Keystone XL Moves One Step Closer

If not for the sequestration circus that played out at the end of last week, the top news story might have been a report issued by the US State Department late Friday.

The report was the Draft Supplementary Environmental Impact Statement (SEIS) for the Keystone XL Pipeline project, and it demolishes environmentalists’ arguments against the controversial proposal for a crude pipeline extension linking Canada’s oil sands to Gulf Coast refineries.  

A Washington colleague of mine told me that the typical reason for releasing a report late on a Friday is to generate the least amount of attention. And in fact, on a conference call with reporters, Assistant Secretary of State Kerri-Ann Jones was almost apologetic about the findings of the SEIS. She emphasized that it was only a draft technical review with no formal recommendations, that the public still needed to weigh in, and that the decision is ultimately in the hands of President Obama.

It may seem rather arbitrary, given the large number of oil and gas pipelines that already criss-cross the US, that this particular one has generated such a high profile debate around energy security and the environment. But this debate isn’t really about a pipeline. This pipeline isn’t going to make or break the development of Canada’s oil sands, nor is it going to make much difference with respect to climate change.

The truth is that the Keystone XL pipeline is symbolic. The environmental movement sees the pipeline as a continuation of a fossil-fuel dependent lifestyle that is leading to a climate catastrophe. Pipeline supporters argue that the pipeline will create jobs and strengthen our relationship with Canada, our most important source of oil imports.

But before examining the newly released SEIS, let’s review a history of this drama.

Keystone in brief
The Keystone Pipeline is owned by TransCanada (TSX, NYSE: TRP). It already has the capacity to move 590,000 barrels per day (bpd) of crude oil from the Athabasca oil sands region in Alberta, Canada, to hubs and refineries in the US. The first phase of the pipeline began operating in 2010 and connects Alberta to refineries in Illinois. In 2011, the second phase of Keystone connected Steele City, Nebraska to the major oil hub in Cushing, Oklahoma.

There are two proposed expansions of the Keystone Pipeline that are collectively called Keystone XL (“XL” stands for export limited.) The southern leg of the pipeline is scheduled to come online later this year. This Keystone-Cushing extension will have an initial capacity to transport 700,000 barrels of oil per day from the Cushing hub to Gulf Coast refineries — and did not require federal approval.

The northern leg, however, would cross the US border. Therefore the State Department must determine that the project is in the national interest in order to grant a permit. This proposed 1,180-mile addition would extend from Hardisty, Alberta to Steele City, Nebraska, carrying up to 830,000 bpd of crude from the oil sands in Alberta and the Bakken oil fields in North Dakota.

In August 2011 the State Department issued a final Environmental Impact Statement (EIS) that concluded the project would have “limited adverse environmental impacts.” The EIS was widely seen as a thumbs-up for the project, and this galvanized the opposition of environmentalists, who marched on the White House.

Bowing to the pressure, the Obama Administration delayed making a decision on the project until after the 2012 presidential election. In January 2012, Republicans pushed through a provision requiring the administration to make a decision. The State Department then rejected Keystone’s application, claiming it was not given enough time to study the project.

In May 2012 TransCanada submitted a new application to the State Department that proposed a new route for the pipeline. The State Department promised a decision in the first quarter of 2013, and the newly released SEIS is one step in the process of making the decision. (The US government has a very protracted decision-making process.)

What the State Dept. found
The newly-released SEIS reads very much like the “final” EIS that the State Department released in August 2011, and once more environmentalists are in an uproar. The problem, as I see it, is that they are making emotional arguments, which aren’t necessarily effective against a technical assessment. When you “do the math,” it becomes clear that their focus on this project is a misallocation of resources.

According to the new SEIS, “Approval or denial of the proposed project is unlikely to have a substantial impact on the rate of development in the oil sands, or on the amount of heavy crude oil refined in the Gulf Coast area.”

Further, the report considered alternate scenarios. Without pipeline routes to move the crude from the oil sands in Alberta, the oil would be moved by rail, it concluded. Because there is a higher cost associated with rail, the report projected slightly lower production by 2030: “the incremental increase in cost of the non-pipeline transport options could result in a decrease in production from the oil sands, perhaps 90,000 to 210,000 bpd (approximately 2 to 4 percent) by 2030.”

On the other hand, if some of the other pipeline projects that are under development go forward, the decrease in production by 2030 is projected to be a more modest 20,000 to 30,000 bpd if Keystone XL is denied.

How significant are these numbers? Even if the largest production shortfall of 210,000 bpd is realized — and presuming the supply wouldn’t simply be developed elsewhere — this only amounts to 0.2 percent of current global oil demand.

Further, because global carbon dioxide emissions are actually dominated by coal consumption, the savings in carbon dioxide emitted to the atmosphere would amount to only 0.07 percent of current global carbon dioxide emissions. How small is that? That level of contribution wouldn’t even be measurable above the background noise of global temperature and carbon dioxide concentrations. It is certainly smaller than the margin of error in measuring global carbon dioxide.

How did environmentalists respond to the report’s findings? By denying the arguments, rationalizing and appealing to emotions.

For example, prominent environmental activist Bill McKibben — who has led many of the protests against the pipeline — said “Groundhog Day — we’re hearing the same rehashed arguments from the State Department about why a great threat to the climate is not a threat at all. Mother Nature filed her comments last year — the hottest year in American history.”

That is an appeal to the emotions, which ignores the math.

Next to McKibben, NASA scientist James Hansen is probably the leading opponent of the pipeline. His response to the SEIS was “To say that the tar sands have little climate impact is an absurdity. The total carbon in tar sands exceeds that in all oil burned in human history.”

That is another emotional argument, and a bit of misdirection because his second sentence has no bearing on the first. The total carbon in tar sands does in fact exceed all oil burned in history. But a very small fraction of that will ever be economically recoverable. The total oil in place (OIP) in Canada’s oil sands amounts to 1.8 trillion barrels. However, the amount that can be economically produced — the reserve — is only 170 billion barrels.

A paper from the University of British Columbia calculated that burning the entire Athabasca reserve could raise global temperatures by 0.03°C. If you could actually burn all the oil in place, the calculated global temperature rise could be as great as 0.50°C, but more importantly even if Canada could grow its oil production from the current levels of 3.5 million bpd up to the 10 million bpd levels of Saudi Arabia and Russia, it would take 500 years to produce that much oil. If we are still relying heavily on oil in hundreds of years it will probably be safe to assume that we survived the climate catastrophe.  

Other environmentalists have taken issue with the notion that the railroads are capable of transporting large volumes of oil. Susan Casey-Lefkowitz from the Natural Resources Defense Council, said “Rail doesn’t appear to be an alternative for the quantities that will be transported by Keystone XL.”

That’s sort of like arguing that airplanes can’t fly as one passes overhead. The Energy Information Administration (EIA) has reported that the US has already seen shipments by rail grow over the past five years from near zero to over 1 million bpd. That is more than the capacity of the Keystone XL pipeline expansion. Canada is projected to triple deliveries by rail this year. Further, the SEIS noted that there are 48,000 rail cars on backorder in North America. (I smell an investment opportunity there, which we will delve into in the next issue of The Energy Strategist.)

My point here is not to bash pipeline opponents. I understand their motivation, and know that they believe they are engaged in the most noble of causes. I understand their desire to get involved and “do something” about climate change. But they won’t make any measurable progress on climate change even if they manage to stop Keystone XL.

The Canadian government understands that developing the oil sands will have a minimal impact on the climate. It also depends on the development of Canada’s natural resources as a major source of revenue. It is going to do everything in its power to develop those resources.

But whether Keystone is or isn’t approved, the real story here is the world’s growing demand for oil. Trying to restrict oil supplies — which is what Keystone XL opponents are attempting to do — is futile when global demand for oil continues to grow. Bill McKibben demonstrated this point himself when he said “One of the great ironies of my life is that I have a carbon footprint the size of a small Indian village.” It is telling that McKibben himself acknowledges his dependence on fossil fuels, but keep in mind that small Indian village would like the same mobility that the developed world enjoys, and is consuming more oil to achieve that goal.

As long as the world demands oil, the crude will find a way to market. And there are many investment opportunities all along the supply chain. Some are obvious, such as the pipelines and railroads growing rapidly to accommodate the rising oil shipments. Some are perhaps less obvious, such as the companies that make the rail cars, or even those that make specific parts for the rail cars. Investors can pick and choose without worrying that they’re endangering the humanity’s future.   
Around the Portfolios

US Silica (NYSE: SLCA)
With drilling for natural gas recently waning as a result of persistently low natural gas prices, investors were braced for downbeat results from the largest supplier of the sand that drillers mix with water to break up rocks.

The Aggressive Portfolio holding had doubled in price between August and January, but then pulled back as much as 15% on worries about a slowdown in hydraulic fracturing. But while the slowdown was real, US Silica felt none of it as they continued to win business and market share. Fourth-quarter results easily beat Wall Street’s estimates and the forecast also impressed, propelling shares 18 percent higher Tuesday.
Since then, the stock has tacked on another 11 percent as the extent of the business momentum spurred buyers. Fourth-quarter revenue jumped 42 percecent on volume gains of 10 percent, with drillers paying big premiums amid a shortage of fracturing sand and locking themselves into long-time supply contracts that have given the company a great deal of security for the next two years.

Earnings before interest, taxes, depreciation, amortization and other items (adjusted EBITDA) hit $150 million, or 34 percent of sales last year, and are expected to increase at least 10 percent this year. That would value the company at less than 8 times the projected EBITDA, hardly expensive for an enterprise expected to grow revenue 25 percent this year.

US Silica remains in full-throttle expansion mode and on track to launch two new production facilities this year. We are raising our maximum buy price to $28. Buy US Silica below 28.

Dresser-Rand Group (NYSE: DRC)
The maker of compressors and turbines for the oil and gas industry also reported strong fourth-quarter results, boosting earnings per share 15 percent on a similar increase in revenue. But even more was expected of a stock that had surged 50 percent since June, and the stock has now dropped 9 percent in the two days since the announcement.

And though Dresser-Rand stood by its prior guidance for sales of new equipment in 2013, it noted that up to two-thirds of those could come in the second half of the year as a result of  project delays. The profit guidance was kept in place as well, but now with “a bias” toward the lower end of the range.

In addition to the project delays, there are concerns about Dresser-Rand’s slipping margins on new orders, which are perhaps indicative of increased competition, and certainly of higher costs. But this is still a fast-growing business with sales set to increase some 30 percent this year and another 13 percent in 2014. On that basis, the current price at 15 times 2013 earnings seems fair. And if the stock falls much further, it will be back below our buy maximum. Buy Dresser-Rand Group below 55.   

— Igor Greenwald

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