U.S. President Donald Trump ushered in his new administration by signing an executive order to advance construction of Keystone XL.
This pipeline has been waiting in the wings since being proposed in the summer of 2008. The proposed 1,900-kilometre pipeline, running from Alberta to Steele City, Nebraska, would carry 830,000 barrels per day.
Era of abundance
If the project moves forward, Canada could see a massive surge in pipeline capacity. The executive order opens the door not only to Keystone XL but also the Kinder Morgan Trans Mountain Expansion project and the Enbridge Line 3 replacement. Collectively, these projects could add 1.8 million barrels per day of new export capacity and support oil sands growth.
More importantly for Canada, increased export capacity could mean smaller discounts for our oil relative to U.S. benchmarks. This is critically important to the long-term viability of the business, especially when we consider the collision of growing supply and infrastructure constraints, which caused the spread between Western Canadian Select (WCS) and West Texas Intermediate (WTI) to explode in 2013, reaching nearly $40 per barrel. The discount to WCS cost the Canadian industry billions in lost profits and became a de-facto subsidy for the U.S. economy.
Critical next steps
In the U.S., the pipeline has some political traction because the increased capacity would allow our southern neighbours to further wean themselves off oil from hostile foreign regimes. Although Keystone XL has received presidential approval, several hurdles remain before the pipeline can become reality.
CHART 1: Proposed Keystone XL route
Keystone XL traverses three states and has secured full right-of-way in Montana and South Dakota, as well as through 92% of Nebraska. The route is being challenged in Nebraska and TransCanada must face a Public Service Commission review, which could take up to a year. What’s more, existing permits in South Dakota are being challenged in court. TransCanada must also seek the re-commitment of shippers using the pipeline.
Best-case scenario: all approvals are in place by the end of 2017 and the US$8-billion project is complete and operational by the end of 2019.
Environmentalists have been fiercely battling Keystone XL, making it a flashpoint in debates about U.S. energy policy and climate change. Landowners in the pipeline’s path also warned that a spill of oil sands crude could compromise the Ogallala Aquifer, a source of drinking water that stretches from South Dakota to Texas. These voices are likely to become louder as this former pipe dream becomes more of a reality.
Table 1: Cost of transporting a barrel of oil from Hardisty, Alta. to key markets
|Pipeline||Rail (manifest)||Rail (unit train)|
|To Gulf Coast||$7 to $11||$17 to $21||$12|
|To East Coast||N/A||$16 to $20||$13 to $16|
|To Canadian West Coast||$3||$10 to $14||$8 to $11|
|To U.S. West Coast||$5 to $6||$16 to $20||$13 to $16|
Source: Financial Post, TD Securities
The unpredictable Trump card
The new U.S. administration has cast a veil of uncertainty over the Canadian energy industry. The seemingly accommodating new regime comes with conditions. Trump has a buy American approach, which may be problematic for Canada. And, the future of U.S. tax policy is unclear. The GOP may implement a Border Adjustment Tax (BAT) aimed at boosting U.S. exports and penalizing imports. At press time, we don’t know whether this will impact U.S. imports of Canadian oil. The worst-case scenario will happen if the BAT places Canadian oil at a disadvantage to U.S. domestically produced oil—leaving Canada in a poor competitive position.
Tighter differentials mean more profitable barrels
Investors should focus on companies that will benefit from higher demand for Canadian crude, and from narrowing differentials as incremental pipeline infrastructure becomes a reality. Investors are also increasingly looking for the oil and gas sector to deliver acceptable rates of return at a corporate level and per-share basis. Coming out of the energy price crash, the Canadian oil and gas sector has reinvented itself with a leaner, more competitive cost structure and highly repeatable drilling opportunities.
Investors should focus on stronger companies with access to capital and sustainable cost structures as we emerge from this downturn. Whitecap Resources, Raging River and Spartan Energy all fit the bill.
by D. Mason Granger, P.Eng., MBA, CFA, is a portfolio manager in Toronto.