The general theme of my posts on the Keystone XL Pipeline have revolved around disagreeing that the extraction of the tar sands in Alberta will at all be affected by the blocking of the pipeline's construction. That, and the meme that the sands will simply be transshipped to China (which I've also addressed) are the two most commonly cited nationally relevant arguments against the pipeline; others, such as environmental contamination, are generally local issues. In this post, however, I'm going to try and show how the Keystone XL pipeline will bring a critical benefit to the US independently of energy security concerns.
First, some background:
Historically, the US benchmark oil price was based on West Texas Intermediate, a high-quality crude oil with a delivery point at Cushing, OK, just outside of Tulsa. Refineries near this delivery point are able to supply most of the American Midwest with fuels (i.e. gasoline, diesel, jet fuel, and heavy fuel oil). Although in reality most east coast refiners got their crude from Africa or Europe, and west coast refiners bought from Mexico or Alaska, the price of oil at Cushing tended to track the world price very closely, and so was used as the standard.
This has been upended in recent years by the exploration of the Athabasca tar sands in Alberta. Too much oil has been coming down from Canada to Cushing to keep WTI tracking the world price. Since Cushing is a landlocked oil delivery point, oil there cannot be transshipped to other areas, and the people selling the crude are forced to sell at a heavy discount. The price spread as of right now between the European benchmark, Brent, and Cushing stands at $18.29 per barrel.
What are the implications of this price spread, and how do they relate to Keystone XL? The most obvious conclusion to draw is that Keystone XL is intended to mitigate this price spread. Crude oil shipped via the new pipeline would be able to sell at the world price, and less crude would be shipped to Cushing until it again was close to the rest of the overseas benchmarks. Crude manufacturers in Canada want to be able to sell at the world price, not be chained to the depressed Cushing price. That's certainly good for them. However, I think it is also good for the US as a whole.
The reason why comes from the second major implication of the Brent-Cushing oil price spread, and is intimately tied into refining and refinery profitability.
Since Cushing's delivery point currently supplies cheaper crude feedstocks to refineries in the US Midwest, but prices for fuels in the East Coast are still high because feedstocks there are expensive, Midwestern refineries are having a field day. Even with transportation costs factored in, Midwestern refineries can compete with East Coast refineries on a cost basis, so the Midwestern refineries are exporting from their usual areas into the US East Coast. This competition is depressing the price of diesel, gasoline, and jet in the rest of the US.
While at first glance that sounds like a good thing, the picture is not so simple. The East Coast, particularly the Northeast, is the largest fuel market in the country. The amount of fuel it takes to supply it is as important as the price of that fuel. In order to supply that amount of fuel, you have to have operating, profitable refiners.
People tend to assume that oil refineries are some sort of cash cow. This is not at all true. Refineries operate at the margin. In an extremely good year, they make $10-15 per barrel of oil they process. More typically, you will see margins of $4-$7 per barrel. So a 100,000 barrel a day refinery at $4 a barrel of profit will make, assuming an operating rate of 340 days a year, $137 million. While this seems like a lot, bear in mind that the cost of an oil refinery runs into the billions. The returns on that investment are really quite low.
A useful tool for measuring the profitability of a refinery is called the crack spread*. The one most commonly used in the US is what's called the 3:2:1 spread, reflecting the mix of products that comes out of US refineries. For every 3 barrels of crude, refineries in the US are configured to get roughly 2 barrels of gasoline and 1 barrel of diesel fuel (jet is traded in much lower quantities). The spread is defined as:
3:2:1 Crack Spread = Price of 3 barrels of crude oil - Price of 2 barrels of gasoline - Price of 1 barrel of diesel
As of roughly four weeks ago, crack spreads for East Coast refineries were negative, meaning that running the refineries would actually lose money. Three weeks ago, they went just into positive territory, causing some idled refineries on the East Coast to start running for the first time in months. On the basis of chronically weak crack spreads, Sunoco is looking to sell or idle its two remaining refineries, and rumors are swirling that the massive 285,000 barrel a day ConocoPhillips Bayway refinery, which supplies much of what New York City consumes, might be next.
There is now looming evidence that the Brent-Cushing delivery point price spread will lead to a fuels shortage in the US East coast. Mitigating this spread is the only thing, barring price supports, that will keep many refineries in that region operating. We may soon ironically see instability and spikes in the price of gasoline and diesel in the Northeast, as refineries there shut down and the Midwest refineries depressing the prices before do not have enough capacity to supply the entire market. Realistically speaking, there may also be shortages of fuel, since I'm unsure if refineries in Europe, the Gulf, and Canada can supply enough refined products to the Northeast with their existing capacity.
Let's not forget that every refinery employs hundreds of people, at least, and that the associated petrochemicals complexes often push the number indirectly dependent on the refinery for the jobs into the thousands.
So if you want to save a bunch of jobs and provide enough fuel for the East Coast, you should raise the price of Cushing WTI. The easiest way to do that is to relieve the oversupply, and the only currently planned way to do it is Keystone XL. It is profoundly depressing that the media reporting on Keystone XL have largely ignored this issue, probably because it doesn't fit into a 600-word column (and because it requires more training and analysis than most reporters have), and instead have simply repeated sound bites from the various advocacy groups.
Have I mentioned how much I hate he-said, she-said style reporting?
* There are a few people at the office who cannot stop giggling whenever this term is brought up. Study to be a chemical engineer, we'll tell you how to get 25 feet of net positive suction head.