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Keystone XL: The End of the Beginning

By David Dittman on January 19, 2012

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Congressional Republicans paved the way for anti-oil factions to claim a short-term victory and provided them oodles of fuel for their fundraising engines by attaching a rider to last fall’s payroll tax bill that would expedite a decision on TransCanada Corp’s (TSX: TRP, NYSE: TRP) Keystone Gulf Coast Expansion Project, or “Keystone XL.” President Obama sealed the deal this week by rejecting–“without prejudice,” in the very frank words of the Canadian prime minister’s press office–the 1,600-mile extension to TransCanada’s Keystone Pipeline System.

This, a whole lotta headlines and a little more momentum for TransCanada’s stock’s post-five-year-high slide are the sum total of this latest expression of Americanized kabuki. The overwhelming likelihood is that the USD7 billion Keystone XL will get built along the new path agreed by the company and the state of Nebraska. As of this writing none of the shippers committed to using the 830,000 barrels per day capacity on XL have abandoned pipeline.

That will ultimately determine whether it gets built, whether demand still exists. Enbridge Inc (TSX: ENB, NYSE: ENB) and its partner Enterprise Products Partners LP (NYSE: EPD) plan to reverse the Seaway Pipeline, which brings oil from the Gulf Coast to a storage hub at Cushing, Oklahoma. But this project is unlikely to steal customers, at least not yet. Enbridge itself doesn’t view its project as a direct competitor with Keystone XL.

The stock has eased back in 2012 after closing 2011 at a five-year high on the Toronto Stock Exchange (TSX). The stock is down more than 6 percent this year to a Thursday close of CAD41.70. Management is likely to continue its pattern of raising the quarterly dividend by CAD0.02 per share, which it’s done every year since 2007, to bring the 2012 payout to CAD0.44 per share per quarter. At that rate the stock currently yields 4 percent.

Five Bay Street analysts have maintained their outlooks for TransCanada in the aftermath of President Obama’s temporary rejection, among them an “outperform,” a “buy,” a “sector outperform,” another “buy” and a “hold.” One house, FirstEnergy Capital, downgraded the stock to “underperform.” The current buy-hold-sell line is nine-five-two. Standard & Poor’s rates the company A- with a “stable” outlook, while Moody’s rates it Baa1 with a “stable” outlook as well.

TransCanada carries a significant debt load, but not out of line with its peers. Its 45.79 percent debt-to-assets ratio compares favorably to Enbridge’s 48.17 percent. Enbridge, currently yielding 3.1 percent, is trading at a 3.72-to-1 price-to-book ratio, while TransCanada is relatively cheap at 1.82-to-1. If Keystone XL doesn’t happen–which at this point remains an unlikely worst-case scenario–TransCanada will be worse off for the sunk costs, about CAD1.9 billion, and the absence of new revenue come from the effort come 2014.

Management, however, continues to add projects apart from XL, though it is the biggest infrastructure project on the North American docket at the moment. TransCanada continues to diversify its overall asset base, adding or making progress on significant power generation assets during the third quarter of 2011, including 590 megawatts of wind power in Quebec.

Comparable earnings for the three months ended Sept. 30, 2011, were CAD417 million, or CAD0.59 per share, up from CAD374 million, or CAD0.54 per share, in the same period in 2010, on new pipeline and power generation assets as well as higher realized power prices in Alberta. Higher interest expense and lower contributions from its US Power and Alberta Gas Storage units dragged on results.  Along with a likely 4.7 percent dividend increase management will report fourth-quarter and full-year 2011 results on or about Feb. 15, 2012.

TransCanada is soldiering on, as management announced yesterday that it will re-apply for a Presidential Permit. In a press release CEO Russ Girling said, “This outcome is one of the scenarios we anticipated. While we are disappointed, TransCanada remains fully committed to the construction of Keystone XL.” Mr. Girling also noted that work is “underway on a number of fronts to largely maintain the construction schedule of the project.” The company “expects” a new application will be evaluated in time for Keystone XL to come online in late 2014.

Management has avoided making any explicit commentary on the process south of the border, though it’s experience on the ground in Nebraska, where it was able to find a solution that satisfied stakeholders across the political spectrum, certainly must compare extremely favorably to stepping into the Washington, DC, swamp. About as controversial as TransCanada’s language has gotten is to label output from the Middle East, et al, “conflict oil,” a turn of phrase perhaps calculated to touch/antagonize social justice buttons among the greens.

Keystone XL won’t solve the North American energy security dilemma. It will not relieve the world of geopolitical stress. It will not bring the per barrel price of oil below USD100 on its own. It will not make you taller, thinner, or wittier, nor will it create all the economic benefits its proponents push. It’s another vital piece in a currently lacking infrastructure puzzle. No one project–fossil fuel, geothermal, tidal, run-of-water, biofuel, wind, solar, nuclear–will solve our energy needs.

At the same time, Keystone XL won’t kill the environment. A fact clearly lost on Darryl Hannah and her compatriots, whose express enemy in their fight is the oil sands, is that the vast majority of carbon emission occurs during the burning phase and not the extraction or production of crude oil. Meanwhile, additional emissions resulting from increased oils sands imports would amount to much less that 1 percent of overall US greenhouse gas emissions. Nor, as has been posited, will oil sands output flowing through XL present a greater environmental danger because of its chemical composition. The type of crude that’ll move through it is already moving all over North America.

The clearest summation of the state of things we’ve come across is the one that came from the office of Canadian Prime Minister Harper, in what’s called among head-of-state press corps “the readout,” this one describing the phone call President Barack Obama made to his counterpart revealing his decision. The prime minister, who last May led his Conservative Party to election wins sufficient to guarantee him his long-coveted parliamentary majority, got his version out first and managed to undermine whatever favor the Obama administration may have tried to curry with greens by pointing out that the decision “was not a decision on the merits of the project” and highlighting an implicit invitation to TransCanada to apply based on the new route.

Mr. Harper’s summary concluded with a diplomatic brush-back pitch: “The prime minister reiterated to the president that Canada will continue to work to diversify its energy exports.”

Had the Keystone XL plan that reached the US State Dept included the route the company has worked out with the state of Nebraska we wouldn’t be discussing this issue today. Construction would be well underway, and the Obama re-elect people would be including it among their pro-jobs/pro-energy/pro-security talking points.

The president, recent economic data lending a beneficial hand to his still-suspect chances for four more years, can afford to come down with environmentalists and against labor on this issue. Had the new claims for unemployment insurance number revealed today been a continuation of an upward as opposed to a downward trend announcing approval of a jobs-creating pipeline project would have worked in his favor.

The conflict between idealism and Realpolitik began playing on these shores long before Nixon and Kissinger went to China. Thomas Jefferson wanted to believe in French popular and intellectual support for the American Revolution. Alexander Hamilton, General Washington’s French interpreter and a key figure in securing the economic and military support of a major European power, also understood that the illiberal despot Louis XVI simply wished to hurt his main enemy, the British Empire and George III.

So President Obama will try to have his cake and eat it, too. If current trends in unemployment insurance claims and hiring persist he’s likely to make out in the bargain.

The really good news is this political stuff may have opened up an opportunity to pick up TransCanada shares–and a reliably growing dividend–on the cheap.

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  1. avatar
    e urdanoff Reply January 26, 2012 at 5:52 PM EDT

    this is a huge disappointment; an even larger disappointment is the number of voters who continue to support this president.

  2. avatar
    Peter Reply January 22, 2012 at 4:41 PM EDT

    Malcolm – I like your posts but one should not forget the Come By Chance refinery in Newfoundland – was designed and built to handle heavy oil – in fact the worst of all heavy oils – so bad no-one else would refine it. When it was to be sold – Canada didn’t want the refinery – now it has been changed over to handle light oils – at great expense to change I add, and can only ship to the U. S..This nation of Canada is made up of so many entities that it never really knows what it wants, or where it is going.
    I strongly agree with you that it makes no sense whatever to export western oil south and import oil in the east, from the U. S. at higher prices…..just as it amazed me for years to see the Canadian Energy Board approve a pipeline from Alberta to Nova Scotia – but not allow a hydro power cable to cross from Labrador to the U. S. for the betterment of Newfoundland. Politics is our greatest problem in Canada – and the costs – past present and future will be our great un-doing.

  3. avatar
    malcolm Reply January 21, 2012 at 1:27 PM EDT

    I agree with you Sandra on some points. However the US government does not have a very good track record of listening to the people that elect them. They listen to lobbyists. Obama wants to get elected. XL rejection makes him sound like an environmentalist therefore winning him votes from that camp that supports him electorally. After the presidential election the State Department will approve the new XL route claiming that they protected the water aquifer in Nebraska and forced TC to re-route it. If the Republicans get in (Newt?) it will also be built.
    But I agree that Canada really needs to diversify its resource exports to growing economies like China and India. It also needs to make things from its raw materials rather than allow others to do the processing and sell back to us at enormous mark-up.
    Making stuff is the key to prosperity for Canadians not exporting raw goods so someone else can make it.
    Malcolm

  4. avatar
    Les Sand Reply January 21, 2012 at 1:03 PM EDT

    I have to admit that while I like money I have serious reservations about the northern route pipeline. The tanker traffic along Canada’s west coast is a disaster waiting to happen . As I see it the USA wants oil and Canada has it . China wants oil and the US could ship it from Alaska , removing the danger of a major oil spill on the west coast . On another topic Eastern Canada imports oil from the Texas gulf at costs higher than we get for oil shipped by pipeline . My question is why isn’t this pipeline being built to supply eastern Canada with oil?

    • avatar
      malcolm Reply January 21, 2012 at 1:18 PM EDT

      Les, The answer to that question is simple. Eastern Canada does not have the refinery capacity to handle heavy oil. When all was hunky dory with Venezuela many of the Gulf oil refineries converted their plants to process heavy oil (Venezuela is the other major heavy oil producer). Now that this supply is under the control of Hugo Chavez there are shortages and those refineries are operating at below capacity. Hence the need for Keystone XL which will pump the much needed heavy oil directly to those already converted refineries. The Cushing, Oklahoma hub which supplies mid-west refineries is already at capacity – refineries there cannot process any more oil thus the Keystone extension to the Gulf Coast is vital to keep the heavy oil processing refineries in business. XL will be built – this is US politics at its best (worst).
      To address your question though there is very limited capacity in Eastern Canada to process Canadian oil from Alberta – at least not without major modifications being done. In other words not all oil is the same. What I do think will happen is that oil refineries will be built in Canada to process the oil into refined products which have much higher value. This is the direction Canada should take.
      Malcolm

  5. avatar
    Philip Evan Hope Reply January 21, 2012 at 12:59 PM EDT

    A liberal government and majority electorate greatly deteriorated the business environment here in Canada for many decades by doing the bidding of a tiny, angry, vocal, misguided, and misinformed minority. It took a public disgrace to finally unmask some of the crazy ‘public checks’ they were writing that we could not and should not pay (Kyoto comes to mind). Pandering to a self-righteous vocal minority is how Liberals in this country (and Democrats in American) do business… and they can be very successful at it. Sadly the Republican Party is playing right into their hands. Any perceived positive vision of them(the Republicans) by the electorate is quickly blurred by the constant in-fighting, and consistent messages of radical right-wing self-interests that are invariably always finding their way first to the headlines. Republicans really do have to smarten up here, and soon, because they are losing the battle through their own lack of foresight, insight, and instability. The Democrats won’t win this next election so much as the Republicans will lose it. And don’t even try to blame it on the public they are not stupid they are concerned. Here in Canada we were more than willing this time around to listen to Conservative plans and ideas for the prosperity through proper fiscal management…we just did not want get all the rest of the nutty out-dated stuff along with it. And our Conservative Party was and remains clever enough to know this and follow our instructions. They will also be out on their ears the day they forget about this too. People want nothing more and (nothing less) than proper fiscal management in North America today. The one thing they will definitely reject in America as a substitute though, is bickering by candidates over some silly, worthless, dusty, political philosophies whilst the ship of state sails further onto the rocks.

  6. avatar
    sandra lewis Reply January 21, 2012 at 12:59 PM EDT

    1. Transcanada and its partners should have mounted a forceful pr campaign to the American public, explaining the environmental and economic positives. When will corporations learn the first rule of pr–make friends before you need them. There is still time to make that effort with the revised route.
    2. Canada pipelines don’t have to be in the US. They can easily run to the Pacific coast for transport to China. And they will if our clueless government continues to ignore global reality.

  7. avatar
    malcolm Reply January 21, 2012 at 12:58 PM EDT

    Very well written article. TransCanada is a powerhouse in the energy infrastructure business and delays in building the Keystone XL pipeline will not have much effect long term. Apart from pipelines TC is also in the electricity business in a big way and has brought on line major gas projects in Ontario on time and on budget. It is also about to bring on line another 1500 MW of profitable nuclear power in 2012. As you say dips in this share price as a result of Keystone XL delays are simply great buying opportunities for the stock. And of course that pipeline will be built because it ALSO allows the Bakken shale oil fields in North Dakota to deliver its oil straight to Texas and Gulf Coast oil refineries. With tensions building in the Middle East watch for a sudden about turn by the State Department when TC submits their new route. I must say I always thought it was a bit idiotic building it over a water supply but the new route should fix that problem.
    Malcolm

  8. avatar
    Douwe Baard Reply January 21, 2012 at 9:32 AM EDT

    I once owned a good chunnc of shares in CN railroad and TCP and when some chemical / oil railcars rolled into a large freshwater lake with a resulting CNR stock disaster I dumped the stock. And then I became nervous about pipelines near or under lakes and went out of “TCP”. This also as Warren Buffet advises
    do not invest in Companies where you are not all the way familiar with.

    • avatar
      malcolm Reply January 21, 2012 at 1:08 PM EDT

      Warren Buffet bought a railroad company last year. Railways are a simple business. They move large quantities of stuff very cheaply and are very efficient in tons per mile per gallon of fuel used. Much better than transport trucks. So moving stuff by rail has become very cost effective as the price of fuel has gone up. There are railway accidents all the time and some make the headlines. As far as I can see it has not stopped stuff being moved by rail. CN and CPR are great investments and so is Transcanada. They pay good dividends consistently and also increase them regularly. Those are the signs of good solid companies to invest in.
      Warren Buffet also says to remember the 2 golden rules of investing
      1. Never lose money
      2. Never forget rule 1
      You broke rule 1 by selling your shares when the market was low and lost money. Do not do that. Look at the BUSINESS you are investing in NOT the headlines.
      Best wishes
      Malcolm