Canada says one of their non-functioning pipelines leaked between 1,000-3,000 barrels of sour crude near Sundre, Alberta, on June 7 and flowed downstream in the Red Deer river to the reservoir.

  • Plains Midstream Canada

    Oil from a pipeline leak coats a pond near Sundre, Alta., Friday, June 8, 2012. Plains Midstream Canada says one of their non-functioning pipeline leaked between 1,000-3,000 barrels of oil.

  • Plains Midstream Canada

    Oil from a pipeline leak coats a pond near Sundre, Alta., Friday, June 8, 2012. Plains Midstream Canada says one of their non-functioning pipeline leaked between 1,000-3,000 barrels of oil.

  • Plains Midstream Canada

    Oil from a pipeline leak coats a pond near Sundre, Alta., Friday, June 8, 2012. Plains Midstream Canada says one of their non-functioning pipeline leaked between 1,000-3,000 barrels of oil.

  • Plains Midstream Canada

    Tracks pass through oil on the banks of the Gleniffer reservoir after a pipeline leak near Sundre, Alta., on Friday, June 8, 2012. Plains Midstream Canada says one of their non-functioning pipelines leaked between 1,000-3,000 barrels of oil.

  • Enbrige's Athabasca pipeline

    Approximately 1,450 barrels of oil spilled from a pumping station along Enbridge’s Athabasca pipeline in June 2012. The spill occurred approximately 24 kilometres from Elk Point, Alta., a village located 200 kilometres northeast of Edmonton.

  • Lake Wabamun

    Wreckage from the August 3rd train derailment and subsequent oil spill is seen lining the shore of Lake Wabamun on Monday, August 8, 2005, as clean-up continues.

  • Lake Wabamun

    Wreckage and black oil from the August 3rd train derailment and subsequent oil spill are seen lining the shore and waters of Lake Wabamun on Monday, August 8, 2005, as clean-up continues.

  • Lake Wabamun

    White absorbent boom is seen lining the shores of Lake Wabamun, Alberta, as the clean-up effort from the August 3rd train derailment and subsequent oil spill continues on Monday, August 8, 2005.

  • Lake Wabamun

    Wreckage and black oil from the August 3rd train derailment and subsequent oil spill are seen lining the shore and waters of Lake Wabamun on Monday, August 8, 2005, as clean-up continues.

  • Lake Wabamun

    Wreckage and black oil from the August 3rd train derailment and subsequent oil spill are seen lining the shore and waters of Lake Wabamun on Monday, August 8, 2005, as clean-up continues. Lake Wabamun was severely polluted when a train carrying heavy oil derailed on August 3, 2005, spilling much of it's load into the lake.

  • Lake Wabamun

    Rail cars leak bunker fuel oil, meters from summer homes bordering Lake Wabamun, after a freight train derailed, in this August 3, 2005 file photo, near the town of Wabamun, Alta. Canadian National Railway faces an environmental charge stemming from the train derailment and oil spill at a popular Alberta lake last summer.

 

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