Varun Sivaram

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Would Keystone XL Lead to Infrastructure “Lock In”?

by Michael Levi
September 26, 2011

One of the most interesting debates about the Keystone XL pipeline revolves around what’s often called “lock in”, the claim that, having developed expensive infrastructure and “opened the spigot”, industry will not pull back, even in the face of later efforts to address climate change.


This is unpersuasive as far as the pipeline itself is concerned. The seven billion dollar pipeline will move that much worth of crude every hundred days. More importantly, if you amortize the cost of the pipeline over thirty years, you’re looking at a sunk cost of about a dollar a barrel. This is not the sort of thing that will make or break producers’ economics.


There is a substantially stronger argument to be made, though, when it comes to the investments in oil sands production infrastructure that Keystone XL would presumably facilitate. Industry tends to believe that investment in oil sands production is sensible if oil prices can be expected to stay above about fifty dollars a barrel or so over the long haul. Once money is sunk into fixed capital, though, the marginal cost of producing a barrel is lower, probably around twenty five or thirty dollars. (I don’t include taxes or royalties in this, since I’m interested in identifying the threshold where production would remain barely viable, and taxes and royalties would be small in that situation.) Demand-side policy that moderates the price of oil, then, would need to pack a real wallop to actually shut in existing production. Even if large demand reductions sent the price of oil down to, say, forty dollars in 2020, new investments in oil sands production following quickly on the approval of Keystone XL would probably continue to pump out oil.


Is this a problem? It depends on your perspective. If you think that, all else being equal, low oil prices and more North American production are a good thing, then this is good news. The same holds if you approach climate change from a traditional economic perspective: given a particular cap on greenhouse gas emissions, or a preset level of carbon tax, economic welfare would probably be improved by this potential oil sands production.


The picture gets more complicated, though, once you bring politics in. Economic theory assumes that emissions cuts should come from wherever they’re cheapest. Pick an emissions cap: if the peculiarities of sunk costs in the oil sands mean that oil sands production is unlikely to be scaled back, more reductions will be found elsewhere in the economy, all at lower net cost. In reality, though, the burden that can be placed on any one sector without inspiring severe and potentially debilitating political resistance is limited. The more you make oil production economically resistant to climate policy, the more other sectors are likely to become politically opposed. The net result may well be weaker climate policy in the aggregate. It’s worth noting, though, that if you think that the optimal climate policy is some set carbon tax, this argument doesn’t really work, since less abatement in one sector doesn’t then imply greater costs in others.


The problematic political dynamic might be compounded by production side politics. Once you’ve built production infrastructure, every extra dollar on the price of a barrel of oil is another dollar in your pocket. (Well, not quite, since that dollar is split among investors, workers, suppliers, and governments, but the basic point remains.) Industry opposition to serious climate policy is probably only going to intensify if it sees more money to be made from inaction.


This all strikes me as respectable logic. But, set against a broader backdrop, I’m not sure how much it matters. The forces for and against serious climate policy are large and powerful; I’m not sure how much these oil sands dynamics would change things at the margin. Moreover, one still must account for the real economic benefits of greater production – the only difference here is that there’s a plausible argument to be made for anticipating greater climate downsides (which have economic consequences themselves) against which they must be balanced. It’s also worth remembering that policymakers have limited capacity and political capital: if they block Keystone XL, they may find themselves making offsetting concessions somewhere else.

Post a Comment 10 Comments

  • Posted by Hans Nicolaisen

    If a carbon tax on oil is levied at final use – such as at the gasoline pump, home heating oil tank, or industrial use – it would be difficult, if not impossible, to separate oil from the Alberta tar sands from, for instance, Cushing WTI at that point.

    Since tar sands oil seems to have a larger “carbon footprint” than conventional oil how would this be handled? Included as a percentage of all oil sold?

  • Posted by Greg Rosychuk

    In response to Hans: To my understanding vis a vis a carbon tax, there would be no need to differentiate between different oil sources at the gas pump. Reason: Oil sand crude’s higher carbon footprint is largely due to consumption of natural gas (to produce steam to unbind the oil). Oil sands producers would pay carbon taxes* on the natural gas consumed. Subsequent consumers need not and should not pay any tax on this imbedded carbon consumption; to do so would be double taxation.
    Carbon taxes levied on oil sands producers due to their NG consumption would constitute an additional cost of business, thereby reducing their profitability. They would have an incentive to reduce their environmental footprint to maximize profit. Overall, not an unreasonable state of affairs.
    * Of course, the above presumes that Canada and the U.S. impose comparable carbon taxes. Not a given, to be sure, but not entirely unlikely either; much would depend on the political stripes of the respective governments of the day, and political pressure brought to bear by NGO’s, other governments, etc.

  • Posted by Bart

    All the people complaining about and protesting this pipeline should have to give up their cars and just drive pedal bikes around.

    Montgomery triangle is Awesome!

  • Posted by Will Wilson

    As I sit and listen quietly to the concerns expressed on the proposed XL Pipeline during the public hearing aired on C-Span today, I am reminded that both ends of this discussion will be nothing more than moot within a few short years.

    Why? Because emerging technolgies in clean energy will likely cost XL investors dearly as they bring down the cost of oil below $20/bbl by 2020.

    As one involved in clean energy technology R&D since 1974, I can assure you that I am no johhny-come-lately and I clearly see the day when solar and wind sources will produce electricity at less than one-half the $/Kwhr cost generated from coal. Similar projections may exist for the transportation sector too as our need for fossil fuels falls to near zero by 2035 due to these new breakthroughs that have been waiting for the American public to realize what is at stake in their futures if we continue to proceed under the thumb of BIG OIL and Energy.

    As these new technolgies in clean energy come to market in the next two years, we will find that the distributed generation they provide us 24/7/365 will also relegate the national grid to the status of “back-up” power by 2035. Nuclear energy will also become a thing of the past and all the rivers that were once blocked with hydro-power dams will once again flow freely by 2050.

    Finally, such developemnts will enable us to enjoy abundant clean energy at a fraction of what we pay today with a highly reliable and secure electrcity source to suit individual needs as homeowners, buinesses, industries and institutions no longer held hostage by the price fixing schemes of the former Oil and Energy buffoons of the last century.

    Anyone who has studied the fossil fuel industry since it began in 1859 with Colonel Drake in Pennsylvania will easily understand my meaning sine it has never been anything more than the whims of industry purveyors who have controlled oil supplies and fuels, contrary to what we have been told about OPEC and other oil producers like Venezuela and Brazil.

    But, perhaps the most alarming aspect of the enitre petroleum and natural gas industry is their tremendous ignorance when it comes to understanding the geological significance (something they should know better about) in shifiting tremendous amounts of fluids and gases from beneath the ground to the surface, thereby leaving vast voids behind where crust slippage may easily develop–and lead to what? Could these activities trigger widespread earthquakes along faultlines no one has ever clearly understood to date? How much will it cost in lives and destroyed infrastructure, homes and businesses if removing stabilizing fluids and gases from the earth causes major disasters from unintended consequences due to unknown tectonic dynamics. Similarly, who will pay for the disaster that may occur if the XL pipeline contaminates the largest underground auquifer in the world serving the water needs of eight states in the heartland of America? Are we really together on all the risks involved with the undertaking of drilling for more oil and fracking for natural gas when no one has any clearly defined idea what the potential short and long-range geological and water resource impacts will be to our country and civilization?

    Just as a house divided cannot stand, neither can a civilization where great disparity exists between those who have and those who are simplty expendable in their eyes. My guess is that there will be a day of reckoning that will come home to roost on those who are willing to sacrifice the needs of the many for short-sighted personal gains and I wish them well in their future endeavors. I think they may need it.

  • Posted by kim

    It is very nice for granola muching celeberties to say No to the pipeline–it is also reality that they have enough money and freedoms that they do not have to worry where they get their oil to power their Escalades. USA needs this oil and it will also provide many jobs and spin-off benefits. If everyone rode a bike then No to the pipeline but that is NOT the case. Grow up and find better means to make the pipeline safer.

    Montgomery is awesome!

    Montgomery triangle is awesome!

  • Posted by Miko

    Now, there is talk of putting the pipeline through British Columbia and allowing China to access the oil in pipeline. Excellent Idea!!–Keep America dependent on oil from the middle east. USA does not want Keystone??? Great!!!–then reroute it and cut America out–they all want to ride bikes anyway

    Why is Montgomery triangle so awesome!?

  • Posted by Miko

    Keystone pipeline delayed–Montgomery triangle is awesome!

  • Posted by Zak

    This is all very nice. But the fact is that the USA still needs oil and will for some time before there can be any meaningful change away from energy independence. It would be great if Transcanada rerouted their oil and sold to Asia. Probably wont happen but it would be good.—Let America wallow in its debt and bankruptcies.

    Montgomery is awesome!

    Montgomery triangle is awesome!

  • Posted by drew peacock

    Keystone has to happen. Obama es a fool, idiot!!

    Watch oil hit $165 on iran news

    Montgomery is awesome!!

  • Posted by drew peacock

    Long and strong oil!!!

    Montgomery triangle is awesoms!!

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