In late November, the lame-duck Congress came within one vote in the Senate of sending a bill to the President mandating approval of the controversial Keystone XL pipeline. That project would bring oil produced in western Canada – primarily from tar sands but also from conventional drilling – down to Nebraska and then on to refineries in Texas and Louisiana for processing into petroleum products for export to Asian markets. Republicans planning their takeover of the Senate and enhanced majority in the House of Representatives quickly vowed to renew their effort to force Keystone construction as a priority after the first of the year, with visions of a possible ‘veto-proof’ two-thirds majority, including Democrats pushed by their unionized supporters attracted to the job-creation benefit, however temporary, associated with the Pipeline’s construction.
Just a few days later, the Organization of Petroleum Exporting Countries (OPEC) decided not to reduce their oil production below the current target of 30 million barrels annually, even in the face of an already precipitous fall of that commodity’s price from over $100 per barrel to a low $70 range since early summer. This fall is due to an oil glut on world markets, partially as a result of tremendous growth in domestic American oil production from shale rock through the process known as ‘fracking.’ The day after OPEC chose not to cut, the price of West Texas Intermediate crude oil (a proxy for what is essentially oil produced in the U.S.) sustained a further, dramatic drop of 10%, down to $66 per barrel.
Oil market professionals and observers had been speculating that Saudi Arabia and a couple of its Arabian neighbor states were purposely playing a ‘long game’ in terms of being willing to tolerate much lower per-barrel prices for their oil (and lower current returns to their ‘petrodollar’ economies and social welfare benefits keeping their young, restless unemployed off the streets) with the security of hundreds of billions of dollar reserves. The object of that game, it was supposed, was to force the oil produced by marginally and precariously financed shale oil producers in the U.S. out of the market. That is, shifting the burden of reducing the global ‘oil glut’ and ultimately increasing demand and a return to higher prices, from OPEC to America’s upstart producers. If a goodly number of U.S. producers happen to go bankrupt and cease shale oil production permanently because they become unable to service their debt due to lower market prices, so be it: all the better to restore and enhance Arab market share once the dust settles.
All of which seems to beg the question: even though we have waited through over six years of environmental studies and political haggling to settle the question of whether to build the Keystone Pipeline to bring more oil to American refiners and more jobs to the American recovery scenario, what’s the hurry now with so much oil product floating around the world that prices have fallen nearly 40% in less than six months, and look to fall even further into the coming year? “On further review,” as they say in football, maybe we need to replay the Congressional debate on Keystone to see if the apparently ‘obvious call’ to move forward really ought to be reversed rather than ratified by the new Congress. Indeed, there seems to be a case to be made that the Saudi’s real objective is not just to crush wildcat shale oil firms in the U.S. but also, and more importantly, to put a spanner into the tar sands works up in Alberta, which produces the same type of oil as most of OPEC’s Gulf States. Here we get into the ‘sweet’ and ‘sour’ distinctions in the oil market, which has a certain charm given that the Arabs and the Canadians are really caught in market share war over the Chinese market!
The fundamental difference between ‘sweet’ and ‘sour’ oil (the former predominant in the U.S. fracking production and the latter in the Canadian tar sands and Arabia) is the amount of sulfurous impurities (primarily hydrogen sulfide) mixed in with the oil. Hydrogen sulfide smells like rotten eggs in low quantities but can be life-threatening in higher amounts. Sour oil is generally defined as having more than .5% of such impurities and must be shorn of them in the refining process before products like gasoline, kerosene and diesel fuel can be safely refined, increasing the production costs. So-called sweet oil (which actually tastes that way, and smells nicer, too) has less than .5% impurities and thus can be more routinely and cheaply refined into those core fuel products.
Since both the Saudi sour oil and the Canadian tar sands sour oil are thus in direct competition for efficient production and marketing to Asian market, particularly China. It is apparent that the Keystone Pipeline project itself is intimately involved in the Saudis’ ‘long game’ calculations. If OPEC can drive down the market price for oil to a level where the process of extracting tar sands oil in Canada, and then shipping it to costly refinement in the U.S., becomes uneconomic, then Keystone itself could become potentially uneconomic as well. Oil prices sustained below $85 per barrel could force deferral of new tar sands extraction project, but opinions differ on how low oil would have to go to cut ongoing production headed for Keystone. Some say as low as $65 would threaten such curtailment, while others point to long term contracts with Keystone customers that could tolerate prices even below $40. Interestingly enough, some market observers are lately predicting just such a fall to the $40 level — recalling that the Saudis previously engineered a crash to around $12 in 1999. The Financial Times reports that Saudi Arabia holds three-quarters of a trillion dollars in reserves to keep its economy and welfare state going, so it is prepared for a ‘long game’ indeed. Meanwhile, the Keystone XL could become a ‘pipeline (with nothing) to nowhere,’ a sensitive point for a Congress already famous for approving a bridge to nowhere.
On the other hand, however, if prices were to stabilize at higher levels more toward a floor of $65, the Keystone Pipeline – as a cheaper, less cumbersome and less costly distribution route for tar sand producers than rail or alternative pipelines to Canadian port refiners – could make the critical difference in whether tar sands production is sustained economically. This could eventuality provide a stronger environmental objection than heretofore recognized by the U.S. State department in its previous reviews of the Pipeline’s likely environmental impact on greenhouse gas emissions. This report presumed that at then-current oil pricing, the tar sands oil production would find its way to market in any event with or without Keystone. If Keystone makes the critical difference to whether tar sands production continues in a much lower oil price environment, as its opponent contend, then it would surely fail President Obama’s announced policy not to approve its construction if doing so would contribute to significant additional greenhouse gas emissions from tar sands oil and its production processes.
Why, indeed, would U.S. shale producers want to use public policy to subsidize Canadian oil producers in an extreme and sustained low oil price environment? Perhaps North Dakota and Texas entrepreneurs will turn out to be ‘for Keystone XL before they were against it?’ Time for a replay in Congress?
Recently published on Huffington Post.
By Terry Connelly, Dean Emeritus, Ageno School of Business, Golden Gate University
Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education