Keystone decision a setback for U.S.-Canada relations

The Obama administration's move to sideline the Keystone XL pipeline is a major setback for relations between the world's two largest trading partners, and threatens Canada's role as the leading energy supplier to the United States.

The U.S. State Department's decision to force TransCanada Corp. to explore alternative pipeline routes in Nebraska pushes out a final ruling until at least 2013, well after next year's U.S. presidential and congressional elections.

The delay puts at risk a vital piece of the historic economic relationship that binds the world's largest oil market and its largest supplier.

The State Department decision sent a shock wave through Canada's energy industry, an economic stalwart of the country that has for almost six decades counted on the United States as virtually its sole export market. The first dribs of oil began to find their way across the border in 1952, when Canada sent an average 3,900 barrels a day south. That volume has grown nearly 500-fold. In 2009, Canada exported a total of 687 million barrels to the United States, which has previously pointed to Canada as a secure source of friendly oil.

Now that bedrock trading relationship has come into question.

The United States is becoming a "less attractive customer in general for Canada, for not just energy but everything because of their own economic and financial difficulties," said Gwyn Morgan, the former chief executive officer of Canadian gas giant Encana Corp.

"This is just another signal that Canada is going to have to diversify away from the United States, not just in energy but in everything else we can."

Canadian leaders appeared caught off guard by the State Department's ruling, which came days before Alberta Premier Alison Redford was set to promote Keystone XL and Alberta's oil sands industry on a trip to Washington.

Prime Minister Stephen Harper had characterized Washington's approval of the project as a "no-brainer" that would create thousands of construction jobs in both countries and meet U.S. needs for a reliable supply of crude in an unstable world. Now Canada is scrambling for a plan B for its oil.

"Canada will be looking for a buyer and so obviously the Keystone project is one that is proposed and one that we would like to see go forth, but obviously we're a resource-based, energy-based country and we'll be looking at all opportunities," said Sarah McIntyre, a spokeswoman for Mr. Harper.

"While we are disappointed with the delay, we remain hopeful the project will be decided on its merits and eventually approved," Natural Resources Minister Joe Oliver said in a statement.

"In the meantime, our government will continue to promote Canada, and the oil sands, as a stable, secure, and ethical source of energy for the world."

The key lesson for Canada in the U.S. decision is that diversifying away from the country's heavy reliance on the U.S. market is now an urgent priority, argued William Robson, president of C.D. Howe Institute, an economic think tank.

"We do want to make sure we aren't hostage just to that one market because they don't treat us as nicely as their self-interest suggests they should," Mr. Robson said.

And that will mean pushing ahead with the Gateway pipeline to move oil sands crude to the West Coast and beyond, to markets such as oil-hungry China, he said.

The Keystone pipeline has become hopelessly tangled in U.S. politics in recent months. The State of Nebraska has threatened to legislate moving the pipeline beyond an environmentally sensitive area, known as Sand Hills, which sits in the middle of the massive Ogallala Aquifer – a vital groundwater source for the U.S. Midwest.

Environmentalists saw the pipeline decision as a chance to attack the oil sands, a major source of global warming carbon emissions.

Now Canada's challenge is to ensure other potential markets for Alberta's crude are not hobbled by the same anti-oil-sands forces.