Skip to main content

In debates over the proposed Keystone XL pipeline, investors often find themselves across the table from environmentalists. But if a study commissioned by a green NGO is right, the two groups may have found an issue they can agree on.

The report, issued Nov. 25 by climate change think tank Carbon Tracker, warns that new oil-sands development is "increasingly economically questionable," and that the profitability of oil sands projects made possible by Keystone XL construction is much smaller than is widely assumed.

The thick, sour oil found in Alberta's tar sands has to be handled by specific refineries, and thus is more expensive to produce than other crude oil. It wasn't until oil prices rose above $60 over the past several years that oil sands projects began to seem profitable.

The current price differential between benchmarks such as Western Canada Select (WCS) oil, and the prices for similar oil, such as Maya (a benchmark set in Mexico that is often used for heavy oil headed for Gulf Coast refineries), is where the pipeline is expected to reel in profits. WCS is currently trading around $65/barrel, while the WTI benchmark hovers around $90/barrel. RBC projects that Keystone would shrink the WCS-WTI price disparity in half, and Goldman Sachs says Keystone would reduce the spread by $10-$16/bbl.

Thanks to the narrowed spread, the Keystone XL pipeline would allow oil sands producers to charge higher prices, perhaps significantly. However, the paper cites sources arguing that production costs for oil sands projects are expected to increase over time, mitigating Keystone's benefits.

The Carbon Tracker model assumes a "break-even" price (the oil price required to make a ten per cent return on investment) of $65/barrel. The report then assumes total transport costs through the KXL pipeline to be $18.50/bbl, which the author cites as consistent with analyst estimates.

Based on an expected price of $89/barrel for the exported Canadian oil, the report projects a net profit of $5.50/barrel above the break-even price.

Carbon Tracker argues that, with a $5.50/bbl profit, the Keystone approval will not improve the economics of oil sands projects by nearly as much as is widely assumed.

University of Alberta professor and energy economist Andrew Leach takes issue with some of the assertions Carbon Tracker makes regarding Keystone's operating costs. First, it assumes the cost under Keystone of transporting bitumen alone, not including costs associated with diluent, is $11/barrel, which "seems really high," Mr. Leach said.

A more reasonable estimate would be "$7 or $8 at most," Mr. Leach said adding that Carbon Tracker is high on cost assumptions across the board. The U.S. State Department says that transport costs through the Keystone pipeline would be "no more than $10 a barrel."

(Mr. Leach also disputes Carbon Tracker's estimates regarding oil by rail. The paper asserts that it costs $24/barrel to transport heavy crude to the gulf coast by rail; Mr. Leach says estimates he has seen are closer to $15, though a Reuters report put the cost as high as $30.)

The difference between the estimates can have a significant impact on profitability. Carbon Tracker are assuming a break-even price of $65, which yields a ten per cent rate of return. So the $5.50/bbl profit, which would be closer to $9 based on Mr. Leach's transport cost estimate, adds to this base rate of return.

"If you get $5.50 per barrel above the break-even price, you end up with 12 to 13 per cent returns," Mr. Leach concludes.

But while there's considerable debate over the costs, many observers agree that even if it's approved, Keystone isn't a risk-free proposition for oil sands investors.

Consider that TransCanada Corp., the company behind Keystone XL, has already invested $2-billion into the project that has still yet to be approved by the U.S., forcing TransCanada to repeatedly delay its projected start date over the past five years. And as the report points out, the oil sands are "exceptionally vulnerable" to changes in costs and prices. The profitability of these projects, therefore, will depend heavily on whether crude oil remains relatively expensive in the medium term, and whether producers can prevent production costs from increasing faster than prices.

"What [Carbon Tracker are] pushing is something people should be looking more at…are the oil sands long term viable energy sources? Are there real investor risks to the oil sands?" Mr. Leach said.

"Oil sands companies are playing both sides of the ball," he added. "They say Keystone XL won't significantly exacerbate greenhouse gas emissions, but they also arguing that it creates all this new value and economic benefits for oil sands producers. If it does create all this new profit, it's hard to believe it doesn't change greenhouse emissions."

President Obama is still debating whether to approve the Keystone XL pipeline. The decision is expected by Dec. 31.