- The Washington Times - Wednesday, July 9, 2014

While Congress and the White House have been fighting over whether to build the Keystone XL pipeline so the U.S. can import more oil from Canada, U.S. energy companies have quietly turned that debate on its head and are now exporting growing amounts of oil to Canada.

Canada has ironically become the biggest beneficiary of a gusher of premium crude coming out of shale oil wells in America’s Midwest. Moreover, the question of what to do with the U.S. oil glut has — as least for the time being — trumped concerns about how and whether to secure a steady stream of crude from Canada for decades to come through its proposed pipeline.

In a sign of how the debate has subtly shifted this year, even as the Obama administration has resisted growing pressure to make a decision on the Keystone issue, it recently quietly answered oil industry calls for help in handling their glut of premium crude by ruling that U.S. companies should be able to export the crude to countries other than Canada as long as it is minimally processed first in the U.S.

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The developments highlight both the significant differences in quality of U.S. and Canadian oil supplies right now and the difficulty in today’s charged political environment of balancing the short-term riches caused by an expected peak in shale oil production in the next five years with the nation’s need to secure long-term sources of crude after production at U.S. wells inevitably goes into decline.

“Oil is not a homogeneous product, and therein lies the challenge for the U.S.,” said Marc Chandler, investment analyst at Brown Brothers Harriman. “Essentially, the shale boom has created a large supply of light oil, but the refineries in the Gulf Coast area are designed to absorb the heavy crude, like Venezuela and Saudi Arabia sell.”

The oil that Canada hopes to ship through the Keystone pipeline is the heaviest kind of crude, and thus would be welcome at the Gulf Coast refineries. But they were comparatively unprepared to deal with the deluge of light, sweet crude coming out of shale wells at Eagle Ford, Texas, Bakken, North Dakota, and other bedrock shale formations in the American Midwest.

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“The U.S. production of ultralight or condensate accounts for nearly the entire increase in U.S. output over the last couple of years,” and that has posed a dilemma for U.S. producers, legislators and regulators, Mr. Chandler said.

Escape valve

With more premium crude on hand than American drivers need or refineries can handle, U.S. oil producers have used Canada as a kind of escape valve for their surpluses. Canada has always been exempt from the ban on oil exports the U.S. enacted in the 1970s, and the two-way petroleum trade between Canada and the U.S. has always been vigorous. But until recently, the balance was lopsidedly in favor of Canada, with Canada in the last decade becoming the nation’s No. 1 source of imported crude.

But that started to change in the last year as Canada became the leading destination for premium crude exports, even as its Keystone project — which could potentially double Canada’s crude exports to the U.S. — got mired in a political stalemate. According to the Energy Information Administration, U.S. crude exports in April rose to their highest level in 15 years, with almost all of the 268,000 barrels of daily shipments going to Canada. At the same time, Canada continued to export about 2.5 million barrels a day of mostly heavy crude to the U.S.

The high-quality crude available from U.S. shale producers has far less sulfur and other pollutants than heavier crudes like the bitumen produced from Canada’s oil sands. The light oil is highly coveted by refineries in Canada as well as the U.S., which needs it to comply with stringent environmental restrictions on air pollution — particularly in the summer in heavily populated areas along the coasts.

U.S. producers are shipping oil to Canada by rail and by tanker and are finding it is actually easier in some cases to export the oil to Canada than it is to send it to domestic East Coast refineries that also need premium crude because of the exacting regulatory burdens placed on domestic shippers. The 1920 Jones Act requires domestic shipments of the oil to be carried in U.S.-built tankers that are in scarce supply.

That is how Canada came to be the top destination for U.S. oil exports, even as it continues to be the No. 1 source of oil imports in the United States. But the breakthrough in shipping more oil to Canada appears to be only a beginning for U.S. producers, who recently received the go-ahead from the Obama administration to ship their premium crude to a broader array of foreign markets.

Export breakthrough

A ruling by the Department of Commerce at the end of last month found that extremely light forms of crude produced by the shale wells, such as ultralight condensates, can be exported if they are first minimally processed by passing through a distillation tower that strips out volatile gases and makes them easier to ship. That was a break for the industry, as condensates in the past had been considered subject to the ban on exports.

James Stafford, editor at Oilprice.com, credited the administration for its regulatory ingenuity.

“Because of the stabilization process, this ultralight crude can be considered a refined petroleum product, for which there are currently no limits on U.S. exports. So they haven’t lifted the ban, per se — they’ve just found a loophole,” he said. “It may not be the oil export coup the industry was gaming for, but it’s still good news.”

Analysts say the ruling will raise the prices American producers get for their light crudes, giving them an incentive to expand production. Currently, because of the surplus of light crude in the U.S., U.S. premium crude prices have averaged $7 to $8 a barrel under the world price for premium crude set in London, which earlier this month was hovering at around $112 a barrel.

Meanwhile, as the debate has turned to dealing with teeming U.S. supplies, action on TransCanada’s Keystone pipeline application has been put on the back burner. Despite intense pressure from congressional Republicans and even some Democrats, few observers expect a decision by President Obama before the fall elections.

The administration’s five-year-long delay recently prompted Canada to give preliminary approval to an alternative pipeline from Alberta’s oil sands to Canada’s western coast, where the oil could then be exported to Asia. If Canada builds other export routes to Asia’s oil-thirsty buyers, that could pose problems for the U.S. in future decades, when it is likely to need more of the Canadian oil as shale wells fall into decline, analysts say.

Canada’s other options

Despite the current glut of premium crude in the U.S., analysts say it is highly uncertain whether U.S. shale producers will be able to keep pumping at the current record-high levels for long. All oil wells decline after peaking in their early years. Moreover, deriving oil from shale bedrock is much more difficult and expensive than drilling in conventional oil fields. Oil experts say the shale oil boom could peak by the end of this decade and decline steeply after that.

“The Keystone pipeline is in the long-term interest of the United States” to ensure the U.S. has secure supplies after the shale boom is over, said Michael Blair, analyst at Renegade Capital Corporation.

He noted that the U.S. remains the world’s largest consumer of oil, burning about 19 million barrels a day, and it continues to produce only about half of that amount. “Obviously, oil imports are going to remain necessary for the United States for decades to come.”

Canada, on the other hand, has the world’s third-largest oil reserves and will be able to export its surpluses for decades once it gets appropriate transportation infrastructure in place. The long delay on the Keystone XL pipeline — which had been Canada’s first choice — has prompted it to explore other options that are becoming increasingly viable, like the Northern Gateway pipeline through British Columbia, Mr. Blair said.

Keystone is just one alternative for Canadian oil development. It is becoming an irrelevant alternative” as Canada devotes billions of dollars to finding other ways to ship its oil, he said. Other options include building rail terminals for shipments of oil to the U.S. and coastal ports for export, as well as a second pipeline going east that would ferry Alberta’s oil to Toronto and export terminals on Canada’s east coast.

“There seems little reason for Canadians to hang in waiting for a decision from the Obama administration when there are lots of potential markets for Canadian oil, [with] Asia being the most convenient,” said Mr. Blair.

“Longer-term growth in China, India and the rest of Asia will provide all of the market Canada needs for its oil. And once the infrastructure is built to serve that market, shipments to the United States will take place only when commitments to Far Eastern customers have been satisfied and there seems to be a temporary excess available for sale,” he said.

For the U.S., “it will have to make sure it maintains good relations with Venezuela, Saudi Arabia, Iran, Iraq and Kuwait, because that is likely where it will have to go to get supply” in the long term, he said.

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