More Canadian oil, higher Nebraska gas?

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March 30, 2011 - 7:00pm

Recently the U.S. State Department announced it would take more time to look at the environmental issues surrounding the proposed Keystone XL oil pipeline. But as the State Department determines whether the pipeline is in the national interest, it will also consider what the pipeline would mean for energy policy and how it might impact the economy. In this Signature Story from NET News, Grant Gerlock talks with Philip Verleger, an economist who has followed the oil and gas industry in the U.S. for decades. He now also teaches at the University of Calgary in Alberta, Canada near the area that would be the source of the oil for Keystone XL. Verleger says the State Department should take a free trade approach to the project, with some stipulations.

GERLOCK: One question the State Department might be asking is if this oil doesn't come to the U.S., might it go somewhere else? Is there a pretty clear answer to that question?

VERLEGER: Oh, I think the oil is going to China. It will go to Houston where it will be put on ships to go to China. It is unquestionably going to China because the consumers in Houston right now get oil from Venezuela, Saudi Arabia, and other places in the world. They will refine some of the Canadian oil. But there is too much of this Canadian oil: A, and B: it's in the interest of the refiners on the Gulf Coast and it's in the interest of the producers around the world to maintain their current relationship. So some of the oil is going to go to China.

GERLOCK: So how should the State Department review that, if this is oil that's going through the U.S., all the way through the U.S. north to south, but then it's getting on a boat and going overseas?

VERLEGER: I have an economic view of oil and agricultural crops. You buy them from the people that are most efficient in producing them. So if I'm going to buy corn or wheat I'm going to buy them probably from a Nebraska farmer. And if I'm going to buy oil I'm going to buy it from the Middle East, or Canada, or the United States, whoever produces it. Since we believe in free trade - agriculture producers benefit from free trade, U.S. manufacturers benefit from free trade - if the oil is exported we should be pleased that the world supply has been increased and that there's more diversification in supply.

GERLOCK: Keystone XL would carry another half million barrels (of oil) per day or so. What difference would that make for the oil sands industry, if it's built or if it's not built? How consequential is this project for the industry in Alberta?

VERLEGER: It's huge. Canada is right now producing about 3.2 million barrels per day. They want to go to 4.2 million barrels a day or 5 (million). They probably can, but they have to build new pipelines to get the crude to the market. They really have three solutions. One is to build the Keystone pipeline. Two is build a pipeline called the Gateway pipeline which would go across Alberta west through British Columbia to Kitimat, from which it would be exported. Or three, to expand, as has been proposed recently, the Kinder-Morgan pipeline which now takes crude from Alberta to Vancouver, build a spur to Kitimat and export the crude that way. If one of those, if all of those pipelines are not built the Canadian oil industry will have to stop pretty much at its current size and expansion will end.

GERLOCK: Gas prices in Nebraska have been up about .80/gallon over a year ago. It would seem like more oil from Canada might cause that to go down, but you've suggested otherwise. How is it that more oil coming from Canada could actually mean higher prices at the pump?

VERLEGER: The Midwestern prices and Colorado prices, I live in Colorado, have not increased as much as prices in the rest of the country because Canadian crude oil now is flowing through Minnesota to Chicago and then south to Cushing, Oklahoma. And historically the refiners in the Midwest paid more for crude oil than refiners on the Gulf Coast. They did that because world crude would come into the Gulf Coast and then be moved north on pipelines and Midwestern consumers would pay say six, to eight, maybe ten cents-per-gallon more than customers on the Gulf Coast. The introduction of Canadian crude means oil flows south not north, and this means that customers in the Midwest should pay six cents, eight cents, maybe even ten cents-a-gallon less than consumers in Houston before one looks at differences in taxes at the pump. And recently that has been happening because crude is flowing south and it costs more money to take it down to Houston where it competes with other crude. What the Canadians propose to do is build this pipeline and bypass Chicago. And by bypassing Chicago they state in their filings with the Canadian energy authorities that they will be able to manipulate the price in the Midwest and Chicago and Nebraska up so that once again the consumers in Chicago and the Midwest will be paying five cents, maybe six cents, maybe 10 cents-a-gallon more than consumers in the Gulf Coast. So it's the diversion through the pipeline that has this impact on Nebraska consumers.

GERLOCK: So is there a bottleneck, a refining bottleneck in the Midwest and Oklahoma and Chicago, or is this jus their interest in going around to get to those refineries down south?

VERLEGER: Well, there are both. But it's primarily their interest. As I said, oil used to flow north from the Gulf up to Chicago. So one would expect prices in Chicago and prices in the Midwest to be higher. The reason is that you have the world price of crude that you can find, or that you determine in Houston, Texas or in the Gulf Coast area. If instead oil is flowing from Canada south, through Chicago, through the Midwestern refineries, you pay lower transportation costs on it to take it to Chicago than you do to take it to the Gulf Coast. And so prices to the refiners in Chicago and the Midwest should be lower than prices to refiners on the Gulf Coast, rather than higher. And so Midwestern consumers should benefit from this and it means that the Canadian producers would get a little less for their crude sold there. Now, the interest of the Canadians is to bypass this by taking the oil straight down to the Gulf Coast. And they said that and they put a number on it of $3.9 billion in their calculations. So that is the economics that I'm focused on. But in this case the Canadian asking permission to bring their oil across the United States so they can get it to Houston. And they want us to help them. I see no reason why we shouldn't if the environmental things can be taken care of. But I certainly don't see why if we help them they can turn around and stick us with higher prices. It just doesn't seem really very fair. What you do is you essentially set a market test on the prices of crude oil costs and deliveries to Chicago. And you would presumably on a monthly or quarterly basis tell the Canadians exactly how much oil they can ship through this pipeline and the Canadians would have to agree to such a stipulation if we allowed them to build it. So that if pipelines were full to Chicago prices would be what a competitive market would dictate and the Canadians could only send as much crude oil through this pipeline as they had as excess.

GERLOCK: Does that match with free trade ideas, though?

VERLEGER: Yes, it does. It essentially what it does is prevent Canada, the owners of the pipeline from exercising monopoly power to boost revenues from Midwestern consumers unfairly to transfer them to Alberta producers.

GERLOCK: One comment that comes up from landowners, from lawmakers, and from others is that we need to be ready for the next one. Do you think there are more pipelines that will be in the works to go through this part of the country?

VERLEGER: I think there will be more natural gas pipelines. Today you can buy natural gas for about $25/barrel crude oil equivalent with crude oil selling over $100 (per barrel). And we have found a great deal of natural gas in the United States. Years ago we thought we were going to run out. This increase of supply in natural gas is going to lead to greater use. We'll replace some coal fired power plants. We'll also probably see natural gas used in transportation. This means that we're going to have to build more natural gas pipelines or expand natural gas pipelines.

GERLOCK: In terms of oil pipelines, would Keystone XL kind of saturate the market there?

VERLEGER: Most likely there will not be a second north/south pipeline because it's easier to expand existing pipelines than to build a brand new pipeline. Keystone XL is a special case because of the new crude oil in Alberta and the projected increases in Alberta.

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