China Seizes Opportunity to Fill Its Petroleum Reserve. Should Others?

• China is apparently snapping up cheap oil cargoes to fill its strategic petroleum reserve.
• That might make sense for the US, too, if earmarked for new regional SPRs, rather than refilling the existing one on the Gulf.

The Wall St. Journal has reported that state-owned oil companies in China are capitalizing on lower prices to fill that country's strategic petroleum reserve (SPR). The obvious question is whether the US should do the same, particularly since surging oil output from shale deposits is a major factor in the recent rebalancing of the oil market. If that means putting more oil into caverns on the Gulf Coast, the answer should be no. However, this could be an opportunity to begin creating strategic reserves for parts of the country like the West Coast that are poorly served by our 1970s-vintage SPR.

Superficially, $80 oil provides a tempting chance to turn a profit while replacing the 30 million barrels of oil the US government sold as part of a "coordinated release" with other International Energy Agency members during the Libyan revolution. Comparing the average WTI price in June 2011 to today's, the Department of Energy could pocket around $15 per barrel on the overall sale and repurchase. However, much has changed in the last three years.

When I examined this subject a year ago, the dramatic reduction in US oil imports resulting from the combination of resurgent production and lower consumption had roughly doubled the effective capacity of the SPR, in terms of the number of days of lost imports it could cover in a crisis. Since then, US crude oil imports have fallen by another 5% or so, increasing SPR coverage correspondingly--at least for the parts of the country to which it can easily deliver.

Yet as I noted in another post earlier this year, US oil imports aren't just falling; they are shifting in location. The West Coast, where domestic production has been declining, not growing, now accounts for about 15% of US crude oil imports. It has essentially no dedicated petroleum reserve, other than commercial inventories that are roughly 50% lower than when I traded oil for Texaco's refining and marketing subsidiary in the early 1990s. If oil prices fell much further, it might even make sense for west coast refiners to stock up, regardless of what official action the US government took.

With US oil production still increasing, demand stable or falling, oil imports shrinking, and imports from Canada growing in both absolute and relative terms, it is high time to reconsider holding nearly 700 million barrels of oil--$55 billion worth even at today's depressed prices--in a part of the country where production could soon surpass its 1972 peak. This seems like exactly the kind of overdue reform opportunity that a new Congress might be interested in taking up next year.

Canada: From Energy Supplier to Competitor?

• In addition to its impact on global oil and natural gas pricing and trade, the shale revolution is altering the energy relationship between the US and Canada.
• This long-standing supplier/customer relationship is becoming more complex as producers in both countries seek new markets outside North America.

In remarks last month the Canadian Natural Resources Minister, Joe Oliver, suggested that with the continued growth of unconventional oil production in the US, "Our only customer will become a competitor." Considering plans for liquefied natural gas export facilities on both sides of the border, he might have included LNG in that comment, too. Let's take a look at the kind of competition he might have had in mind.

Canada has long been an important supplier of crude oil to US refineries, since at least the 1950s. For much of the 1980s and '90s it was in a virtual three-way tie with Mexico and Venezuela for the #2 spot on the list of top oil exporters to the US, behind Saudi Arabia. Since 2004 Canada has claimed first place on that list as its production expanded, while Mexican and Venezuelan output declined and some Saudi oil went to other markets. From 2010 to 2012 exports of Canadian crude oil to the US, including oil sands crude, increased by 23% to over 2.4 million barrels per day (bpd). This has provided Canada with a reliable outlet for its production and the US with additional supplies not exposed--except for price--to ongoing instability in the Middle East and other regions.

However, with or without the Keystone XL Pipeline, the competition to feed US refineries is becoming more intense.  Canada's growing crude exports, including significant quantities of heavy and/or sour crude oil, must displace similar crudes imported into the US from  Latin America and the Middle East without losing ground to the expanded light oil production from US shale plays such as the Bakken and Eagle Ford, and the otherwise mature Permian Basin of Texas and New Mexico. Each of these areas now yields a million bpd. These dynamics are compounded by 1970s-vintage US oil-export rules that keep domestic crude bottled up in the Gulf Coast and weaken the economics of oil production throughout much of North America. 

If it seems odd for a Canadian official to talk about competition within the US market in this way, consider that the main country exempted from current US oil export restrictions is Canada. US oil exports to eastern Canada by rail and by tanker have grown rapidly in the last two years and are likely to expand beyond the current 100,000 bpd level, if export license applications are any indication. US oil exports to Canada may be displacing non-North American crudes today, but they likely also have an adverse effect on the economics of projects intended to ship more western Canadian crude eastward. So Canada now understandably looks towards Asia, home to the world's fastest oil-demand growth, as the logical destination for at least some of its future oil production.

 Natural gas creates another, perhaps more plausible arena for export competition between Canada and the US. Canada envisions a resurgence in gas production similar to what the US has experienced, based on a combination of conventional gas discoveries, such as in the Mackenzie Delta of the Northwest Territories, as well as the shales of Alberta and British Columbia. It also stands to gain additional gas reserves if it is successful in its bid to claim more of the Arctic. As Canadian gas is displaced from its long-standing export market in the US by the shale boom in the lower-48, LNG exports from B.C. are looking more attractive. The province lists five projects in different stages of development and highlights B.C.'s advantageous shipping route to Asia.

Many more LNG export projects have been proposed for the US, with at least four having received approval to sell to countries with which the US does not have free-trade agreements. A number of these are based on existing, or at least previously permitted, LNG import facilities, giving developers a head-start on construction. The US also has a big edge in proved natural gas reserves and technically recoverable gas resources, including shale gas.

Despite these US advantages, aspiring Canadian LNG exporters won't have to contend with an enormous domestic market for their gas, in which many industries are competing to use more gas in power generation, chemicals and other manufacturing, and different paths for displacing oil from transportation, including CNG, LNG, methanol, ethanol or gas-to-liquids fuels. As a result, I suspect that a Canadian LNG plant could count on a more stable long-term cost of gas than one on the US Gulf Coast.

The protracted controversy over the Keystone XL Pipeline project has focused a great deal of public attention on a single aspect of our energy relationship with Canada, while obscuring other aspects that are beginning to shift. Adding a new competitive overlay to our long-standing energy supply chains could ultimately increase North American leverage on OPEC's pricing power, while helping to develop a deeper and more flexible global market for LNG, with resulting environmental benefits. While this might result in winners and losers at the project and company level, the overall effect should be positive for both countries.

A different version of this posting was previously published on the website of Pacific Energy Development Corporation.

Would An Emissions Deal Break the Keystone XL Deadlock?

• A Canadian proposal to facilitate US approval of the Keystone XL pipeline by committing to greenhouse gas reductions gets to the essence of principled objections to the project.
• The offer provides a chance for defined, quantifiable emissions reductions, instead of the highly uncertain emissions consequences of rejecting the permit for this pipeline. 

A couple of weeks ago Bloomberg and others reported that the Canadian Prime Minister had sent a letter to President Obama, proposing to work with the US to reduce greenhouse gas emissions from the oil and gas sector as a way to facilitate US approval of the Keystone XL pipeline (KXL.) It seemed an obvious way to break the current deadlock . If opposition to the pipeline is based mainly on the greenhouse gas emissions profile of Canadian oil sands crude--accurately or not--then environmentalists should have welcomed this overture. Instead, environmental groups have urged the President to reject both the offer and the pipeline.

You would never know it from protest slogans conflating all types of air pollution as if they were identical, but the characteristics and effects of greenhouse gases (GHGs) like CO2 are very different from the smog-forming emissions from automobile tailpipes or the sulfate pollution from coal power plants. For that matter, air containing 400 ppm of CO2 (0.04%) is no more harmful to breathe than pre-industrial air with 280 ppm of CO2. More importantly, the climate consequences of each ton of CO2 emitted to the atmosphere are effectively the same as for every other ton, regardless of where they are emitted or from what source. While scientists can distinguish CO2 from fossil fuel combustion from the CO2 you just exhaled, based on differences in the ratio of carbon isotopes they carry, their effect on global warming is essentially identical.

That sounds trivial, yet it has great value for expanding our options for managing the accumulation of these gases in earth’s atmosphere. Not only don’t we have to treat GHGs the way we do local air pollutants, but it can be more effective not to. In practical terms, that means that unlike the well-established approaches for mitigating smog, it isn’t necessary to tackle all GHG emissions at the source, particularly when it’s expensive or impractical to do so. Saving a ton of CO2 by preventing deforestation or improving vehicle fuel economy is exactly equivalent in its effect on the climate to reducing a ton of CO2 emitted from producing oil, which accounts for less than 20% of the emissions from the oil value chain.

Prime Minister Harper’s proposal has been greeted with skepticism by some environmental groups, including a representative of Sierra Club Canada who expressed doubt that Mr. Harper was serious. I am in no position to comment on that, other than to point out that entering into negotiations on a proposal such as this one would be an excellent test of his government’s seriousness about reducing emissions.

In fact, a proposal to approve Keystone in exchange for reducing emissions provides a test of the seriousness of all the parties involved. If the project is worth pursuing for the Canadian government and Canada’s oil sands producers, then it should be worth additional efforts on their part, over and above those already undertaken, to reduce emissions from oil sands production and to find suitable emissions offsets elsewhere. Of course it’s also a test of how serious President Obama was when he  explicitly linked approval for KXL to “whether or not this is going to significantly contribute to carbon in our atmosphere.” And because the administration’s protracted delays in approving or rejecting the project can fairly be attributed to political considerations, the proposal also tests the seriousness of “movement” organizations like 350.org that influence the politics of Keystone within the President’s political base.

Opponents of the Keystone XL project who are genuinely concerned about addressing climate change ought to at least be willing to consider a framework that links approval of this project to quantifiable and verifiable reductions in greenhouse gas emissions on a comparable scale. Since the determination of such reductions depends on the assumptions governing the alternative state of the world against which these reductions would be compared, that would require a willingness to accept a reasonable set of baseline assumptions about what would happen if this pipeline were not permitted to cross the US border. While I don’t pretend that would be easy, I have trouble seeing how one could reject such a concept outright and still claim to adhere to sound science and consensus policies.

This strikes me as an opportunity to embrace the kind of constructive and responsible compromise, the absence of which in our government so many Americans have lamented. Or, to put it bluntly, is opposition to Keystone really about greenhouse gas emissions, or is it just about symbolism?

The beauty of this offer, if it has actually been made and depending on its details, is that it provides President Obama with a potential two-fer: a pathway for approving a project that would please a large majority of Americans, along with a way to obtain significant greenhouse gas reductions--also pleasing many Americans--without requiring the highly unlikely enactment by Congress of comprehensive climate legislation. If we can do a deal with Russia over Syrian chemical weapons, there should be no impediment to doing a deal with Canada over CO2 emissions.

A different version of this posting was previously published on Energy Trends Insider. 

Will the Keystone XL Decision Be Based on Incorrect Assumptions?

• Some of the facts about the Keystone XL pipeline project that President Obama cited in an interview last month turned out to be wrong. That's significant, if he is the ultimate decision-maker on this question.
• Whatever his assessment of the pros and cons of the project, the politics of Keystone are trumping the facts, indicating the decision is likely to be deferred as long as possible. 

When President Obama commented on the merits of the Keystone XL pipeline project in an interview in the New York Times last month, the Washington Post suggested that his remarks “give opponents reason for hope.” Although he confirmed that the White House’s main objective criterion for making this decision was still the pipeline’s greenhouse gas impact, the President also speculated about the project’s job-creation potential and the ultimate destination of the crude oil it would carry. This appeared to endorse arguments raised by opponents of the project. These issues deserve more than the dismissive treatment they received in the interview.

With regard to the number of direct construction jobs that the northern leg of the Keystone XL Pipeline (KXL) might create, I don’t know whether the right number is the 2,000 the President cited or the tens of thousands estimated in an earlier State Department study. However, fact checking by both PolitiFact and AP concluded he was wrong.

In any case, this administration lacks credibility on counting such jobs. Consider the White House's metric of “jobs created or saved” for assessing the impact of the 2009 stimulus, or the routine touting of projects with “green jobs” potential, not just in terms of their direct employment gains, but also their indirect job creation estimated via generous multiplier effects. Either indirect jobs are always relevant, in which case KXL would create far more jobs across the economy than the President seems willing to admit, or they also aren’t relevant to justifying clean energy and other, more favored infrastructure projects.

The more interesting issue Mr. Obama brought up relates to the disposition of the oil-sands crude that the KXL would ultimately carry from Alberta to the Gulf Coast. For starters, this isn’t relevant for whatever volume of North Dakota production the pipeline might also carry, since current rules prohibit its export to anywhere except Canada. Of the pipeline’s planned capacity of 830,000 barrels per day, some would be used to ship US crude to US destinations, some would carry Canadian  oil destined for US refineries in the mid-continent, while an unspecified remainder would arrive at the Gulf Coast.  However large the latter figure might be, it’s doubtful that much of it would ever leave these shores. To understand why, you need to consider the quantity of US oil imports of similar quality currently coming into the Gulf.

Overall, Gulf Coast crude oil imports have fallen by around a third since 2007, but they still amount to around 4 million barrels per day – 5x the total capacity of the KXL. Unsurprisingly, much of the crude imported into the Gulf is either sour or heavy, since the refineries in the region have invested billions of dollars in the hardware required to process such crudes, which are typically cheaper than lighter, sweeter grades. A quick glance at the countries of origin of the import mix confirms this, with suppliers such as Mexico, Saudi Arabia, Venezuela, and Iraq dominating recent imports. Imports from Algeria, Angola, and Nigeria have been slashed by surging production of light, sweet crude in Texas and other states.

In the interview, President Obama said, “So what we also know is, is that that oil is going to be piped down to the Gulf to be sold on the world oil markets, so it does not bring down gas prices here in the United States.” For him to be right about that, we must believe that the current importers of around 2.7 million barrels per day of generally similar crude from South America and the Middle East would ignore the arrival in their market of new supplies from Canada and continue to buy from existing suppliers, and that those other suppliers would be able to continue to charge the same prices as before, despite significant new competition. Although I wouldn’t argue that oil sands crude would never be exported from the Gulf, imagining that most of it would simply sail right by the closest and largest global refining center equipped to handle this type of crude oil reflects a remarkably superficial view of how oil markets actually work.

The Keystone XL decision process clearly encompasses both factual and political considerations.  On the facts alone and the criteria set by the administration, the pipeline would eventually have to be approved, since even in the worst realistic case its impact on global greenhouse gases would be minimal--on the order of 0.4% of global emissions--while it offers clear benefits including reliability of supply. The protracted delays in approving this project provide all the evidence needed to confirm that political considerations outweigh the facts. Deciding now in favor of either side offers limited political benefits but carries huge risks; continuing to leave the issue in suspense has paid dividends at little apparent political cost.

A different version of this posting was previously published on Energy Trends Insider. 

The Keystone XL Pipeline: Pyrrhic Victory Ahead?

Last weekend thousands came to Washington, DC to protest against the Keystone XL pipeline project, just a few days after a smaller protest in front of the White House resulted in a batch of arrested celebrities.   The State Department's decision on the cross-border permit is expected within a few months.  However, unless the President devises an unexpectedly Solomonic solution, one side or the other will come up short. That much is obvious, but I'd suggest that it's also worth considering the possible unintended consequences for the winning side.  Keystone could prove a Pyrrhic victory for either environmentalists or the energy industry.

That assessment starts with the fact that both sides have contributed to exaggerating the stakes out of all proportion, especially on the part of those concerned about the climate impacts of a new pipeline to carry crude derived from Canada's oil sands, or "tar sands."  With Nebraska having signed off on a new route avoiding the Sand Hills, the entire question now hinges on its global greenhouse gas (GHG) emissions, which would be far less than some claim. Without belaboring this point--not the aim of this posting--you needn't take the word of Transcanada, the pipeline's owner on this.  It's straightforward to demonstrate that any expansion of oil sands production would still account for a small share of Canada's GHG emissions, which are in turn a thin sliver of global emissions.  Such facts are easily overshadowed by pronouncements such as the oft-cited "game over" assertion from NASA's James Hansen, reminding us that even Ph.D.'s should be cautious when straying so far beyond their expertise.

Likewise, supporters of the pipeline have made numerous expansive claims about its potential economic and employment benefits.  Even if those are accurate, they're a lot less relevant at this stage of the debate than they were a year or two ago.  This issue has grown far beyond an argument about the facts, or even about a pipeline.  It has become a battle over a symbol, and the responsibility for that development rests with the administration, which declined multiple opportunities to issue a simple up-or-down decision, even when the Congress attempted to force the President's hand in late 2011.  Blame it on the election cycle, or unwillingness to disappoint one or another important constituency.  But extended this long, indecision turned the project into a giant version of Schrödinger's Cat, existing in a sort of limbo that compels attention.

When the pipeline's fate is finally revealed, the consequences could match its inflated, symbolic stature, rather than its actual importance as an energy project. The possible blowback is probably easier to imagine if the pipeline were approved.  Outraged environmentalists would be unlikely simply to pack up their signs and go home.  Aside from seeking new ways to impede the project, they might turn their attention to other energy projects that are currently uncontroversial, or at least less so than Keystone XL.  They might also choose to vent their anger on an administration they were counting on to see this argument their way.  The resulting fallout in lost voter enthusiasm might hinder Democratic candidates in the 2014 mid-term elections. 

Now imagine what might happen if the pipeline were rejected.  As I understand the process, that would require the new Secretary of State to rule that the project is not in the US national interest.  That would constitute a serious snub to our largest trading partner and largest source of imported crude oil.  Canada won't cut us off, but its government and industry would certainly intensify their efforts to diversify their oil export destinations, by means of other options headed either west or east, by pipeline or by rail.  The oil would still get through, but the relationship between the US and Canada would suffer, and environmentalists would be seen as responsible.  In any case, what won't happen is the shutdown of oil sands development. If anything, making this oil harder to bring to market could lend further support to high oil prices, and paradoxically preserve the incentive to produce more of it or gain access to these supplies.

The outcome that should worry environmentalists most about that scenario is the prospect of up to 800,000 barrels per day of crude oil loaded onto rail cars--roughly 1,000 a day of them--and moving all over North America.  Aside from the increased emissions associated with that mode of transport, compared to pipelines, the risks of a serious accident or spill would multiply.  If such an event occurred, it would attract significant attention from media that wouldn't be shy about reminding viewers why this oil was in rail cars in the first place.  But even without an accident, opponents of the pipeline are placing an implicit bet that oil prices will stay flat or decline if the pipeline isn't built.  If they go up instead, they stand to bear part of the blame, whether accurately or not. 

Stopping the Keystone XL pipeline won't result in appreciably lower US or global oil consumption, or a material change in global GHG emissions.  The key to oil's emissions lies on the consumption side, where most of them occur, and thus in focusing on the hundreds of billions of dollars per year spent by developing and transitional countries on sheltering their industries and consumers from the price of oil, along with countries that still generate significant amounts of electricity from oil.  Nor would approving the pipeline restore the US economy to its pre-financial-crisis growth rate.  The energy security benefits that it would bring, like the climate benefits opponents seek, are more about reducing risk.  Yet whether or not you agree with the editors of Bloomberg that keeping "Canadian oil flowing to U.S. refineries in the most efficient way, within the bounds of safety" is the principle that should guide Secretary of State Kerry, no one has benefited from dragging the decision out this long.  The winners might end up regretting that as much as the losers. 

B.C. Aims to Sell Cleaner LNG

I just ran across British Columbia's new provincial natural gas strategy, which includes a specific strategy for expanding liquefied natural gas (LNG) production as a way to mitigate global climate change. That might sound odd to those who are worried--unnecessarily--that gas might be even worse than coal, emissions-wise, but the province seems to have a good grasp of the benefits of replacing coal combustion in Asia with cleaner fuels like natural gas. They've also come up with a unique selling point for their LNG, on the basis that it would be produced using low-emissions electricity and thus have an emissions edge over other LNG sources. Whether this will confer an advantage on B.C.'s LNG by enabling it to collect a premium or capture a larger share of rapidly growing global LNG trade remains to be seen.

This story caught my eye because it fit neatly with one theme of a webinar in which I recently participated at The Energy Collective. Although most greenhouse gas emissions from fossil fuels occur at the point of combustion in a car, truck, plane, train, ship or power plant, the upstream emissions aren't insignificant and can be reduced in some cases by employing renewable energy in their production. Examples I cited in the webinar included an enhanced oil recovery demonstration project in California that employs concentrated solar power to produce some of the steam used to extract oil from an old oil field, and another project to extract geothermal energy from hot fluids brought to the surface as part of the oil production process.

The case that B.C. makes for reducing greenhouse gas emissions from LNG production by relying on the province's bountiful hydro- and wind power resources is a different application of the same principles. That's because whether the energy for cooling billions of cubic feet per day of natural gas to its liquefaction temperature of -162ºC comes from a local electricity grid or from burning some of the gas in a dedicated cogeneration facility, in most locations this adds significantly to the lifecycle emissions of the LNG. One study that I found on the California Energy Commission's site, produced by PACE Consultants, indicates that liquefaction accounts for around 10% of the lifecycle emissions of LNG converted to electricity in an efficient gas turbine power plant. Eliminating those extra emissions by powering a liquefaction plant with green electricity would bring the emissions from LNG much closer to those from pipeline natural gas and increase its advantage versus coal.

So now what B.C.'s LNG projects need is customers in Asia who will put a premium on "cleaner LNG"--presumably in countries that have committed to large greenhouse gas emission cuts that they can't achieve with indigenous fuels. Japan comes to mind, but I'm sure there are others. These customers would also have to be willing to deal with the longer voyage times from Kitimat, northern B.C. to Asia, compared to competing projects in Australia. That extra 1,000 miles or so translates into higher freight costs and a larger tanker fleet, along with somewhat higher emissions from transportation--though not enough to negate the liquefaction advantage. With so many new and expanding LNG projects around the world competing for market share, I'll be very interested to see whether B.C.'s new strategy pays off.

Playing Games with US Energy Security

Well, that didn't take long. The administration issued its decision denying the Keystone XL Pipeline application today, rather than using the remaining 34 days in the Congressionally mandated timeline to attempt to find a better solution. This is a prime example of what frustrates so many Americans of all political affiliations about how the nation is being governed. If you read the carefully drafted press release from the State Department, which had been given responsibility for determining whether the pipeline was in the national interest, it explicitly states that today's decision was neither final nor on the merits of the project. Implicit in this document is that today's move is exactly that, the latest move in the game that the President and Congress have been playing with a project large enough to affect the energy security of this country for decades to come. It is unseemly, and it didn't have to be played this way, despite the White House's protests that the 60-day timeline was unrealistic--after three years of study.

Here's a different statement the President could have issued, which might not have satisfied either side of the argument but would have left his administration looking like one with a bias for action and answers, instead of delays and obstacles:

"Today I have instructed the State Department to issue a pro forma finding against the application for the Keystone XL Pipeline project, with the clear understanding that this decision is a temporary expedient to provide the time necessary to resolve the remaining outstanding issues, as quickly as humanly possible. I hereby commit that my administration will do everything in its power to work with the government of Canadian Prime Minister Harper and with Governor Heineman of Nebraska to reach a mutually satisfactory solution that will allow this critical project strengthening the energy bonds between our two nations to proceed, while finding meaningful ways to address the concerns that many Americans have about the project's potential local and global environmental impacts. With renewed tensions in the Persian Gulf and with millions of Americans still out of work, we can do nothing less, even as we remain committed to protecting the environment that benefits us all. I have directed Secretary Clinton to work closely with Energy Secretary Chu and EPA Administrator Jackson and with their counterparts in Canada to develop a solution that addresses these needs, and to report back to me within 90 days with its outline ."

I don't diminish the political challenges of issuing such a statement when key parts of the President's support base have been so vocal in opposing this project. All you have to do is look at the latest set of talking points against the project from the Natural Resources Defense Council (NRDC). As disappointingly illogical a mishmash as they may be, based on misinterpreted data and a bizarre defense of cheap oil for the Midwest, they still reflect heartfelt, even visceral, reactions to the Keystone project--or more accurately to the oil sands development that it was expected to enable. Fair enough. I respect their right to an opportunity to provide input and guidance toward an eventual compromise, but not to a veto over US energy policy.

Nor should the opponents of the Keystone XL project fool themselves. Today's decision was guided by expediency, just as the future, possibly quite different decision for which the door was left open would be, perhaps at a point in time when the political calculus has shifted in favor of the project due to some external event. A decision based on principle would have looked quite different. "The Department’s denial of the permit application does not preclude any subsequent permit application or applications for similar projects." Whose move is it now?

Oil Sands Anxiety Is Overblown

As I was catching up on a two-week backlog of news after my vacation, I ran across a New York Times editorial with the promising title of "Tar Sands and the Carbon Numbers." Thinking that perhaps the Times might have woken up to the necessity of comparing the lifecycle emissions from oil sands to those from other crude oils, I was disappointed to find its editors perpetuating the common misunderstanding concerning these emissions when viewed only from an oil-production perspective. That's a shame, because it results in the scape-goating of Canadian producers and pipeline companies while conveniently avoiding the soul-searching that ought to accompany a clear understanding that, whether we're talking about oil sands or conventional oil imported from any other source, the vast majority of the lifecycle emissions will occur here, when the products into which these oils will be refined are consumed. It is also condescending toward the sovereign responsibility of our NAFTA neighbor for managing their national emissions under the Kyoto Protocol, which they ratified but we didn't.

The pending State Department review of the proposed Keystone XL pipeline project linking Alberta's oil and oil-sands projects to Gulf Coast refineries has become a hot-button issue for US environmental groups. Producing oil from oil sands, which were more commonly called tar sands until that became a term of disparagement, certainly involves more environmental consequences than most--though not all--conventional crude oils. Since US groups haven't been very successful targeting the oil sands projects in Alberta, where they contribute significantly to Canada's oil output and overall economy, the export pipeline has become a target of convenience. From my perspective, the angst about pipeline safety and acidic bitumen is mainly a red herring; the oil industry routinely handles other crude oils of similar sulfur levels and acidity, usually by adjusting the metallurgy of the pipes and vessels involved. The real issue here is greenhouse gas emissions, which the Times and most other critics of oil sands narrowly compare to those from producing conventional oils.

The Environment Canada report cited by the Times indicates that oil sands production and upgrading result in emissions about 70% higher per barrel than for the production of Canada's average conventional oil. That's in the range of other estimates I've seen. However, what the Times fails to mention is that such "upstream" emissions only account for a fraction of the total lifecycle emissions attributable to any oil. By far the biggest portion--even for oil sands--comes from the combustion of petroleum products by end-users.

So if at least 70% of the emissions from oil sands crude occur in the US, rather than Canada, and if the lifecycle (well-to-wheels) emissions from oil sands only average around 15% higher than for the average US refinery's crude slate, while emitting little or no more than some commonly imported crude oils from other countries, are the XL pipeline's opponents exaggerating its impact? I believe they are, unless they're also willing to take on imports of consumer goods and other products from higher-emitting countries like China. That would be difficult to justify to the World Trade Organization, considering that the US doesn't have a statutory limit on its own greenhouse gas emissions. It might also put us in an awkward position with regard to our exports to countries that have adopted strict emissions reduction targets.

Meanwhile we shouldn't forget that under UN agreements it is Canada that bears responsibility for the extra emissions that oil sands generate in Alberta. The Environment Canada report indicates that oil sands are likely to contribute 11.7% of Canada's GHG emissions by 2020, up from 6.7% in 2005, when Canada's share of global GHG emissions stood at less than 2%. The expected increase in oil sands output would account for essentially all of the projected 7% rise in Canada's emissions over that interval, an amount equivalent to 0.1% of current global emissions. The means by which Canada could address those incremental emissions include improved technology, offsetting cuts in other sectors, emissions trading and offsets purchased from other countries, or the Canadian government could simply choose to restrict oil sands output. Whatever path they choose, we have plenty of our own emissions to consider without going into a tizzy over a Canadian sector that currently emits roughly as much as US livestock waste management.

Trying to control the emissions from oil sands by blocking this pipeline is a perfect illustration of the difficulty of attempting to tackle a complex global environmental problem by focusing on isolated measures that only bear indirectly on the outcomes that matter. The weakness of the Times' argument is reflected in the following sentence, referring to Canada's policies: "The United States can't do much about that, but it can stop the Keystone XL pipeline." The implication seems to be that we would be better off if Canada exported its oil sands to developing Asia, their next best market, relieving us of any associated guilt, even if it made no actual difference in global emissions. I hope that when the State Department decides this matter, it gives appropriate weight to the fact that, other than fuel economy improvements in the US car fleet, our energy ties with Canada represent the single most effective energy security measure undertaken by this country since the oil crises of the 1970s.

What's the Alternative to Oil Sands?

I can recall when technologies like oil sands and coal gasification were commonly referred to as alternative energy, with the same high-tech aura now attached to solar power and advanced biofuels. Much has changed since then, not least our perspective on climate change and the greenhouse gases that contribute to it. It's no longer possible to consider Canada's oil sands production and the means of transporting it without a serious examination of the environmental consequences, both at the source and along its journey to market. However, while I understand that perspective, the reaction to the proposed Keystone XL pipeline seems disconnected from the reality that crucial supplies of Middle Eastern oil suddenly look much riskier than they did. We should certainly weigh the costs and benefits of oil sands carefully, but the missing element from this conversation is the question of what the alternative would be if we ruled out more oil sands imports.

This train of thought began with a sobering analysis of the energy implications of the unrest in the Middle East by Amy Myers Jaffe of the Baker Institute at Rice University in Houston. The challenge she highlights is much subtler than the risk of exports from countries like Libya being disrupted for a few months or even a few years. Existing spare capacity in other producing countries can cope with some of that, although a portion of that capacity is in other countries that could be just another domino or two down the road, while the rest is in Saudi Arabia, which might not be immune, either. Yet if the worst case is the disruption of exports, we have a substantial Strategic Petroleum Reserve to fall back on. Prices might rise significantly, but the prospect of no fuel at your local gas station at any price remains remote for now.

However, as Ms. Jaffe demonstrates, much of the incremental oil production capacity on which forecasters have been relying to meet additional oil demand over the next two decades, and to backstop declining production in non-OPEC countries, must come from the same region that is now in turmoil. And as the charts in her presentation show, revolutions--democratic or otherwise--rarely result in higher oil output. If new governments or chastened existing governments don't invest in developing that extra capacity, then Peak Oil won't just be a theoretical construct in geology; it will be a very real outcome in geopolitics, and one that strategic inventories like the SPR would be unable to mitigate.

We have had a tendency to view Canada as the Saudi Arabia of the north. Considering that we now receive more oil from there than from all the countries of the Persian Gulf combined, and that our NAFTA partner's proved reserves of 178 billion barrels are second only to those of the Kingdom, that's not unreasonable. As recently as 2002, though, Canada's oil reserves were under 6 billion barrels, before the oil sands could be booked as reserves in large quantities. Without its oil sands, Canada would be just another mature oil province with declining conventional output. The question of how rapidly to develop those resources, and whether to export their output outside North America to any significant degree, is currently a hot topic in Canadian politics. The pipeline to transport this oil to Kitimat, British Columbia for export to Asia seems to be subject to a similar debate to the one we're having in this country concerning the Keystone XL line from Alberta to the Gulf Coast. But what if these projects didn't go forward? A world without oil sands might have a little less in the way of greenhouse gas emissions, but it would also have much higher oil prices, and those prices would be more volatile.

So what are the alternatives to these "dirty tar sands", as environmentalists now invariably refer to them? Well, if you're been reading my blog for a while, you know that wind and solar power don't enter into this discussion, because very little electricity is used for transportation and very little oil is used for generating electricity, outside of the developing world and now post-Tohoku Quake Japan. If we don't have access to oil sands imports, then the only other near-to-medium term options for reducing our oil imports from less stable suppliers involve more domestic oil production, more efficient vehicles, and more biofuels production.

Unfortunately the latest Department of Energy forecast incorporating all of those options still leaves us importing nearly 9 million barrels per day of oil in 2025. Without a significant portion of it coming from Canadian oil sands, we will still be forced to rely on imports from places like Venezuela and the Middle East, some of which aren't much more environmentally sound than the oil sands production. And that assumes that all the domestic production in these plans actually materializes. Turning up our noses at both offshore drilling and oil sands is pretty much mutually exclusive. (Or for that matter, shale gas and oil sands, even though these are different forms of energy.)

As for biofuels, we've already got just about as much corn ethanol as we can handle for many reasons, and the more advanced variety has not been especially cooperative in turning up on schedule. Replacing the oil sands capacity that the proposed Keystone XL pipeline could deliver would require more than 23 billion additional gallons per year of ethanol, or 180% of last year's US ethanol output. That figure exceeds the entire 2022 cellulosic and advanced biofuel target under the federal Renewable Fuels Standard. Biofuels are an important part of our energy mix, but the time when they could make oil sands crude unnecessary is still a long way off.

Americans are conflicted. We complain about $4 gasoline, and we're uneasy about another military intervention in the oil patch of the Middle East and North Africa, but then we throw obstacle after obstacle in the path of one of the few options that can provide us with a larger supply of reliable fuel from North America. No matter how sympathetic I am with communities that don't want the new pipeline to pass through or near them, or with concerns about the 17% increase in lifecycle greenhouse gas emissions that oil sands represent, compared to conventional oil, closing our border to additional imports of oil sands crude can only undermine US energy security, at the worst possible time.

Putting Energy Security At Risk

In catching up on a week's worth of news after my vacation, several stories caught my eye. The US Congress is apparently renewing its effort to cut tax breaks for the domestic oil & gas industry, while the administration intends to reinstate the offshore drilling moratorium that had been set aside by a federal judge in Louisiana. At the same time, 50 members of Congress have written to Secretary of State Clinton asking her to block a new pipeline to carry crude produced from Canadian oilsands to US refineries. However, even when you factor in the energy contribution of new initiatives such as the $2 billion in loan guarantees for solar power projects announced last week, the net result of all of this would be to undermine two of the central pillars of US energy security for the last several decades: producing more energy here at home and importing energy preferentially from stable and friendly neighbors like Canada and Mexico. For all the lip service about energy independence prompted by the Gulf Coast oil spill, these actions would ultimately make us more reliant on OPEC and unfriendly regimes.

Start with the industry subsidies, which Representative Blumenauer (D-OR) indicates are worth $6 billion per year. Setting aside the important context that these represent reductions in industry tax rates that even after these benefits are still higher than those most other US industries pay, this works out to an average of just $0.18 per million BTUs worth of domestic petroleum and natural gas production, or about $1.05/bbl. Compare that to $18.90/bbl in subsidies for corn ethanol and the equivalent of $2.60 per million BTU for electricity from wind and other renewable sources. As I've noted many times, oil & gas subsidies amount to a lot of money--though ethanol subsidies will come close to exceeding them in aggregate this year--not because they're overly generous, but because the scale of oil & gas still dwarfs all renewables combined.

I'm not a big fan of any of these subsidies, and I think it's high time that the ethanol subsidy, in particular, be brought more in line with its net energy contribution. At the same time, if we want a domestic energy industry that can make a meaningful contribution to covering our needs, then some level of tax breaks and other benefits appears necessary. And while the oil & gas industry is certainly mature and profitable, relative to biofuels and renewable electricity, it is also a global industry that competes with producers around the world, many of which are owned by the same OPEC members that have set the current oil price through effective constraints on their own production. And when drilling eventually resumes off the Gulf Coast, it is guaranteed to be much more costly. Adding higher taxes to these higher costs and tighter regulations must inevitably result in fewer wells being drilled and more oil imported--and from where?

Not from Canada, if the signers of the oilsands letter get their way. Oilsands production raises legitimate environmental concerns, both locally and globally. Producing oil from these deposits results in higher greenhouse gas emissions, though environmentalists usually fail to mention that tripling the emissions from production, compared to conventional oil, raises the total lifecycle emissions of the oil by just 17% compared to the average barrel refined in the US, because the vast majority of those emissions occur when the resulting petroleum products are burned, not when the oil is produced or processed. Now, a 17% increase in emissions is not nothing, but it must be weighed against two other factors. First, if oil prices are high enough, this oil will likely be produced anyway, even if we don't take it. Canadian companies have already signed deals to send oilsands crude to China, and they would do more of this if we turned up our noses at the stuff. Secondly, there's no guarantee that the oil we'd import from elsewhere would result in substantially lower emissions. That's particularly true for crude produced from heavy oil deposits in Venezuela and elsewhere, which average 14% higher lifecycle emissions.

Canada has been our largest foreign oil supplier for years, but with oilsands making up a steadily-growing share of Canadian output, restrictions on our oilsands intake would torpedo that relationship. With Mexican production going into steep decline, we would have to import more from Russia and the Middle East to make up the difference. That doesn't sound like a recipe for energy security to me.

Nor can greener sources close this gap any time soon. If you doubt that, take a look at Abengoa's Solana concentrated solar power project, which the Department of Energy just awarded a $1.45 billion loan guarantee. This technology uses the sun's energy to generate steam for electricity production, and its thermal storage allows it to do so more reliably, and over a longer portion of the day than photovoltaic cells. This is one of the most promising renewable energy technologies available, though at an effective cost of over $5,000 per kW of capacity it's hardly cheap. Yet when you convert its annual power output into equivalent barrels of oil (via the quantity of natural gas it would likely back out) it works out to less than 3,000 barrels per day. Replacing the energy contribution of Gulf Coast drilling or Canadian oilsands imports would require hundreds of such facilities, along with tens of millions of electric cars to enable their output to substitute for oil, very little of which is used to generate electricity in the US.

While renewable energy sources must inevitably meet a growing proportion of our energy needs in the years ahead, for the present US energy security still hinges on oil, which accounts for 92% of our net energy imports. If the Congress is serious about enhancing US energy security, then it should focus its efforts on reining in consumption, rather than erecting further barriers to oil produced here in the US or by our most reliable foreign supplier.

Climate Change and Unconventional Oil

While Americans are focused on the debate over expanded oil drilling, which might eventually add up to a million barrels per day of incremental oil production, a much larger expansion is underway north of the border, tapping Canada's oil sands reserves. Today's Financial Times (subscription required for full access) reports that environmentalists and socially-responsible investment funds are meeting today with Shell and BP, concerning the environmental and financial risks of the greenhouse gas emissions inherent in oil sands production. This has important implications for future oil supplies, particularly with oil prices falling to a level that might threaten further investment in oil sands, even without considering the cost of mitigating or offsetting the sector's CO2 emissions.

Worries about the greenhouse gas (GHG) emissions from oil sands operations are not new. Ten years ago my former company approached one of the large Canadian producers about employing Texaco's (now GE's) gasification technology to turn byproduct petroleum coke into gas to fuel the oil sands extraction process, incidentally creating an option for the CO2 to be sequestered in depleted oil and gas reservoirs. Neither the economics nor the consensus for action on climate change was sufficient to move ahead, at the time. But with Canada imposing stricter rules for industrial sources of CO2, and with a new global agreement on climate change in prospect at the end of 2009, that perspective may be shifting.

According to the FT, the groups in today's meeting in London are focused on the financial risks associated with emissions from oil sands--emissions that are several times larger than those from conventional oil production. Some are calling for a moratorium on new oil sands and oil shale projects. If oil were still over $120/bbl, that argument would carry little weight. Even if the most extreme estimate provided by Greenpeace were correct, suggesting that oil sands extraction emits 100kg more CO2 per barrel than conventional oil production, that would equate to under $4/bbl of extra cost, based on the price of 2012 emissions credits on the European Climate Exchange at current exchange rates.

Two factors render that figure more significant than it might appear. Falling oil prices are pushing new oil sands projects close to their breakeven point, according to Total, hampering the industry's ability to mitigate emissions. At the same time, the sheer magnitude of the oil sands expansion makes these emissions too large to ignore. The latest forecast from the Canadian Association of Petroleum Producers indicates that oil sands output should increase from 1.2 million barrels per day (MBD) last year to 2.8 MBD in 2015 and 3.5 MBD in 2020. Without making expensive changes in operations to reduce emissions and capture and store CO2, or buying emissions offsets, oil sands operations could increase Canada's current GHG emissions by as much as 10%. As a signatory to the Kyoto Protocol, the Canadian government cannot just look the other way, while these emissions mount.

There are many areas in which the goal of improving energy security aligns with reducing GHG emissions, including improved efficiency and more use of renewable energy. But oil sands--and by extension oil shale--represents a clear conflict between our desire to reduce our dependence on Middle Eastern oil and the need to halt the accumulation of greenhouse gases in the atmosphere. And with oil nearing $90/bbl, a $4 increase in production costs to manage CO2 could stall new development and reduce future oil output by enough to tip the global supply and demand balance even further in favor of OPEC and Russia. Unless the next administration is willing to sit down with our NAFTA partners to discuss a comprehensive North American approach to both energy and emissions, this matter will ultimately be settled in Ottowa, where neither the US Congress nor President can offer more than friendly advice.

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.

Limiting CO2 from Oil Sands

For a decade Canada's expanding oil sands production has been on a collision course with the country's commitment to reduce greenhouse gas emissions under the Kyoto Protocol. The Canadian government is now addressing this issue with tough new regulations that would require oil sands projects starting up after 2011 to capture and sequester their emissions. The rule would also apply to other new industrial sources of emissions, including coal-fired power plants. In combination with the new royalty rates that went into effect last year, this restriction alters the economics of future oil sands extraction and has implications for all other carbon-intensive industry in North America.

Because of the extra energy used in oil sands production, including the heat required to liberate the hydrocarbons from the sands in which they are bound and intensive processing of the resulting heavy bitumen into synthetic crude oil, these projects emit much higher levels of greenhouse gases than conventional oil projects with comparable output--at least three times more, according to some studies. Under the Kyoto Protocol, Canada committed to reducing its emissions to 6% below 1990 levels by 2012. Instead, and partly due to the dramatic growth of the oil sands industry in Alberta, Canadian emissions had increased by 25% over 1990's by the end of 2005. Absent tough new measures, the country would likely also miss its new target of a 20% reduction by 2020 imposed last year.

At an estimated average CO2 intensity of 250 lb. per barrel of oil sands production, carbon sequestration and storage (CCS) could add up to $4.50/bbl to syncrude costs, assuming a cost for CCS of $40/metric ton CO2. Although $4.50/bbl might not seem extraordinary in a world of $100+ oil, it's a significant increment on top of production costs that were already near the top of the range for the oil supplied to market. Depending on how one views the role of oil sands in the global market, the long-term consequence could be constrained oil sands production, higher oil prices, or both.

I don't think the consequences end there. A new US administration takes office next January, and it seems likely to bring a more aggressive approach to reducing our emissions. It wouldn't be surprising for a new EPA Administrator to see this Canadian rule as something that could be implemented quickly here, while Congress wrestled with the much more complex challenge of cap & trade legislation. Industry might even welcome clear guidelines about carbon sequestration as a way to reduce their uncertainty, and to enable a new generation of coal plants--incorporating CCS from day one--to compete with natural gas and other generation alternatives. In this context, Canada's regulation of emissions from oil sands isn't just a signpost for the oil market, but for the entire North American energy and industrial sector.

Joining the Party Up North

Marathon's announced acquisition of Western Oil Sands Inc., a Canadian firm with a significant stake in the Alberta oil sands play, extends a sequence in which most of the large integrated oil companies have expanded their portfolios to include these unconventional hydrocarbons. With the notable exception of BP, the majors have all either been there from the start, decades ago, or bought their way in, as access to other opportunities around the world dried up. Marathon's move could signal a further shift, however, in which the next tier of the industry also looks north; this might not be limited to integrated firms or independent producers, either.

A decade ago, Venezuela's Orinoco Belt looked like the place that everyone had to participate, for many of the same reasons that Canada's oil sands now look attractive: enormous potential reserves with minimal exploration risk, a friendly government, and a big technology component that fits the international firms nicely. Like the Orinoco, oil sands exploitation involves big, upfront investments that pay healthy returns as long as oil prices are high. Unlike Venezuela, however, it's hard to imagine a scenario in which Canada would unilaterally change the terms of access or nationalize these resources. Political risk was always the Achilles' heel of the Orinoco, and the only risk in Canada that comes close to the same importance is climate change policy, given the high greenhouse gas emissions of oil sands extraction.

When you consider the characteristics of these projects, there is little that would prevent a company with no current upstream exposure or expertise from getting involved. Much of the capital of these facilities is tied up in the refinery-like processing hardware that turns the gooey bitumen into a synthetic crude suitable for pipeline transportation and handling in a conventional oil refinery. To the extent that upstream expertise is required, Canadian partners can provide it. So might an oil sands investment appeal to one of the big independent refiners, Valero or Tesoro?

On the face of it, the idea of a pure-play refiner integrating upstream might seem unlikely. These companies largely built their portfolios from the divestitures of majors that saw little benefit in integration. Part of their appeal to investors is their lack of exposure to the above-ground risks that bedevil the majors in places like Nigeria, Russia, and Venezuela. But in a scenario in which crude oil became not only expensive but hard to get, integration could again pay big dividends, and independent refiners could find themselves under-running their multi-billion dollar assets. One needn't even believe in imminent Peak Oil to imagine such a scenario. Unwillingness on the part of OPEC to boost oil output, the continued growth of Asian demand, and a wave of new refinery construction in the Middle East and Far East could combine to leave US refiners scrambling for feedstock. Companies with their own equity crude to run or trade would have a real edge, as we saw in the early 1980s. Having a lock on a supply of pipeline crude from Canada might be worth a lot in such an environment.

Please note that this idea is entirely speculative; I have no reason to believe that either Valero or Tesoro is pondering such an investment. But if I were in charge of strategy for either firm, this option would now be high on my list for consideration.