Keystone XL: Pipe Dreams

TransCanada’s (TRP) third-quarter earnings call with analysts on Nov. 1 ought to have been a victory lap for Chief Executive Officer Russell Girling: profit at the Calgary-based energy infrastructure company was up 20 percent over the same period in 2010; total revenue had risen 11 percent to C$2.14 billion ($2.07 billion); and he had a fat dividend to announce. Instead of enjoying the good news, however, Girling’s presentation was dominated by the same thing that has dominated pretty much all news about the company over the last five months: the tortured approval process for TransCanada’s next big thing, the Keystone XL pipeline.

First proposed in 2007 as an extension to another TransCanada oil pipeline, the XL will be three feet in diameter, run 1,750-plus miles, mostly below ground, cost roughly $7 billion to complete, and transport up to 700,000 barrels of oil a day. Crucially, it will carry crude oil from Alberta’s tar sands region across Montana, South Dakota, Nebraska, Kansas, and Oklahoma and through to refineries on the coast in Port Arthur, Tex., that can handle the heavy crude that comes from oil sands. The pipeline, says Doug Cogan, a research analyst at New York-based financial services giant MSCI (MSCI), “would be a huge win not only for TransCanada, but the Canadian oil sands industry generally, because it would mean building a new backbone through the center of the U.S. that would allow access to markets within the U.S.”

If only it were that easy. Any pipeline crossing a U.S. border needs an O.K. from the President, with the application process handled by the State Dept. According to money-in-politics watchdog Center for Responsive Politics, TransCanada has spent nearly $1 million lobbying the State Dept. ahead of President Obama’s final decision, expected by Dec. 31. Just a few years ago the XL’s predecessor, which runs from Canada to Oklahoma and branches into Illinois, breezed through the permit process during the Bush Administration with barely a whiff of concern from the public.

Not this time. Beginning in June with an open letter from former NASA climate scientist James Hansen calling on others to speak out in opposition, an unlikely coalition of environmentalists and cattle ranchers, the Republican governor of Nebraska, the Hollywood greener-than-thou crowd, and a Vermont college professor, among others, have turned Keystone XL into a symbol of ecological plunder, corporate arrogance, and political cronyism. Pipeline opponents contend that it might leak, poisoning portions of the aquifers of the Great Plains, and that it will commit the U.S. to increased greenhouse gas emissions and delay a transition to renewable fuels. Furthermore, the State Dept. Inspector General’s office announced on Nov. 7 that it will conduct an internal investigation into possible influence-peddling and conflicts of interest. The company hired by the State Dept. to conduct the main environmental impact study (EIS)—Cardno Entrix, in Houston—is a client of TransCanada’s, and TransCanada hired a former campaign staffer for Secretary of State Hillary Clinton as a lobbyist. Critics also accuse TransCanada of threatening landowners along the proposed route with eminent domain and taking them to court—all before it had a permit. “I find it appalling that a foreign company can dictate to Nebraskans how we can use our land,” one local fumed in September at a meeting held by the State Dept. to take public comments on the pipeline. (TransCanada declined requests for one-on-one interviews with Girling and other executives. In an e-mail, TransCanada spokesman Terry Cunha wrote: “Our commitment is to treat landowners with honesty, fairness, and respect, to work with them and come up with the best possible solution. We have reached voluntary agreements with over 90 percent of landowners along the pipeline route and we continue to negotiate with landowners.”)

TransCanada has already blown through more than a billion dollars on the XL without laying an inch of pipe inside the U.S., buying up rights-of-way and stockpiling steel along the U.S. portion of the route in anticipation of receiving a permit. In the Q3 conference call, Girling, 49, repeated the company’s talking points: First, Keystone XL would reduce U.S. imports of crude oil from the Middle East. Second, the XL would create 20,000 jobs in the U.S., up from the 3,500 to 4,200 range TransCanada had been using previously). Finally, the project had been subject to “by far the most exhaustive and detailed analysis ever conducted of a crude oil pipeline in the United States.”

“It’s a continuing process of dealing with these allegations that discredit the process and the regulators,” Girling said in response to a question asked at the earnings call by Bloomberg Businessweek. Nonetheless, he reaffirmed, “We do expect to receive a Presidential permit by the end of the year.”

Obama threw himself into the fray on Nov. 1 in an interview with a TV station in Nebraska, where much of the most strident opposition to Keystone has originated, in which he said health and safety would have to be weighed against the pipeline’s economic benefits. Yet Obama has signaled a willingness to favor energy development over environmental concerns, first in August with his conditional approval of Royal Dutch Shell (RYDAF)’s plans to develop oil fields off the coast of the Arctic National Wildlife Refuge, and again in September by withdrawing a U.S. Environmental Protection Agency proposal for stricter air-quality rules.

Even if TransCanada gets its go-ahead, however, building the pipeline is a significant risk, not only for TransCanada, but also for Suncor Energy (SU), Total (TOT), Shell, and the rest of the companies involved in the mining and drilling and upgrading of Alberta’s oil. The price to produce a barrel of oil from the sands could soar if producers are forced to assume some currently external costs, such as the huge carbon emissions produced by extracting bitumen, the thick, sour form of crude found in Alberta tar sands. It’s a cost already being addressed in multiple markets, such as California and Europe. There is mounting evidence of negative health effects on local populations exposed to mercury, arsenic, and other toxins used in oil-sands extraction—a huge potential liability. Producers will also need to address new cleanup measures. One plausible scenario: The pipeline gets built, but oil sands production remains prohibitively expensive.

Petroleum geologists have known for decades how to get crude from the oil sands (or tar sands) that lie beneath the vast boreal forest of northern Alberta. Containing an estimated 171 billion barrels of recoverable oil, the Alberta tar sands are the second-largest reserve of hydrocarbons in the world, after Saudi Arabia’s. But oil sands production is expensive, which is why few outside Canada had heard of it until oil went (and stayed) above $60 or so a barrel in the middle of the last decade, and profitable production began to look possible. There isn’t nearly enough demand within Canada, however, to use up the 3.2 million barrels a day the industry hopes to be producing in Alberta by 2019. Hence the need for a pipeline. “The oil sands market will not grow if it can’t access new markets,” says Jackie Forrest of Colorado-based energy research firm IHS-CERA (IHS).

Alberta’s oil is relatively expensive to produce because tar sands are hard to get out of the ground, and once unearthed, the bitumen is hard to separate from the rest of the muck. Two metric tons of tar sands yield just one barrel of oil that’s of a grade most refineries can handle. Unlike other forms of oil, bitumen also requires “upgrading” before it can be transported. “It’s too thick to meet pipeline specs,” says Forrest. This pre-refining process costs money and energy. It dilutes the bitumen with natural gas condensate, which usually contains the carcinogen benzene. Despite the upgrading, bitumen remains a challenge to refine; it’s better suited for road asphalt than transport fuel.

It’s no secret that bitumen requires a robust price-per-barrel to be profitable, but what’s more recently become apparent is that oil—not just tar sands oil—also has a price ceiling. “Oil reaches a point where the global economy can’t sustain its price,” says Cogan. In other words, people will pay only so much for a gallon of gas: The number of miles driven in the U.S. fell for the first time in 2008, when oil peaked at $147 a barrel. According to Daniel Yergin, the Pulitzer prize-winning author of The Prize and The Quest, and chairman of IHS-CERA, that ceiling is somewhere between $120 and $150. At that point consumers behave more efficiently, regulators and legislators change policy, innovators innovate, and alternatives to petroleum, such as biofuels and electric cars, become competitive on price—all of which destroy demand for oil, including bitumen. To some extent, investors in oil sands development seem to have noticed this ceiling. After three straight years during which inflows averaged $16.6 billion, investment fell to $13.5 billion in 2009, a drop of nearly 35 percent from 2008, when oil prices peaked near the top of Yergin’s ceiling.

Much of tar sands oil is extracted by mining: basically, digging it up with enormous machinery. The problem is that a great deal of what can be extracted by mining already has been: Only 20 percent of Alberta’s oil sands is close enough to the surface to be mined. According to a 2009 report by the Canadian Association of Petroleum Producers, mining production will be flattening relative to other more expensive methods beginning as soon as next year.

These other methods are known collectively as in situ extraction, and largely involve heating deposits deep underground and sucking them up. (In situ is Latin for “in place.”) According to analysts at Deutsche Bank (DB) and Goldman Sachs (GS), in situ extraction raises the price of tar sands production by anywhere from $5 a barrel to as much as $35 a barrel, depending on the method used. In situ extraction has a much greater footprint on the boreal forest than mining. Already a Florida-size portion of the breeding habitat of 30 percent of the songbirds in the U.S. has been lost to oil sands development.

In situ extraction requires natural gas to heat water into steam; every gallon of oil produced needs up to four gallons of water, most of it coming from a river that has usage restrictions for much of the year. The steam is then injected underground, warming the oil sand until it liquefies sufficiently to flow into the well. Some of the water is used again, drawn from a toxic mixture that must be isolated.

All of this puts tremendous pressure on the economic viability of oil sands, especially if producers must bear all costs related to water scarcity, potential health problems, cleanup, and carbon emissions—almost none of which have been borne by producers up to this point. Treating spent water could add another 5 percent to extractors’ costs, according to a 2010 report co-authored by Cogan arguing that oil sands production might not be economic. When producers finish with the water, it ends up in “tailings ponds” along with the sand that’s been separated from the oil—reservoirs of petroleum-based sludge. “After 40 years of production, there’s 170 square kilometers of tailings ponds in northern Alberta—an area the size of Washington, D.C.,” says Nathan Lemphers, senior policy analyst at the Calgary-based Pembina Institute, a Canadian ecological think tank. Producers are supposed to clean them up, but according to a 2009 Pembina report, not a single one has so far been certified as “reclaimed” to government standards. Lemphers says that Suncor has made significant progress at one site known as Pond 1, but “it’s not an end point.”

“Tailings management has not been successful for economic, rather than technical reasons,” says Cogan. In other words, it can be done but no one’s been willing to put up the money. “In an industry that’s on the margins of profitability,” Lemphers adds, “it’s pretty risky to go out on a limb and implement new technology or a new operating strategy if not required to do so by regulation.” Pressure is growing on the industry. A tailings-management rule known as Directive 74 requires costly management of tailings ponds (though enforcement has been lax and only Suncor is currently in compliance, according to the Simon Dyer, policy director at Pembina), and a new regional planning initiative may ask producers to undertake more—and more costly—tailings management. Cogan’s group at MSCI estimates that cleanup of toxic waste will soon add $1 to $4 per barrel to production costs. He has also looked at a number of the big oil sands players and concluded that heavier cleanup costs could substantially reduce profits.

Opposition to the XL pipeline runs on parallel tracks, one local and one global. Locally, there’s concern over pipeline leaks. TransCanada points to measures it says it will take to prevent spills and clean them up completely and expeditiously if they do happen, but oil transport is a dirty business. A pipeline owned by Calgary-based Enbridge (ENB) dumped 19,500 barrels of oil into Michigan’s Kalamazoo River in 2010, much of which is still there one year and $702 million in cleanup costs later. (A spokeswoman for Enbridge did not respond to a request for comment.)

In July a pipeline owned by ExxonMobil (XOM) ruptured, spilling oil into the Yellowstone River. A week later a University of Nebraska water-resources engineer issued a report, commissioned by environmental group Friends of the Earth, stating that TransCanada had grossly and misleadingly underestimated the number and volume of potential spills from Keystone XL.

Concern over spills has focused on an area of Nebraska known as the Sandhills, which Keystone XL’s proposed route transects. It’s an ecosystem where the water table is so high it sometimes bubbles to the surface: Black Angus cattle drink from these tiny ponds, or “wet meadows,” as well as from the giant tubs into which windmills pump water from a few feet below ground. In September, I met Susan Luebbe on her ranch, south of Stuart. She was heading out to find and tag a newborn calf. “If there’s a slow leak and benzene or arsenic gets into the cattle, you can lose your whole herd,” Luebbe said. Her bank won’t extend her operating loan, she said, because of just such a fear.

Although “oil’s not very mobile, benzene and other involved constituents are,” says University of Nebraska hydrologist John Stansbury. “There can be a leak at 1 percent of flow rate and as long as it stays beneath the surface, they will not detect it. [Luebbe] could very well be exposed to benzene, and so could her cattle.” (A TransCanada spokesman said in an e-mail that the company’s system can detect below 1 percent, though the draft environmental impact statement put it at 1.5 percent.)

From a global perspective, opponents like Hansen and Bill McKibben, an author, activist, and professor at Middlebury College who has been arrested protesting the XL in front of the White House, contend that the pipeline would accelerate development of Alberta’s oil sands and thus increase the carbon in the earth’s atmosphere. Bitumen extraction is more carbon-intensive than other forms of oil because of the considerable fuel necessary to run the mining machinery or heat the steam for in situ extraction, to “upgrade” it for transport, and to refine it from heavy crude into gasoline or diesel. Analysts like IHS-CERA and Cogan, as well as environmental groups, calculate that a barrel of oil derived from tar sands produces as a byproduct of the process an additional 6 percent to 22 percent more CO₂ than conventional oil, depending on the assumptions of the model. That doesn’t even count the carbon increases from the deforestation necessary for oil-sands production. (Girling has said on a couple of occasions that transporting oil by tanker causes greater greenhouse-gas emissions than by pipeline.)

The pipeline, if built, will be like a catheter draining tar sands oil from Canada into the world marketplace. During the Q3 earnings call, Girling claimed the real aim of Keystone’s opponents is a “reduction in the development of the Canadian oil sands. And that’s their target.”

Guilty as charged, McKibben says. Keystone is “a proxy for the myriad decisions we’re going to make about going after unconventional fuel sources. We’re starting to run out of the easy stuff everywhere.” Noting the difficulty of extracting, transporting, and refining bitumen compared with traditional oil sources, McKibben asks, “Do we take that as a clue we should get serious about the transition to renewables, or as a signal we should rip apart the planet trying to get another hit of fossil fuels?”

Over the summer, McKibben and XL opponents got some indirect help from WikiLeaks. On July 13 the Los Angeles Times reported on a diplomatic cable acquired by the group that described a State Dept. official, David Goldwyn, as having “alleviated” Canadian officials’ concerns about accessing U.S. markets and coaching them on “improving oil sands messaging.” (After leaving the State Dept. for a law firm with ties to TransCanada, Goldwyn testified before Congress in favor of Keystone XL.) Two days later seven Senate Democrats wrote to Secretary of State Hillary Clinton that “several remaining questions must be addressed before the permitting process can proceed.”

Friends of the Earth and the Sierra Club have subsequently made public government documents obtained through a Freedom of Information Act request that reveal apparent bias in the vetting process. “Go Paul!” wrote one State Dept. employee upon learning that TransCanada lobbyist Paul Elliott had secured Montana Senator Max Baucus’s support for Keystone XL. Elliott had formerly worked on Secretary Clinton’s 2008 Presidential campaign.

TransCanada has tried to fight back. On Oct. 18 it offered to post a $100 million performance bond for Nebraska to use if the company failed to clean up a spill in the Sandhills, and offered to store cleanup equipment in the area to expedite spill response. But the company couldn’t catch a break. The New York Times reported that TransCanada had threatened landowners with eminent domain in order to obtain the right to build on their property (including, Bloomberg Businessweek has learned, one woman in a nursing home, who has since died), and sued recalcitrant landowners along the proposed route, though it does not yet have the permit to build. On Oct. 26 fourteen members of Congress called for an investigation into whether the State Dept.’s outsourcing of the EIS violated the law. The Nebraska legislature also announced a special session to consider if it should (and could) force TransCanada to re-route the pipeline. Any such delays, TransCanada executives said, could cost the company $1 million a day and threaten its agreements with shippers, who take ownership of the oil as it moves from point to point.

There remains yet another financial factor working against tar sands producers: efforts in both North America and Europe to make carbon-intensive fuels more expensive. California has already implemented low-carbon fuel standards, which require a 10 percent reduction in overall greenhouse gas emissions associated with transport fuel sold in the state by 2020.

Considering the higher amount of CO₂ emissions associated with tar sands oil, bitumen will have a tougher time penetrating the California market. Meanwhile, governors of ten Midwestern states—tar sands oil’s largest current export market—as well as seven Western U.S. states, four Canadian provinces, and the U.S. Conference of Mayors, are moving toward implementing carbon-fuel standards that could be similar to California’s. Half the U.S. could soon be under the mandate. And the European Union has already signaled its intent to price transport fuel originating in Alberta higher than competitors’ due to its low carbon efficiency.

All these concerns could push the cost of production above the price of a barrel of oil. Under California’s regulation, Cogan calculates, tar sands oil could cost producers another $11.40 per barrel in 2020. Add that to today’s generally accepted $60-a-barrel cost, Cogan’s figure of $1 to $4 a barrel for tailings ponds remediation, the $5 to $35 per barrel of additional costs that Deutsche and Goldman figure for in situ production, and yet more expenses from the additional water treatment necessary for in situ, and production costs potentially climb to around $115 per barrel. That’s not counting any unexpected liabilities from health issues. (One company had to pay C$3 million when it was held responsible for the deaths of 1,600 … ducks.) As this article went to press, North Sea Brent was trading at $113.90, which might mean that Russ Girling’s fossil-fuel superhighway may not, in the end, actually matter.

Tullis is a Bloomberg Businessweek contributor.

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    (TransCanada Corp)
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