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Canada's Foreign Minister John Baird speaks during Question Period in the House of Commons on Parliament Hill in Ottawa in this file photo from June 3, 2013.CHRIS WATTIE/Reuters

The Keystone XL pipeline remains a lightning rod for concerns over Canada's environmental policies and has been bogged down by U.S. political quibbling, but the southern segment of the oil pipeline system began operating Wednesday with relatively little fanfare.

Just last week, U.S. Secretary of State John Kerry told Canada's Foreign Affairs Minister John Baird in plain language that the U.S. will only make a decision on the controversial pipeline when it's good and ready. However, U.S. President Barack Obama endorsed the Gulf Coast project – originally just referred to as the Cushing, Okla., to the Gulf Coast leg, or the southern portion of Keystone – almost two years ago.

TransCanada Corp. said Tuesday that it was doing its final testing on the Gulf Coast line and waiting for the final sign-off from the U.S. Pipeline and Hazardous Materials Safety Administration. Some U.S. public advocacy groups have argued that the safety of the pipeline deserves more scrutiny, but the project does not require a presidential permit like the northern Keystone XL, which would transport Alberta oil sands crude across the U.S. border.

"We remain focused on beginning deliveries of oil through the Gulf Coast project on Jan. 22," TransCanada spokesman Shawn Howard said Tuesday.

The opening of the southern leg will solve one problem – the inability of shippers to move crude oil out of the massive storage hub in Cushing, the delivery point for the New York Mercantile Exchange West Texas intermediate (WTI) contract.

But it could add to an emerging risk of a glut in the U.S. Gulf Coast, a refining market that has long been viewed as Shangri-la by Canadian heavy crude producers seeking the higher prices afforded there.

The long-standing glut at Cushing, which coincided with steady gains in production in areas such as the U.S. Bakken and Canadian oil sands, pulled WTI to deep discounts versus the international benchmark Brent oil. Alberta oil production was hit with a double-whammy – congested pipelines for moving crude out of Canada, which widened the spread against WTI, coupled with the North American discount to Brent.

The $2.3-billion Gulf Coast project's startup helps address the Cushing problem, as 700,000 barrels a day of crude will be drained from the oil storage hub into the Texas market. That volume will jump to more than one million barrels a day by around the middle of this year, when the capacity of the Seaway pipeline, another link from Cushing that is co-owned by Enbridge Inc., gets twinned to 850,000 barrels a day.

But the risk of an oversupply in the largest U.S. refining market is one potential glitch in an overall bullish outlook for oil prices in North America, said Martin King, an analyst at FirstEnergy Capital Corp.

He noted that fast-growing U.S output is one of the main drivers behind a growing call in Washington to lift a long-standing ban on oil exports.

"Let's say [production growth] stays north of a million barrels a day for the next three years. You've got to put the crude somewhere out there into the marketplace, and if the U.S. can't export its own crude to the rest of the world, then where is that stuff going to go?" Mr. King said.

"It could end up being a pretty negative picture for crude oil producers."

However, on Tuesday, he forecast improving price differentials for U.S. and Canadian crude over the next two years, as transport options such as TransCanada's Gulf Coast pipeline open up. Mr. King estimated WTI to sell for an average discount to Brent of $7.25 (U.S.) a barrel this year and $5 in 2015, compared with $17.53 in 2012 and $10.79 last year.

He pegged the Western Canada Select heavy crude discount to WTI at $19.08 a barrel this year and $15.25 next year. It averaged $25.87 in 2013.

Follow Jeffrey Jones on Twitter: @the_Jeff_JonesOpens in a new window
Follow Kelly Cryderman on Twitter: @KellyCrydermanOpens in a new window

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