Market News

 April 04, 2012
The Keystone XL delay was a gift to Canada

 Vladimir Putin spent much of 2008 in a dispute with Ukraine over the price of natural gas supplied by Gazprom, the state-owned Russian energy company. Negotiations culminated in early 2009, when, in a moment of brinkmanship, Mr. Putin briefly cut off supplies to Ukraine, through which Russia ships 80 per cent of its Europe-bound gas.

While this muscle-flexing may have given Moscow a short-term political boost, the incident signalled to Europe the danger of depending on Russia for its gas supplies. Europe has since worked to diversify its energy sources, including potentially restarting nuclear facilities and increasing the amount of imported gas from Norway and the Caspian. Major European oil and gas companies (including Shell, BP, Total, Statoil, BG and Repsol) have all since invested tens of billions of dollars in U.S. shale gas, in part to learn techniques for developing that resource in Europe.

The results are clear: Ukraine has pledged to reduce Russian gas imports by two-thirds, and the European Union as a whole reduced Russian gas imports by 30 per cent last year. In other words, Mr. Putin's political grandstanding backfired -- it has actually made Europe more energy independent.

U.S. President Barack Obama's decision to delay, for a second time, approval of the Keystone XL pipeline has become his Putin moment.

For most of the previous 80 years, Canada and the United States enjoyed a mutually beneficial supplier-customer relationship. In 2011, Canada supplied the U.S. with 2.1 million barrels of oil and 8.9 billion cubic feet of gas a day, making Canada the largest source of imported U.S. oil and gas.

Keystone XL was designed to further strengthen the Canada-U.S. relationship by shipping bitumen from Alberta's oil sands to Gulf Coast refineries for upgrading. It received Canada's National Energy Board approval in March of 2010, and South Dakota Public Utilities Commission approval in February of 2010. Later that year, the Environmental Protection Agency said that, with proper safeguards, the pipeline would present "no significant impact" on most resources.

Since Mr. Obama's decision, the Canadian government and private enterprise have been doing what any supplier would do when it discovers that a customer is not reliable -- they are working to diversify their market. Fortunately for Canada, Asia is more than willing to step in. Prime Minister Stephen Harper went to China in February to encourage Chinese investment in the oil sector. He has declared that regulatory approval for Northern Gateway, a proposed oil sands pipeline to the West Coast, is a national priority.

Asia has responded enthusiastically. Since Mr. Obama first raised concern about Keystone in September, the pace of Asian investment in the Canadian energy sector has increased. In October, Sinopec announced it was acquiring Daylight Energy for $2.1-billion. In February, Mitsubishi invested $2.9-billion in a joint venture with Encana on its B.C. gas assets. Both are looking at the potential to ship gas to B.C. for the Asian liquefied natural gas market. In January, PetroChina expanded its oil sands investments by acquiring, for $680-million, additional oil sands assets from Athabasca Oil Sands Corp. In February, PetroChina acquired a 20-per-cent interest in Shell's Groundbirch asset for an undisclosed amount. Sinopec is also a major investor in the Canadian oil sands market and an investor in the Gateway pipeline.

In addition to diversifying away from its unreliable customer, Canada will get two additional benefits of forging a relationship with Asia.

First, Canada will get better oil prices. Canadian oil currently sells at a discount to world markets due to lack of capacity out of the U.S. Midwest at Cushing, Okla. In 2011, this discount between West Texas Intermediate and Brent cost producers amounted to $4.6-billion, according to oil consultant Peter Tertzakian. Keystone XL would help to alleviate this bottleneck. Canada has awakened to the fact that it does not need to be a price taker, dependent on internal U.S. price dynamics. According to a December report by oil consultant Wood Mackenzie, Canadian producers will lose $8-billion in revenue a year by 2020 if U.S. bottlenecks are not loosened.

Second, Canada will get cheap capital. As Canada shifts its focus away from the U.S. to Asia, the Canadian oil and gas industry is getting access to lower cost Asian capital. With more than $134-billion in oil sands projects under construction or about to start, Canada needs to find investment dollars with the lowest investment hurdle rate.

Perhaps sensing his foolishness, Mr. Obama recently welcomed TransCanada's proposal to build the southern leg of Keystone XL. Unfortunately, his actions may be too little, too late. Even with the likely eventual approval of Keystone XL in 2013, Mr. Obama will be closing the barn door after the horses are gone. He has clearly given Canada (and China) a wonderful gift.