It’s a pipe dream

Opinion: January 23, 2012 at 12:00a.m.

By William Edwards

McClatchy-Tribune

Desperation can lead to poor decisions, as can wishful thinking. Both elements are at work in the case of the Keystone pipeline project, rejected by the Obama administration on Wednesday.

The economics of the proposed pipeline are nonsensical. It makes no sense for Canadian oil producers, acting essentially in a panic mode, to ignore the economic red flags that should prevent them from turning a blind eye to the reality of competitive economics.

They are committing billions of dollars toward patently unsound projects. The cost of production from Canada when moved to the U.S. Gulf Coast by pipeline is on the order of $50 per barrel more than conventional foreign oil imports. Obviously one would never expect Canadian supplies to be competitive in this location.

Production increases

The major impetus for the Keystone pipeline to the Gulf Coast is the urgent need of the Canadian Tar Sands producers, who literally extract crude oil from sands in remote western Canada, to create an outlet for their planned production increases. Billions of dollars of investment have already been spent, and more is committed, to create facilities capable of extracting Canadian bitumen from the vast Tar Sands reserves.

The current high price of petroleum has provided the economic justification for these projects. Universally, all of the planned production is assumed to be marketable regardless of quality. This is the fatally flawed assumption.

Canadian bitumen contains a component not present in most of the world’s current oil production, save for Venezuela. This component is asphaltenes, a material with the same characteristics as coal. In the case of previous Venezuelan and Canadian production, the producers have provided upgrading capacity, essentially on-site or in dedicated facilities financed by the producer, to facilitate removal of the asphaltene component. The remaining asphaltene-free oil is what is then moved into the market.

The current Canadian production expansions omit this costly step and, instead, assume that somehow, this expensive impediment will magically disappear. Such is not the case.

Market value

Transport costs are another overlooked fact. All crudes of identical quality will have the same market value at any U.S. location. This simplifies the decision on movement from an inland location as this decision is reduced to the relative transportation cost of one destination versus another.

But in the case of in-land transportation of Canadian crude from Hardisty, in the province of Alberta, the two obvious outlets are Canadian/U.S. West Coast and U.S. Gulf Coast. Both moves would best be accomplished by pipeline.

The distance and therefore the cost to the Gulf Coast is approximately four times that to the West Coast. When this difference in distance is expressed as pipeline cost in dollars per barrel, the West Coast destination is $8 to $10 a barrel less costly.

Since the crude has the same value delivered to each location, it is obvious that the West Coast outlet will be the one that is ultimately chosen. A pipeline to the U.S. Gulf coast cannot compete while shouldering this large added expense with no offsetting benefit.

William Edwards, who runs Katy, Texas-based Edwards Energy Consultants, has spent more than 50 years working in oil economics and pricing. He wrote this for McClatchy Newspapers.