Thursday, March 20, 2008

Friendly Fire

When it first came to light that an obscure provision of the 2007 Energy Bill would bar imports of synthetic oil that entailed higher emissions than conventional domestic crude, and that this might apply to purchases by the Defense Department of fuels sourced from Canadian oil sands, one might naturally have assumed that this was an unintended consequence of the law, as Canada's ambassador to the US has suggested. It now appears this consequence was quite intentional. In light of our concerns about energy security, this looks like an unfortunate case of "friendly fire" against our largest trading partner and our largest oil supplier. While the theory behind this facet of climate change regulation is sound, its application in this case is unwarranted and unwise.

As I noted last week, Canada has a growing problem with the greenhouse gas emissions from oil sands production. I've been concerned about this since the 1990s and have written about it here, going back at least to 2005. The Canadian government has finally recognized this problem and taken strong steps to address it, within the context of their own commitments under the Kyoto Protocol--which they have ratified but we have not--and a recent, stricter national goal. Oil sands emissions can be brought in line through a combination of efficiency and sequestration technology, though this will take time. In the meantime, the extra emissions can be offset either through the official Kyoto Clean Development Mechanism (CDM), or with offsets bought on the Chicago Climate Exchange or the new NYMEX Green Exchange.

This is not to say that the oil sands emissions are not a serious concern, or the tip of the iceberg in terms of the "outsourced carbon" in which we share responsibility, as importers and ultimate consumers. However, the logic behind this provision of the Energy Bill deals with two specific aspects of climate change policy, neither of which applies to Canada's oil sands. First, it is intended to prevent emitters from going offshore to avoid emissions regulations. In this case, the incentive results more from the cumulative effect of decades of federal and state restrictions on drilling for the same lower-emissions domestic oil against which we are comparing Canadian syncrude, thus pushing energy companies to look north of the border, where the oil sands comprise a world-class resource. At the same time, this sort of measure is designed to impose external pressure on countries that are not addressing their emissions, with China as the most frequently-cited example. Canada does not fall into that category. They are tackling this problem head on, and they have the motivation and technical and financial wherewithal to manage their own emissions without prodding from us. Frankly, we are lucky that we have not been on the receiving end of such restrictions by EU countries that have been reducing emissions with almost religious fervor. This situation conjures up the unpleasant image of the US government, which has led the world in foot-dragging on climate change, going after Canada with the zeal of a brand-new ex-smoker who sees someone else light up.

As to the practical consequences of restricting our use of Canadian syncrude, this would harm US industry and consumers at least as much as Canadians, without materially reducing the emissions associated with a product that could be exported to eager customers in Asia. To understand why, look at the market and infrastructure for Canadian crude imports into in the US. The syncrude is blended into the main Canadian export stream coming down the Enbridge Pipeline system into Chicago, and ultimately into the US Mid-Continent. This system provides the primary crude supply for many Midwestern oil refineries. If the DOD is barred from buying fuels containing oil sands components, then any refinery selling to the military would have to certify that it either runs no Canadian crude oil, or that it can segregate its output from other crude oil sources. That's not impossible, but with most refineries operating at much higher rates than their present tankage was built to accommodate, that would be awkward and expensive. The net result would be to reduce the number of refineries willing to bid for DOD business and drive up the price the military--and thus taxpayers--pays for fuel. It would also reduce US imports of Canadian crude and force us to buy more from other, less secure suppliers. That's hardly in sync with our concern about relying on Middle East oil.

Sooner or later, we'll all be paying more for energy, in order to deal with climate change. Some will see no problem with starting here, forcing the government to walk the same talk it wants the rest of us to follow. From my perspective, though, in the absence of any comprehensive US policy on greenhouse gases--the 2007 Energy Bill doesn't qualify as either comprehensive or policy--this seems like a particularly counter-productive and hostile way to begin enforcing new and untested standards. I hope the experts who are crafting the cap and trade legislation that will likely be enacted in the next year or two are paying very close attention to this negative example.

Energy Outlook will observe tomorrow's market holiday for Good Friday.

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