Final approval of the Keystone XL pipeline is closer to reality based on news on Friday, January 31, 2014. The U.S. State Department will issue an environmental review of the pipeline that states it will not lead to a significant increase in carbon emissions, and it will not face any environmental objections from the State Department. This opens the path to the President signing off and the $7 billion project moving forward. It is a victory for oil and gas, along with some companies in the sector. It could also mark the shift away from rail transport and negatively impact some firms as well.
The project previously was held up by environmental objectors and U.S. regulatory review. President Obama blocked approval in January 2012, stating he did not have enough time to review all the facts before a Republican imposed deadline. It bought time for him to delay the decision until after his re-election bid. Concerns included the footprint of the pipeline and it generally causing an increase in oil production from the oil sands in Alberta. There is a view the harvesting methods of shale oil are unfriendly towards the environment.
Construction of the Keystone XL pipeline will improve the ability of producers to export south from the Canadian oil sands, across the U.S. border to Steele City, Nebraska. It will have capacity of 820,000 barrels per day and merge in Nebraska with another pipeline. Canadian pipeline firms, oil sand producers and gulf coast refiners are some of the winners from the projects approval.
Winners – Refiners, TransCanada, Oil Sand Producers
Clear winners are the gulf coast refiners based in the U.S. Oil from the Canadian oil sands currently trade at a discount to oil along the Gulf Coast and WTI. The pipeline will provide access to cheaper oil and likely help reduce the discount level on oil from Northern geographies, that Bakken and Canadian heavy crude trade at. In 2012, only 100,000 barrels of Canadian heavy crude were refined in the Gulf. Refiners of heavy crude along the Gulf include Exxon Mobil (NYSE: XOM), Chevron (NYSE: CVX), Total SA (NYSE: TOT), Valero, Phillips66 Partners (NYSE: PSX) among others.
TransCanada (NYSE: TRP), the second largest Canadian pipeline manufacturer will operate the pipeline. U.S. E&C Bechtel will handle the engineering and construction of the pipeline for TransCanada.
The production firms like Suncor Energy (NYSE: SU) located in the oil sands are clear winners from the pipeline construction. It will reduce producer’s transportation costs, while also increasing the average price per barrel as oil from the sands starts to trade more in line with WTI. In 2013, Canadian heavy oil traded at a $40 per barrel discount at one point to West Texas Intermediate due to transportation problems in Alberta.
Potential Losers – Rail Transport
There are also groups of potential losers from the Keystone XL pipeline. First, exporters of Latin American oil, Venezuela especially, will have their volumes replaced by the Canadian oil.
Second, the railroads and railcar manufactures that are currently benefiting from hauling oil out of Alberta. Traditionally, rail was not heavily used in transportation but the lack of pipeline has pushed around 200,000 barrels per day onto the rails in Canada. This is also how the US moves oil from Bakken, which will experience a similar modal shift as pipeline capacity increases to that region.
Canadian Pacific (NYSE: CP) and Canadian National (NYSE: CNI) are two Canadian railways that could see some impact. In the U.S., Burlington Northern, owned by Berkshire Hathaway (NYSE: BRK-A) and Union Pacific (NYSE: UNP) may see some mild impact. For Bakken, Burlington Northern and Union Pacific are the largest rail transporters.
Other companies that have had a boom from oil sand and oil shale production are the tank car manufacturers such as Trinity Industries (NYSE: TRN), American Railcar (NASDAQ: ARII) and Greenbrier Companies (NYSE: GBX). The shift to pipeline would free up certain types and tank cars and create an oversupply in the marketplace.
Pipeline construction could continue to accelerate beyond the Keystone XL with concerns around the safety of continue to grow rail based oil transportation. There were seven railcar accidents transporting oil recently, including one that killed 47 people in Canada in 2013. Investors should follow this sentiment and look for a modal shift. At some point over the next 3-5 years, pipelines will take over for railcars since it is more efficient.
The plays off of the pipeline construction are improved probability by the Canadian oil sands producers, a slight positive impact on Gulf Coast margins, and the construction and E&C companies involved. The losers are more interesting, especially when considering recent safety concerns. Keystone XL and pipeline capacity out of the oil sands and oil shale projects should be monitored, especially for holders of UNP and the some of the railcar manufacturers.
What are your thoughts on the Keystone XL pipeline and a shift away from rail transportation of oil?