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A New Keystone XL Paper is Probably Wrong

by Michael Levi
August 13, 2014

I’ve been trying to avoid two things lately: Keystone XL and picking on shaky scientific papers. But a new paper on Keystone XL in Nature Climate Change has been generating a lot of  buzz and requests for comment, so a post on it seems worthwhile.

The paper claims to show that the State Department has underestimated the emissions impact of the pipeline by as much as 83 million tons of carbon dioxide equivalent annually. The authors say that the State Department “did not account for global oil market effects” that would lead to greater world oil consumption – and therefore emissions – as a result of higher Canadian oil sands production. They claim that, by now including those effects, they have produced the correct emissions number.

The authors are on reasonable grounds to argue that State should have been less confident in assuming no impact of higher oil sands production on world oil consumption – an issue that scores of analysts (myself included – see, for example,  this 3+ year old blog post or my 2013 book) have long understood is real. But their estimate of that impact is thoroughly unpersuasive and almost certainly too high. Let me explain why in three pieces.

The authors assume that, climate change aside, the world oil market is a perfect market.

No manipulation, no politics, nothing. Just textbook economics. If you’re skeptical of this, you’re right.

The authors’ basic methodology is straightforward. Assume that Keystone would add to world oil supplies. This would push world oil prices down. The result of that would be to encourage increased oil consumption and deter some now-uneconomic oil production. The system would come to equilibrium at a lower oil price and a higher level of oil consumption. That new price and consumption level can be estimated using observed or calculated elasticities of oil supply and demand.

Here is the central problem: It is hugely controversial to claim that that price changes affect oil production only through altered project economics. That’s how a normal market works. (If, say, I’m selling milk, and the price of milk drops so far that I can’t profitably do my business, I’ll cut back or shut down.) But there are oodles of serious people (including  big environmental groups and analysts that produce the  regulatory impact assessments that justify things like fuel economy rules) who reasonably think that that’s not all that’s going on when it comes to oil. Instead they believe that one or more big players in the world oil market – think Saudi Arabia or OPEC – manipulate their production to maximize revenue or target a particular oil price. What that means in practice is they believe that a production increase in, say, the United States or Canada would be met by production restraint in, say, Saudi Arabia. The net result is to blunt the impact of Keystone XL and its ilk on supply, prices, and consumption. Indeed it is precisely this phenomenon that environmental advocates rely on when they claim that increased U.S. oil production would do almost nothing to benefit U.S. consumers at the pump.

I don’t know how Saudi Arabia and other low cost producers might react to increased Canadian oil production. The State Department analysis implicitly assumes that their reaction would fully offset any Canadian increase; I find that implausible. But the new paper assumes without any serious attempt at an argument that they don’t change anything at all; I find that even more difficult to believe.

In essence, both the State Department and the Nature Climate Change paper probably have the politics wrong. Assuming that each of them otherwise have the economics correct, the State Department number becomes a lower bound on the impact of Keystone XL, and the Nature Climate Change paper gives an upper bound.

Which brings us to the second and third problems with the Nature Climate Change paper.

The authors’ numbers for oil supply elasticity are shaky.

A low elasticity of oil supply means that lower prices caused by a rise in Canadian oil production will do relatively little to prompt other suppliers to cut back on their own production. The lower an oil supply elasticity one uses, the greater the impact of Keystone XL appears to be. The headline number that the Nature Climate Change paper reports (a net addition of 0.6 barrels to world oil production for each extra barrel of Canadian crude) assumes a supply elasticity of 0.13. The paper reports a sensitivity test where the supply elasticity is 0.6; that cuts its estimated impact by more than a factor of two.

So where does the 0.13 figure come from? It’s read off the following chart from Rystad, a consultancy.

Rystad oil supply curve

The steeper the supply curve, the lower the supply elasticity – and the authors have read their supply elasticity off the almost-steepest part of the curve (at 96.62 million barrels a day, an EIA projection for 2020 oil consumption, to be precise). That might be fine if this particular supply curve were gospel, but it’s not – there’s enormous uncertainty around the cost of future supplies. (Incidentally, if anyone can explain to me why the right hand side of the supply curve is a mile above the estimates shown for cost of each source of supply, I’d really appreciate it.) The authors also have no reason to be confident that, excluding Keystone XL, world oil consumption will be 96.62 million barrels a day in 2020 – yet a quick glance at the curve shows that even if you accept the Rystad supply estimates, the point on the curve at which you estimate supply elasticity can have a very large impact on the result. The basic implication of all this is that a lot of pieces need to line up in order for the paper’s central conclusion to hold up (again, we’re setting aside the political assumptions for now), but there’s no compelling reason given for believing that they actually do. Indeed I’ve left one more out so far.

The authors’ assumptions are in far deeper conflict with the State Department analysis than they acknowledge.

The authors understand that State Department analysis already concluded that only if oil prices were somewhere around $65-$75 would a lack of pipeline capacity tilt the balance against oil sands, since otherwise, rail would be able to pick up the slack. They write:

“The overall GHG emissions impact of Keystone XL is determined… by the extent to which Keystone XL leads to an increase in oil sands production. Here, the State Department concludes that owing to availability of other pipelines… or rail for transporting oil sands crude, the rate of Canadian oil sands extraction would most likely be the same with or without Keystone XL…. The State Department also suggests a case in which the oil sands production could increase by Keystone’s full capacity. If future oil prices are lower than expected, specifically $65–$75 per barrel, ‘higher transportation costs (due to pipeline constraints) could have a substantial impact on oil sands production levels, possibly in excess of the capacity of the proposed Project’.”

The authors then go on to elaborate reasons that oil prices might indeed end up in that range as a way to motivate the possibility that blocking Keystone would actually constrain oil sands production.

But take another look at the supply curve. If you really believe that curve (which the authors say you should), and you’re now looking at a case where oil prices are $65-$75, that means you ought not be looking at the point on the curve where production is 96.62 million barrels a day – instead, you should be looking well to the left, at a part of the supply curve that’s far flatter and hence less supportive of the paper’s conclusions. A quick read of the supply curve suggests an elasticity of about 1 in the $65-$75 price range – well above the number they use, and even outside the range of their sensitivity analysis.

Despite all this, I wouldn’t go so far as to say with 100 percent confidence that the authors’ emissions estimate is too high.

Odds are that the numbers in the Nature Climate Change paper are too high and that those in the State Department report are too low. (That doesn’t necessarily mean that State has overestimated the likely emissions impact — given that, in the case it considers most likely, Keystone has no impact on Canadian oil production, and hence no impact on emissions. What’s too low is State’s upper bound.) If you forced me to bet, I’d put the real number a lot closer to the State Department one than to the Nature Climate Change result. But there are all sorts of uncertainties involved in analyzing world oil markets beyond the ones I’ve just discussed. There are undoubtedly more uncertainties than the new Nature Climate Change paper acknowledges. One nice thing for policy analysis is that many of those uncertainties (such as in the elasticity of oil supply) affect not only the environmental costs of Keystone XL but also the economic benefits – so that, in a proper cost-benefit analysis, they often cancel out.

One last thought: Cross-over papers that take climate change and fossil fuel markets both seriously are important and too rare. It’s good to see people trying to bridge that gap. (Even the Bob Howarth paper on methane leaks, for all its extraordinary flaws, was commendable for trying to grapple with both worlds). But you’re rarely going to find two peer reviewers who can credibly tell an editor whether such a paper is fit for publication – the range of expertise required is almost inevitably too large. Either journal editors need to solicit a larger numbers of reviews (covering a wide range of expertise) than typical for such papers, or journalists need to lay off treating them as much more than preliminary ideas until they’ve withstood sustained public scrutiny. I doubt the latter will happen, but one can hope that journal editors take new steps to get these sorts of papers right.

Post a Comment 8 Comments

  • Posted by Chip Knappenberger

    Squabbling over Keystone XL emissions details misses the bigger point. As I explained in Congressional testimony last summer, no matter whose emissions numbers you use, the climate impacts are trifling.

    -Chip

    [ML: Agreed on the specific. But this is part of a much broader debate over whether/when restricting oil production directly has a meaningful impact on climate change. The scale of that issue is large, and much of the analytical substance is the same.]

  • Posted by David Appell

    We need to cut CO2 emissions. But all efforts to cut CO2 appear, individually, to have a “trifling” impact on climate. By that reasoning, we shouldn’t cut any CO2 at all, which is a logical contradiction to the premise that we need to cut CO2 emissions.

    [ML: I prefer distinguishing between cuts whose benefits exceed costs and those whose costs exceed benefits. No one believes that we should pursue any possible emissions reduction opportunity, no matter how large or small, whatever the cost. Lots of small costs add up too.]

  • Posted by Emil Morhardt

    Excellent analysis…I see no reason not to go after poorly reasoned papers, and what we don’t need is more specious arguments for proponents and opponents to trot out. On this topic, though I tend to agree with Chip; the politics surrounding the XL pipeline seem to have a lot less to do with climate change than something else…though I’m not quite sure what. There seem to be many interests in play.

  • Posted by nilo

    “the summation of the different global emissions insignificant” =?

  • Posted by David Appell

    >> ML: I prefer distinguishing between cuts whose benefits exceed costs and those whose costs exceed benefits. <<

    Many noncarbon ideas have lower costs already, when you factor in the cost of their negative externalities. The National Academy of Sciences estimated (2010) that fossil fuel use causes damages of at least $120 B/yr to health and the environment. This paper finds that power-generation by coal and oil creates more damage than value:

    "Environmental Accounting for Pollution in the United States Economy," Nicholas Z. Muller, Robert Mendelsohn, and William Nordhaus, American Economic Review, 101(5): 1649–75 (2011).
    http://www.aeaweb.org/articles.php?doi=10.1257/aer.101.5.1649

    To summarize that paper's findings: for every $1 in value that comes from coal-generated electricity, it creates $2.20 in damages.

    Total damages: $70 billion per year (in 2012 dollars).

    Petroleum-generated electricity is even worse: $5.13 in damages for $1 in value.

    [ML: Yes - many non-carbon ideas may have lower costs already. That doesn't mean that blocking Keystone XL is one of those. Also: Your interpretation of MMN is correct at the margin; it is not correct for all coal-fired electricity. The marginal damages due to each ton is the same; but the marginal value is declining in the amount of electricity produced.]

  • Posted by mnemos

    @Appell – I’ve opened the paper and will take some time to look at the 28pp, but from a first order thought process…

    40% of our electrical energy comes from coal, and electrical energy is the basis or our entire energy infrastructure behind our industrial and service economies… so to simplify, say 40% of our economic output is based on coal electricity, and 2.2x that is the damages from it… so the we create damages of ~88% of our economic output just from generating coal… Does that make any sense? Or for example are they making a silly argument that the “value that comes from coal generated electricity” is the price of that electricity, which would be exceptionally poor thinking or poor wording. In some sense this is equivalent to the magical thinking from the renewables lobby: just stop burning coal and all the sudden alternatives will appear riding on the back of unicorns. You can’t assume that the economy continues without the majority of the current energy sources (coal+gas=~66%, coal+gas+nuclear=~87%) so that needs to be accounted for as generated value.

  • Posted by Fernando Leza

    An analysis of the impact should consider the Canadian oil blend assay. If the pipeline doesn’t provide for batch pumping then the overall assay must be considered (including the USA produced oil streams they plan to add). The impact analysis should then consider which import streams are likely to be displaced. The most likely competitors are Mexican Maya and the Venezuelan heavy oil blends.

    Venezuelan heavies move to the USA by tanker into the USA Gulf Coast. They are intentionally blended to achieve about 17 to 18 degrees API. The large majority of Venezuela’s reserves are heavy and Orinoco extra heavy crudes. The Orinoco extra heavy has been booked by PDVSA using a 20 % recovery factor. Approximately 75% of this 20 % will require steam injection (some would argue the figure could be as high as 90 %). Therefore the life of the field emissions from Venezuela will likely exceed Canada’s, simply because Venezuela’s oil operator is less efficient and gas prices are likely to be lower.

    Thus the analysis should proceed to estimate the impact on the world oil market of Venezuela’s loads (not Canadian oil arriving in the USA Gulf of Mexico region). I’ve ignored Maya because it’s declining fast and I don’t think it will play a major role as a USA supply stream. I have t seen an analysis of what happens to Venezuelan extra heavy Orinoco blends displaced out of the world market. These loads will likely be sold at distressed prices given the lack of refining capacity to handle oils with large asphalt and resin fractions.

    Thus the impact of the Canadian entry into the market could easily lead to lower prices for the extra heavy Venezuelan blend. Internal Venezuelan economics will be impacted. Which also makes me wonder if PDVSA may not be pulling strings to have the Keystone pipeline stopped? Think about this.

  • Posted by Jack William

    Solar distillation can be used to make saline or brackish water potable. The first recorded instance of this was by 16th-century Arab alchemists.

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