The Death of Keystone XL and the Myth of US Energy Independence

Sometime tomorrow after Joseph R. Biden, Jr. takes the Presidential Oath of Office, one of his first actions will be to issue an executive order cancelling the Keystone XL pipeline permit.

The highly anticipated move will be lauded by liberals, praised by progressives, and applauded by environmentalists.

It will also be wrong.

Now, before anyone jumps up on a soapbox to shake fists in my general direction, allow me to explain why. Because I guarantee you the reason is not what you think.

In general, I have been in favor of this project because human beings are responsible for being good stewards of the environment. 

I get the fact that statement runs counterintuitive to most narratives. But if you really want to understand why that is — and if you’re an environmentalist, you should — you must understand how supply chains work.

In this case, that means you must first understand that “oil” comes in a wide array of qualities that are blended at refineries. 

Next, you must understand the refining process itself — plant design, material flow, and product distribution. 

Given that those products are consumed by people and industries, you must understand both consumer demand and the industrial business cycle, which in turn requires some detailed knowledge of those industries as well.

And finally, you must understand logistics, so that you have a feel for not just how those products come to market, but also how safely they can come to market.

That’s a tall order for Greenpeace marketing consultants and 19-year-old political science majors to digest. 

And I get it. It’s way easier to focus on how we feel and what we want right now… because the alternative is much harder.

The alternative in this case, involves putting in the time to understand how energy markets are structured right now. And then, one must put in the hard work necessary to figure out how to achieve those long-term goals.

So, although this project may be dead in the water — and believe me, it is now deceased — I still think there’s some value in discussing it. 

First, because the issues that necessitated Keystone’s inception in the first place have not gone away, nor are they capable of being solved quickly. 

But second — and perhaps most importantly — because understanding these issues uncovers the truth behind one of the biggest false narratives ever perpetrated by the oil and gas industry.

It shows that American energy independence is a big, fat myth.

Mythbusting

First thing’s first — there isn’t just one type of “oil”.

Much like milk comes in several versions — full fat, 2%, 1%, et cetera — crude oil has several quality types as well.

Primarily, it varies according to overall viscosity and total sulfur content. Thicker, more viscous oil is called “heavy,” whereas thinner, watery oils are called “light.”

Similarly, crudes with higher sulfur content are called “sour” and those with lower sulfur content are called “sweet.”

If we chart them according to those properties as EIA has done here, we can see that most US varieties are toward the bottom right (lighter, sweet), whereas production from Mexico and Middle Eastern countries are typically toward the top left (heavier, sour).

Source: EIA

But what is often not understood is that US refineries — particularly those on the Gulf Coast — cannot solely consume the light, sweet crude produced domestically. 

Those facilities — largely designed at a point in time where heavy crude from Mexico and the Middle East was cheap — were built specifically to handle that inexpensive, viscous production. For instance, the weighted average API Gravity for Texas refineries has never consistently held above 35, roughly the thinness of North Sea or Nigerian production.

Source: EIA

So, while domestic consumption has increased to some extent, US refiners are essentially maxed out the amount of West Texas Intermediate crude they can consume. 

And although the US does produce some heavier crude from offshore Gulf of Mexico rigs (roughly 2M barrels per day at peak), in Alaska (~0.5Mb/d) and California (~0.4Mb/d)…

Source: EIA, Bloomberg, Seawolf Research

It’s not enough to satisfy the roughly 10-12 million barrels per day of US demand for heavy crude.

Source: EIA

The rest must be imported.

And so, despite what politicians, oil and gas producers, industry advocacy groups, and your conservative uncle may have been telling you all these years…

America has never been — nor will we likely ever be — “energy independent.”

Keep Your Friends Close…

In the past, we typically relied on a combination of Saudi Arabia, Venezuela, Iraq, Mexico and Canada to meet this gap in heavy crude demand… called the Mayan Spread in oil trader parlance.

But in recent years, there has been a clear bipartisan preference to rely more on our neighbors than on socioeconomically unstable governments like Venezuela and Iran, or on regimes with whom we have other geopolitical conflicts like Saudi Arabia. And as a result, crude imports from Canada have doubled over the past decade.

Source: EIA

And that’s really what the Keystone XL pipeline was designed to do… to bring in a product we need from a country we trust in the safest and most environmentally friendly way possible (believe it or not).

Instead, the political will of the people has demanded that we find a workaround, and in this case, the result has been to rely on transport by rail and truck.

Ironically, this mode of transportation causes roughly twice the level of air pollution and greenhouse gas (GHG) emissions as pipelines. Not to mention accidents can be just as destructive in terms of environmental damage, and far worse in terms of directly affecting both human and animal life.

So, while I never really loved the idea of building a pipeline itself, the pros (safer, lower emissions, reduces reliance on OPEC, creates jobs in rural areas) always outweighed the cons (it’s a frickin’ pipeline).

Because no matter how much we might want it, the United States is simply not going to sell their gas-powered cars tomorrow and go buy Teslas… There’s no developed market yet, there’s no charging network, and our century-old power grid is ill-prepared to handle either storing the energy or delivering the load.

Instead, the transition will be gradual — perhaps taking as long as two decades or more.

And even if it were possible to transition the entire vehicle fleet tomorrow, transportation only comprises 28% of total US carbon emissions.

Source: EPA

How we decarbonize the power and industrial supply chains is a whole other ball of wax.

So, whether we like it or not, crude markets are here to stay for a long time, and our friends in Canada — particularly major producer Suncor Energy Inc. (NYSE: SU) — are likely to be some of the biggest benefactors over time.

Shares have reinflated since last March’s price shock but are still sitting at extremely low levels compared to the past few years.

Source: Bloomberg

Crude markets have slowed down a little since the huge run over the past two months, so this isn’t a price level I’m interested in at the moment.

However, when year-on-year economic data begins to show cracks toward the middle of the year, there’s a chance we could see a huge pullback in commodities. And whenever that happens, I would consider nibbling here in the $12-14/share range.

In the meantime, though, I’ll be pouring one out for ol’ Keystone XL, and instead taking a much closer look at Canadian railroad stocks.

Who knows…maybe I’ll find another myth worth busting?

All the best,

Matt Warder