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What Low Oil Prices Mean for the Keystone XL Pipeline

by Michael Levi
January 7, 2015

Keystone XL Pipeline Reuters/Andrew Cullen


The 114th Congress is in session and the Keystone XL pipeline is at the top of its docket. Senate Republicans have vowed to push the pipeline through and President Obama has threatened to veto any bill that does that. After five years of battle, this is mostly more of the same. But one thing about the world has changed radically since the Keystone XL pipeline became a top tier issue: oil prices have plunged. So what do lower oil prices mean for the costs and benefits of the Keystone XL pipeline?

Expert discussion has been focused on the State Department Environmental Impact Statement (SEIS). This is more relevant to political handicapping than to actual cost-benefit analysis, but it’s still worth digging into. The SEIS concluded that the pipeline would probably have no “substantial impact” on greenhouse gas emissions. This seemed to line up with President Obama’s statement that he would only approve the pipeline if it did not “significantly exacerbate” climate change. But the SEIS claimed that there was one exception: if oil prices were between $65 and $75, the Keystone XL pipeline could make a significant difference, tipping the economics of Canadian oil production from red to black and thus increasing emissions. Hence the political hook. Indeed as oil prices fell below $75 late last year, I began getting calls from reporters asking if this was a game changer for Keystone. Once oil dropped below $65, the calls stopped.

The $65-$75 range was never particularly compelling in the first place. No matter what the prevailing price of oil, if you reduce the cost of transporting it, you will improve project economics, and, at the margin, you should expect oil companies to produce more. How much more is impossible to confidently predict. Among other things, the breakeven price for Canadian oil will likely move with the oil price and with transport costs: if nudging transport costs a little when oil costs $70 a barrel really does threaten to shut in a large amount of Canadian oil, there’s a good chance that the Alberta government will try to blunt the impact through changes in tax and royalty treatment. On top of all that, of course, is the fact that oil is no longer trading between $65 and $75, and no one knows when it next will.

It’s much more interesting to ask how lower oil prices affect the costs and benefits of approving the pipeline. As a starting point, it’s important to stipulate that no one really knows where the long-run oil price will settle. And it’s the long-run price, not the current one, which matters when you’re talking about the consequences of a pipeline that has the potential to operate for decades. So let’s focus on what “lower” oil prices mean for Keystone XL rather than what any particular prices does.

Lower oil prices reduce both the costs and the benefits of approving the Keystone XL pipeline by reducing the odds that it will ever be fully used. There’s an outside chance that, if prices are sustained at an extremely low level, the Keystone XL pipeline won’t get built. That scenario isn’t likely – among other things, if Canadian production doesn’t grow, the odds of sustained low prices decline substantially – but it’s not zero. Lower prices also raise the odds that the pipeline will be built but not fully utilized. In that case, you still get the up-front construction stimulus, but you get less benefit from greater oil production, and less climate damage from the same. You also have a waste of economic resources.

The more likely scenario, though, is that the Keystone XL pipeline gets built and used. In that case, lower oil prices reduce its economic benefits without any clear impact on its climate costs. If you assume a constant elasticity of oil demand, then a given addition to world oil production should push down prices by the same percentage, regardless of what the starting point is. Imagine you think that the Keystone pipeline would boost net world oil production by 100,000 barrels of oil a day and you believe that would cut world oil prices by 0.3 percent. If prevailing oil prices start at $100, you’re cutting them by 30 cents; if they start at $50, you’re reducing them by only 15 cents. In both cases the marginal reduction in oil prices saves Americans money through reduced import costs and reduced absolute price volatility. (There is one countervailing force – at lower oil prices, U.S. imports are higher, and therefore a given reduction in oil prices yields more economic benefit – but this shouldn’t fully offset the main economic effect.) The upshot is that, in the lower oil price world, any savings from Keystone XL are reduced.

What about the climate impact? For a given net impact of Keystone XL on world oil production, the climate damages should be unchanged – the impact is a fixed function of how much extra oil is produced in Canada and how much additional oil is consumed worldwide. So whatever you think the excess of benefits over costs is for Keystone at $100 a barrel oil (and many people, of course, think that “excess” is negative), you ought to think that it’s smaller when prevailing oil prices are reduced. Keystone XL, like any oil production project, is less compelling when prices are lower.

What about the absolute impact on both economics and climate? This is much more difficult to pin down. The absolute impact of Keystone XL on both depends on how other producers respond in the long run to any additional production that it enables – that’s what determines the net impact on world production and consumption. How that changes depending on the prevailing oil price is unclear. Nailing that down would require knowledge of global oil supply economics, as well as oil producer politics, that no one confidently has.

What hasn’t changed is that both the climate damages and the economic benefits from Keystone XL are small in the grand schemes of climate change and the U.S. and global economies. A Keystone XL decision will have much larger consequences for U.S. politics, U.S.-Canada relations, and perhaps the broader rules-based global trading system than it will for climate change or the economy – and that’s where serious decision-makers ought to mostly focus. Lower oil prices haven’t changed any of that.

Post a Comment 7 Comments

  • Posted by Gregor Macdonald

    The reasoning in this piece is excellent. Really enjoyed it and a rarity amidst the mountain of material generated over the years on KXL. The hyperbolic claims on all sides about climate and macro impacts have been really extraordinary, and sadly they continue.

  • Posted by Mark

    There is an opportunity for compromise here.

    Why couldn’t Congress just include the Keystone Pipeline as part of the infrastructure bank projects? This is exactly the type of project we could use to create some construction jobs — we just need a lot more than just one project.

  • Posted by Dennis McConaghy

    I very much concur with your conclusions on what ther real impacts are if the Keystone XL pipeline is rejected by Barrack Obama.

    The immateriality of the actual incremental carbon impacts attributable to the project have never been in dispute to any fair minded analyst , let alone the Department of State over three separate environmental assessments of the project now stretching over six years.

    Resistance to the project from the American environmental movement was about the project as a political symbol to revalidate thier own relevance.

    One wonders how much better off North America would be if their resourucesd eployed against Keystone XL had rather been invested in trying to forge a genuine political consensus for carbon pricing.

    If Obama chooses to indulge in a fatuous political gesture of rejecting the project simply to appease the sensibilities of that movement, its consequences will be especially difficult for future Canadian-US relations.

    Speaking both as a Canadian and as a former TransCanada executive who was part of the development of the Keystone XL pipeline project , I can only wonder if the oil sands had been an American resource if the “due process” accorded the project would have profoundly different.

  • Posted by Tyler P. Harwell

    Accord with all of the above.

    This is a fine piece of thoughtful, conscientious, insightful and articulate analysis of the economic impacts of the XL pipeline proposal, inclusive of those of an environment nature. Of course, it is not exhaustive. But that is not a flaw since, as the author concludes, there is no way to know the answer to the politically significant questions that have been posed by it. He convincingly argues therefore, that a truly exhaustive treatment would be a fool’s errand. And that, Ladies and Gentlemen, is what the United States Department of State has been up to for the past six years. If anything, the author has given this subject more attention than it deserves.

    At the highest level of government in the United States, the decision of whether to approve this pipeline has never been one of negative consequence, except in symbolic terms. In that sense, it would merely represent a defeat for the “environment movement” – whoever that is presumed to be – because the self-same “environment movement” chose to pick a fight over it.

    The Obama administration’s public position on this subject is rubbish. World wide, North American, and US carbon emissions result from fossil fuel consumption, not from fossil fuel. It is ridiculous to speculate on whether construction of the Keystone XL Pipeline would therefore have any effect on carbon emissions in China, or anywhere else besides the United States.

    As regards the United States, carbon emissions, and/or the projected future levels of carbon emissions, have abated. This is for several reasons. None of them would be effected by this project. To wit: More fuel-efficient cars and other vehicles, machinery and equipment, including electric light bulbs; carbon emission regulation by the EPA and consequent investments that have yielded a relative reduction in same; the effects of $4.00 a gallon gasoline in 1987; and a lengthy and severe economic downturn that partially resulted from that, and which has brought about reductions in demand. Also, conversion of power plants from coal to gas turbine.

    At the same time, US oil and gas production has steadily risen due to technological advances, to the point where the United States could be – if it wanted to be – an exporting nation competitive on the world market. It is now on a course to become one of the world’s top three oil and gas producers, while, incidentally sitting on enough coal to last for hundreds of years.

    There is at the present time, therefore, no shortage of oil and gas in the United States, nor is there one projected to be at any time in the forseeable future. Thus consumption of these products is not at present constrained by supply. This is one of the reasons for the recent dramatic fall in world oil prices.

    The Keystone Pipeline is not a new source of supply for this market. It is merely a proposed new means of transportation for a source that is already reaching this market. Most of northern New England gets its gasoline, diesel fuel, heating oil, kerosene, and other such projects from refineries in New Brunswick Canada, through retail facilities owned by Irving Oil Company of same. Alberta crude is presently making its way to these refineries by railroad tank cars that travel through both the United States and Canada: through Lac Megantic, for instance, where the calamitous derailment occurred two summers ago. And over the New York Thruway in Buffalo, New York.

    The construction of this pipeline will probably do nothing to the price of oil and gasoline, etc., in the United States one way or another. It surely will do nothing to add to US carbon emissions. If anything, it will reduce them as a more efficient means of transportation. The Obama administration knows this. And this is why it has sat on this project.

    The present controversy over this matter is the sort of thing that long ago earned Economics the title of “the Dismal Science”. It is essentially both depressing and uninteresting.

    A more interesting question for the author might be this: Why does not someone build a refinery in Canada close to these fields, and ship value-added finished products to US Midwestern markets, and to the still gas-hungry West Coast ?

    North Slope Alaskan products would have to be more expensive. And thus such a development might go a long way towards repairing the environment damage that has been done, and continues to be done by production and development there, and by the continued use of the now old Alyeska Pipeline.

    Respectfully submitted,

    Tyler P. Harwell

  • Posted by Andy

    Type your comment in here… If 500,000 additional barrels of Canadian Oil is shipped to the U.S. southern coast via Keystone whose oil is displaced? this is the real impact of the pipeline. I suspect Saudi oil is displaced. not likely they willbe happy.

  • Posted by Richard Solomon

    Sorry that I am late to reply to this but I just learned of it via another blog.

    I agree that this is a thoughtful, carefully written piece. I must ask though if the author has taken two factors into account in regards to KXL’s impact on the climate. First, the extraction process for tar sands oil is about 15-17% more energy intensive than other kinds of oil. Second, one of its byproducts is pet coke. This is a particularly polluting form of coal burned in power plants in China and India. These plants have already been buying and using pet coke from Alberta.

    Even if the production of tar sands declines because of the lower price of oil, will not these sources still contribute somewhat to global warming? Enough to tip the scales against the advisability of allowing the pipeline to be built?

  • Posted by Jeff Moore

    It’s funny that Michael is saying that low energy prices killed Keystone when just a while backed he said: “Few people would have predicted that Keystone would become such a central issue, not only in the countries energy fights, but in its broader political fights, so by that yardstick, the environmental groups that pushed this, have succeeded”.
    When environmentalists win you need to lie and say they had little impact.

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