TODAY’S STUDY: ABOUT THAT OIL IN THE KEYSTONE XL PIPELINE

Exporting Energy Security; Keystone XL Exposed
September 2011 (Oil Change International)

Overview

TransCanada’s proposed Keystone XL pipeline is a $7 billion project to bring heavy, sour crude oil from tar sands production in Alberta, Canada to Port Arthur, Texas for refining. It has sparked an ongoing struggle as advocates and opponents of the project make their case in various ways to the Obama Administration.

Among the most oft repeated talking points by industry and their allies is the idea that Keystone XL is necessary for American energy security, and that its construction will help wean America of its dependence on Mideast oil. But the idea that Keystone XL will decrease America’s dependence on foreign oil is demonstrably false.

To issue a presidential permit to the proposed Keystone XL pipeline, the Obama Administration’s State Department must find that the pipeline serves the national interest. This report demonstrates compellingly why it does not.

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On August 25, 2011, Robert Jones, a spokesperson for TransCanada declared: “The U.S. has a decision to make, [d]o they want to import oil from Canada or get conflict oil from OPEC nations?”…

On the surface this notion has a clear, if facile, appeal. But an understanding of the changing realities of the oil market in the United States and globally, and a close scrutiny of the oil companies that stand to profit from the pipeline, reveal a completely different story. In fact:

1. The Keystone XL pipeline is an export pipeline. The Gulf Coast refiners at the end of the pipeline’s route are focused on expanding exports, and the nature of the tar sands crude Keystone XL delivers enhances their capacity to do so.

2. Valero, the top beneficiary of the Keystone XL pipeline, has recently explicitly detailed an export strategy to its investors. The nation’s top refiner has locked in at least 20 percent of the pipeline’s capacity, and, because its refinery in Port Arthur is within a Foreign Trade Zone, the company will accomplish its export strategy tax free.

3. The oil market has changed markedly in the last several years, with U.S. demand decreasing, and U.S. production increasing for the first time in nearly 30 years. Higher fuel economy standards and slow economic growth have led to a decline in U.S. gasoline demand, while technological advances have opened up new sources in the U.S. Increasingly, U.S. refiners are turning to export.

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These facts reveal the important truth that the Keystone XL pipeline would not in fact enhance U.S. energy security at all. The construction of Keystone XL will not lessen U.S. dependence on foreign oil—rather, it will feed the growing trend of exporting refined products out of the United States, thereby doing nothing to enhance energy security or to stabilize oil prices or gasoline prices at the pump. If completed, it will successfully achieve a long term objective of Canadian tar sands producers—access to export markets beyond the U.S.

The oil market is fundamentally global. The only way to truly reduce our dependence on foreign oil is to reduce our dependence on all oil.

This report looks at data from the U.S. Energy Information Administration (EIA), corporate disclosures to investors and oil market analyst reports. This information should form the basis of the Obama Administration’s deliberations on the Keystone XL pipeline. An honest assessment of the Keystone XL project will show that the oil will be exported and will not benefit U.S. consumers or any reasonable definition of the nation’s interest.

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The Oil Market Today: Fundamental Changes

Since the early 1970s and the Arab oil embargo, the United States has faced the same essential challenge regarding oil: rising demand in the face of declining domestic production. For the last two years, and for the foreseeable future, that dynamic has reversed: demand is in decline, while domestic supply is rising. These two facts fundamentally change the current and future U.S. oil market.

This was not the case when the Keystone XL pipeline was originally proposed. However, since 2008, oil market analysts have repeatedly asserted that U.S. gasoline demand is in decline as a result of increasing vehicle efficiency (See Figure 1)2.This trend has recently been confirmed and reinforced by the introduction of more stringent fuel efficiency standards…

Keystone XL’s backers argue that Alberta’s oil is needed to replace foreign imports. A related argument says that Keystone XL is essential to relieve gridlock at the crossroads for U.S. oil trade, Oklahoma’s Cushing hub. But these arguments don’t stand up to scrutiny. In fact, the purpose of the pipeline is to give Canadian tar sands producers access to international markets.

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Here are the key facts about the changing face of the oil market in the U.S. today:

• Gasoline demand is declining due to increasing vehicle efficiency and slow economic growth;

• Meanwhile the surge in new shale oil production in North Dakota and Texas has led to the first rise in U.S. oil production since the mid-1980s and is forecast to continue for some time (see Figure 2);

• As a result of stagnant demand and the rise in both domestic and Canadian oil production, there is a glut of oil in the U.S. market;

• Refiners have therefore identified export markets as their primary hope for growth and maximum profits;

• The shale surge and the glut of oil is driving the oil industry to adapt America’s petroleum transportation structure to a completely new reality: oil and fuel moving from the heartland to the coasts, instead of the other way round.

As a result of these new market dynamics, Canadian oil, which is already flowing in on two new pipelines, is competing with the new domestic oil. This is because a number of big refineries have refitted (or are in the process of refitting) in order to process the Canadian oil, which is different than most of the oil in the United States.6 Once these refineries are configured for the heavy sour oil from Canada, it is less profitable for them to process the light sweet oil being produced in North Dakota and Texas…

In short, Canadian tar sands producers are undercutting U.S. domestic oil producers, and Keystone XL will only help to make that situation permanent.

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Globally, the state of the oil products market is also important to look at in understanding the attraction of U.S. refiners to export. Consider:

• There is a shortage of diesel capacity in global refining thanks to high demand in Europe and developing countries;

• There is a long term shortage of refining capacity in Latin America;

• As a result gulf coast refiners have been in creasing exports of diesel to Europe and Latin America (see Figure 3);

• These structural dynamics are forecast by the EIA to be long term;

In short, there are market fundamentals at work here that provide incentives for a company that is properly positioned to refine the diluted bitumen from Keystone XL into diesel for export. Several refiners are positioned like this, in particular Valero.

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TransCanada’s Business Model for Keystone XL

Generally, pipelines operate by shipping oil on what is known as the “spot market”—selling space to whatever oil company is willing to pay the most in a “cost of service” model. Keystone XL is different. Keystone XL is planned to operate on a business model of long-term contracts with very few shippers. Keystone XL’s unique contractual set-up allows us to reveal the ultimate fate of the diluted bitumen (dilbit) the pipeline will deliver.

In 2009, TransCanada identified the six shippers, or customers, who have signed confidential long-term binding agreements that according to TransCanada’s statements to Canada’s regulators, account for 76 percent of Keystone XL’s initial capacity…

Port Arthur, Texas is the southern terminus of the Keystone XL pipeline and three of the shippers have refineries located there—Shell, Total, and Valero. Two of the shippers are tar sands producers in need of access to markets (Canadian Natural Resources and Cenovus/Encana), and the final one is an oil trading firm specializing in export (Trafigura). The six shippers are:

• Valero: Valero—the largest exporter of refined products in the United States—has a long-term contract with TransCanada to ship oil on the Keystone XL pipeline. It also has a contract with Canadian Natural Resources to take 100,000 barrels per day via the Keystone XL pipeline. Valero has also stated that it has additional contracts with other producers. The company’s business model relies on capturing profits from low-grade heavy sour oil (such as dilbit from Keystone XL), with sales growth now focused on export markets. It is upgrading the Port Arthur refining facility to process heavy sour oil into distillate…or diesel, for export…

• Shell: Shell has major stakes in the Alberta tar sands and is also a partner with Saudi Aramco in refining company Motiva. Motiva is currently expanding its Port Arthur refinery to become the largest in the U.S. with substantial heavy sour crude capacity…

• Total: Total has stakes in the tar sands and has a newly-upgraded refinery in Port Arthur…

• Canadian Natural Resources: This major Canadian oil producer has new diluted bitumen (dilbit) fields coming online but lacks upgrader or refining capacity to handle anticipated volumes.

• Cenovus/Encana: Like Canadian Natural Resources, Cenovus/Encana also has new dilbit fields coming online but lacks upgrader or refining capacity to handle anticipated volumes.

• Trafigura: This scandal-ridden company is a major player in the Latin America petroleum trade. It was at the center of the Iraqi Oil for Food scandal and was fined one million euro for waste dumping in the Ivory Coast.17 Its prime business is import/export…

Finally, the Motiva, Total and Valero refineries in Port Arthur are within a Foreign Trade Zone, meaning they are exempt from customs duties on imports and exports as well as various state and local taxes…This amounts to a sizeable subsidy to the oil industry to export refined oil products.

While Valero has been the most explicit, as documented below, all refiners face the same market dynamics. Declining U.S. demand means the best growth opportunities lie in the export market.

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Valero’s tar sands export strategy

The Keystone XL pipeline would probably not have gotten off of the drawing board without Valero. The refining company has the biggest single commitment to the pipeline guaranteeing TransCanada a customer for at least 100,000 barrels per day, or 20 percent of Keystone XL’s initial capacity20. The long-term binding commitments with Valero and five other suppliers, refiners and traders, the details of which remain confidential, underpin the commercial viability of Keystone XL.

The tar sands-derived heavy sour crude that Keystone XL will deliver requires special equipment to refine. Following a series of refits and upgrades, Valero’s Port Arthur refinery will be capable of processing at least150,000 barrels per day of heavy sour crude by late 2012 (See Figure 4). The refinery is strategically located near the proposed terminus of Keystone XL.

This slide outlines Valero’s strategy for the $1.5 billion hydrocracker at its Port Arthur refinery. It notes that the “main products are high quality diesel and jet fuel for growing global demand” and that the refinery is well located for exports…

Valero is able to process a very high proportion of that heavy sour crude into diesel. Indeed, the upgrades nearing completion at two different Valero Gulf Coast refineries involve hydrocrackers, which can be uniquely calibrated to yield 90 percent diesel…

There is a surplus of diesel on the U.S. market due to the much higher proportional demand for gasoline in the United States and the fact that refining crude oil results in a range of products, so that all refineries are making diesel even if they are configured to prioritize gasoline…

However, in the global market, there is strong demand for diesel because of the popularity of the more fuel-efficient diesel engine in passenger cars in Europe and elsewhere. The growth market for the global trade in petroleum products is dominated by diesel (see Figure 5). Valero’s strategy of converting its Port Arthur refinery to maximize diesel production through the processing of cheap, heavy sour crude from the Canadian tar sands is entirely focused on exporting the diesel into the global market…

Valero has also purchased a refinery located in Wales in the United Kingdom. The company stated that it intends to import gasoline from this refinery into the United States while exporting diesel and other products from its gulf coast refineries (See Figure 6).26 In short, Valero’s strategy is to exploit arbitrage in the Atlantic basin, selling gasoline into the U.S. market while exporting diesel to Europe and both diesel and gasoline into Latin America.

The idea that Keystone XL enhances U.S. energy security is undermined by Valero’s business model that seeks to export products made with imported oil while further importing gasoline from a third country.

Not only is Valero increasing U.S. imports of oil and gasoline, but it will also avoid paying tax while doing so. The Port Arthur refinery operates as a Foreign Trade Zone (FTZ), which traditionally gives tax benefits to companies that use imported components to manufacture items within the United States.27 Usually refineries importing oil tax-free will still pay taxes when selling the refined products into the U.S. market. By both importing into and exporting from Port Arthur the company will avoid paying tax on the product sales.

In sum, Valero appears to have positioned its Port Arthur refinery with a captive supply into a tax-haven where it refines product not for the United States, but for foreign markets. Only the pollution stays behind.