The Keystone Rejection and the Shift Back toward OPEC

Although the International Energy Agency's latest warning of future energy security risks doesn't mention the Keystone XL pipeline, it provides important context for assessing President Obama's decision turning down that project's application. The IEA's newly issued global energy forecast indicates that if oil prices remain low until the end of the decade, it "would trigger energy-security concerns by heightening reliance on a small number of low-cost producers," a polite way of referring to OPEC. The Keystone verdict could help reinforce that shift.

I've devoted a lot of posts to different aspects of the Keystone issue. In a post last year on the State Department's Final Supplemental Environmental Impact Statement, I pointed out the pipeline's relatively modest potential to affect climate change, with a range of incremental greenhouse gas emissions (GHGs) equating to 0.02-0.4% of total US emissions. Even if the full lifecycle emissions of the oil sands crude it would have transported were included, they would still not have exceed around 0.3% of global CO2-equivalent emissions. For these and other reasons, I have consistently concluded that the decision would be made on political, rather than technical grounds, consistent with the symbolism the project has taken on with environmental activists during this administration.

Whether the Keystone rejection is attributable mainly to domestic political considerations or to positioning in advance of next month's Paris climate conference is a minor distinction. As the editors of the Washington Post put it, the distortion and politicization of the issue "was a national embarrassment, reflecting poorly on the United States’ capability to treat parties equitably under law and regulation." If the IEA's assessment of the trends underlying today's low oil prices is correct, we may come to regret last Friday's ruling for other reasons, too.

Recall that last year's oil-price collapse had two principal triggers: surging US oil production from shale deposits in Texas, North Dakota and several other states, and a decision by OPEC to forgo its historic role as balancers of the global oil market and instead to produce full out. The latter explains why oil remains below $50 per barrel, even though US shale output is now retreating.

Yet while shale production is expected to rebound once prices start to recover--whenever that might occur--the same cannot necessarily be said for conventional non-OPEC production from places like the North Sea and other high-cost, mature regions. Oil companies have canceled or deferred over $200 billion in exploration and production projects, while existing oil fields accounting for more than 10 times the output of US shale will continue to decline at rates of perhaps 5-10% per year.

The combination of all these factors sets the stage for a future oil market very different from what we've experienced in the past few decades. If OPEC and particularly Saudi Arabia assume the role of baseload, rather than swing producers, the price of oil will be set by the last, most expensive barrels to be supplied. That would constitute a much more normal market than one that has been dominated by OPEC production quotas, but it would also lack the margin of 3-5 million barrels per day of "spare capacity" that OPEC has typically held in reserve. That is a recipe for increased risk and volatility ahead.

If this comes to pass, the result might not be an exact re-run of the oil crises of the 1970s. The global economy is much less reliant on oil than it was four decades ago, especially for electricity generation, which as the IEA points out will increasingly come from renewable sources. However, oil will remain indispensable for transportation for many years. In a global oil market again dominated by OPEC, additional pipeline-based supplies from a reliable neighbor like Canada would be highly desirable, and the US Strategic Petroleum Reserve, which the Congress just voted to shrink in order to raise a couple of billion dollars of revenue, could become a lot more valuable.

The decision to reject TransCanada's application for the Keystone XL pipeline was ostensibly made on long-term considerations related to climate change, but it reflects a short-sighted view of energy markets. In that light, the President's conclusion that Keystone "would not serve the national interests of the United States" seems very likely to be revisited by a future US president.