It was Canadian Prime Minister Pierre Trudeau who once announced, “Canada is a country whose main exports are hockey players and cold fronts. Our main imports are baseball players and acid rain.”  Yet the head of state’s wry humor belies the significance of the U.S-Canadian relationship, and how this relationship is destined to shape – and to be shaped – by the posture that the United States takes towards the explosion of unconventional oil production occurring because of the Canadian oil sands.

Conventional wisdom would suggest that the prospect of a nearly 2,000 mile long pipeline between Canada and the United States, the TransCanada Corporation’s “Keystone XL” project, should be welcomed as a harbinger of closer ties and safer energy supplies.  Under the surface, however, lies a complex geopolitical and commercial logic that suggests it is Canadian producers – not American consumers – who stand to gain most from the project.

Our neighbor to the north will hardly ever receive the bursts of attention or scrutiny that Saudi Arabia or China garner in present times, but it is this bromidic consistency on Canada’s part which places it squarely, albeit quietly, as a foundation of US energy policy.  The US has been Canada’s largest market reaching back to the beginning of the Cold War, and the two are currently the world’s largest trading partners.  Canada has the world’s second largest oil reserves – after Saudi Arabia – and is the United States’ number one source of oil imports, almost doubling the volume of its closest competitor – Mexico.  In 2008, Canada provided 90% of US natural gas imports, and also boasts one of the world’s largest reserves of high-quality uranium.  Were the country anything other than a stable Western democracy sharing a similar colonial heritage with the United States, our deep interdependence with such an energy superpower might prove alarming.  Instead, it is often cited as a source of strength.

Increasingly, the oil that Canada extracts and exports is of the unconventional variety – much of it comes from the Athabasca oil sands in Alberta that are rich in bitumen (a form of extremely heavy crude oil).  Using open-pit mining technology the bitumen-rich earth is dug up and transported to separation facilities where bitumen is extracted from other clays, water and sand.  After a series of cleaning and processing procedures, the bituminous heavy oil is transported to refining facilities where it can be turned into gasoline, diesel and other petroleum products.  The process is more emissions and energy intensive than conventional oil production, although much debate has taken place over just how much dirtier oil sands really are.  Recent estimates have ranged from “around 6 percent” to “at least 20-40 percent” greater GHG emissions than normal oil production.  Depending on the exact method employed, extraction of oil sands crude can also involve significant quantities of natural gas.

Athabasca Diagram

Such is the backdrop for the proposed “Keystone XL” pipeline, a 1,980 mile long piece of infrastructure that would move crude from Alberta’s oil sands to refining and export facilities along the US gulf coast.  The pipeline is currently awaiting State Department approval before it can go forward, and the politics surrounding this process has been quite contentious.  The storyline being presented for the $7 billion project is primarily one of energy security, as the pipeline would eventually add 500,000 barrels a day into the US market from the north.  This represents a significant upgrade over the existing “Keystone” pipelines, a sister network that currently carries 400,000 barrels a day to the Midwest.

A recent study commissioned by DOE found that in the long term, the pipeline could help to “virtually eliminate” Middle East crude imports.  The report also offered qualified support to the argument that the energy-and-GHG-intensive production of oil sands crude will continue to expand regardless of whether the pipeline is built, endorsing industry growth projections that envision a near doubling of the industry by 2020.  One investment bank has also recently stipulated that uncertainty about the future of offshore drilling regulations in the United States could accelerate investment in the Athabasca region.

Canada Production

Source: Canadian Association of Petroleum Producers

The DOE report also addresses the so-called “Asian threat”, an oft-repeated “use-it-or-lose-it” warning from Keystone advocates that if the growing supply of oil sands crude is not permitted to enter US markets it will instead be transported to the Canadian west coast and subsequently shipped to Asia to satiate burgeoning demand, with Asia constituting 75% of the world’s refining capacity growth between now and 2030.  Potential pipelines to connect the Athabasca oil sands to West coast shipping terminals include Kinder Morgan’s TMX 2 and 3 projects, which would increase capacity along the company’s existing TransMountain pipeline, as well as the Enbridge Northern Gateway project, requiring completely new right-of-way and infrastructure.

Although the Northern Gateway project recently received some publicity for its revelation that Sinopec, one of China’s increasingly assertive national oil companies (NOCs), was amongst the members of a Chinese-Canadian consortium that has contributed $100 million so far to the project and stands ready to line up further financing, many remain skeptical of the pipeline’s viability in the near future.  The DOE report highlights the right-of-way challenges that Enbridge has encountered due to strong opposition from native peoples living along the pipeline route, and the Northern Gateway’s commercial viability has come under scrutiny as well.  Traditionally, no shovels will be brandished on a costly pipeline project unless the “shippers” – those companies actually producing the oil – have signed long-term supply contracts guaranteeing that the pipeline capacity will be utilized.  Enbridge has not yet signed any supply contracts, meaning that even if the project is approved by the Canadian government at some point next year, the targeted completion date of 2016 may still be overly optimistic.

In contrast, Keystone XL has so far secured long-term contracts for 380,000 barrels/day of oil sands crude with an average contract length of 17 years.  Just last month, TransCanada – the company behind Keystone XL – also agreed to terms with oil producers in Montana and North Dakota to bring 65,000 barrels/day from the states’ shared Bakken oil formation through the pipeline alongside Canadian crude.  The five-year contracts, which will also require the construction of an additional $140 million pipeline to feed in the Bakken production, may help to quiet vocal opposition from landowners who have filed legal challenges to TransCanada’s plan to appropriate property along the proposed pipeline route.  These additional contracts also bring committed capacity from 75 percent to just under 90 percent.  However, despite the deft maneuvering of TransCanada, one must be careful not to assume that Keystone XL has successfully navigated the economic and environmental shoals of constructing a major new international pipeline.

Pipeline Map

Source: Canadian Association of Petroleum Producers

In fact, the momentum of the Keystone XL pipeline for U.S. energy policy appears less and less definite the deeper one digs into the project’s promises and pitfalls.  Putting aside the likely “paper tiger” of Enbridge’s Northern Gateway, thus far TMX 2 and 3 look to pose the greatest threat to Keystone XL, as they would connect to greater existing shipping capacity further south in Vancouver and would require smaller capital investments.  If constructed, the 400,000 barrels/day of Asia-bound capacity they would add is large enough to possibly affect the quantity and/or price of any crude moving through a hypothetical Keystone XL pipeline.  Furthermore, the inclusion of domestic U.S. Bakken crude may not be sufficient to placate a plurality of Keystone XL critics, as recent news cycles have brought word of a Nebraska state bill that would increase the regulatory burden in an attempt delay the project, outright hostility from Texas landowners and oil workers, and, in Oklahoma, what is  believed to be the first legal challenge to the use of eminent domain to secure U.S. right-of-way for a proposed oil sands pipeline.

Perhaps most salient, however, is the possibility that the pipeline will only marginally increase the overall supply of Canadian oil while delivering significant benefits to producers by boosting the market price of Canadian heavy crude.  Currently, existing markets for Canadian crude are oversupplied, a dynamic that is set to become even more exaggerated in March once TransCanada completes an extension of its existing pipeline system to pump an additional 165,000 barrels/day into Cushing, Oklahoma.  Cushing, of course, is a major oil hub and the physical delivery point of all NYMEX futures contracts, and the problem is that nearby storage capacity for commodities traders who wish to take physical delivery and then store their oil has been increasingly strained in recent years.

This dynamic, referred to by many as “Cushing syndrome”, is partially responsible for the growing spread between WTI and Brent crude prices and means that the incoming shipments of Canadian crude will only add to the glut and put more downward pressure on prices.  The significance of Keystone XL, then, is that it would allow oil to flow to the DOE administrative district known as “PADD 3”, including the gulf coast, where it then has the ability to be refined and/or shipped onwards to other markets.

PADD 3 Map

The long-term effect would be for Canadian oil producers to see a price increase of at least $3/barrel.  According to figures included in a TransCanada report submitted to the Canadian government in 2009, this could boost annual oil sands producer revenues from the current $2 billion to $3.9 billion in 2013.  Depending on how much of the added price is absorbed by refiners who purchase the oil and how much is passed on at the pump, consumers could see an increase of up to around 7 cents per gallon as a result.  In sum, the price discontinuities currently brought about by the “Cushing syndrome” are advantageous to U.S. consumers in the near future, a dynamic that the Keystone XL pipeline would mitigate significantly were it to begin operation in 2013.

The decision, therefore, becomes highly contingent upon the likelihood that the necessary infrastructure will be put in place in the near future to ship Canadian oil sands crude to Asia.  If Northern Gateway or TMX 2 and 3 struggle to materialize, then “crude export dispositions from Western Canada and levels of imports to the USA would be similar to those which would [be obtained if Keystone XL] were built,” in the words of the DOE report.  Indeed, the report believes that the spare capacity exists to increase imports from Canada even without Keystone XL, and that if it were built the US would still have tar sands pipeline overcapacity until at least 2020.

The same goes for GHG emissions – if oil sands production is to stay relatively consistent regardless of whether the new pipeline is built, then carbon emissions then Keystone XL would not of itself have major impacts on emissions.  In other words, the Keystone XL drama is much more of a routing – rather than production – decision.  As with any complex system, this is vulnerable to change – especially if Canadian supply quickly finds a means to link to Asian markets. Until then, however, there does not seem to be a compelling rationale for laying down pipe for the sake of allowing our northern neighbors to earn more for the oil that they already plan to sell.


David Livingston is a Contributor in AEL’s New Energy Leaders Project and his work will be regularly featured on the website. The views expressed are those of the author and do not necessarily reflect the position of AEL or those of his employer, the Carnegie Endowment for International Peace.