New report casts doubt over economic benefits of Keystone pipeline for Canadian oil-sands investors

Benefits of Keystone pipeline could prove a ‘mirage’ for oil-sands investors, former investment bank analysts warn

Approval would encourage investment into risky high-cost, high-carbon projects, dependent on rising oil prices

25 November — Approval of the controversial Keystone XL pipeline would have only a marginal positive impact on the economics of the Canadian oil-sands industry, but could nevertheless trigger a rush of high-risk investment into additional projects that would rely heavily on rising oil prices, according to new research from the Carbon Tracker Initiative.

Keystone XL Pipeline: A Potential Mirage for Oil-sands Investors challenges many of the economic assumptions surrounding the pipeline, and shows how investors in Canadian oil sands could be facing both economic and environmental exposures.

“New Canadian oil-sands development is increasingly economically questionable without the additional export capacity that pipelines such as Keystone XL would bring”, says Mark Lewis, external research advisor to a report from Carbon Tracker, a think-tank focused on the investment risks posed by excessive fossil fuel extraction. “But the vision of improved prices it promises could quickly be wiped out by increasing costs, meaning investors who believed the mirage of improved oil-sands economics with KXL will be left disappointed.”

“KXL will improve returns in the short-term, which means that it will help catalyze new investment, more oil-sands production, and additional greenhouse gas emissions,” adds co-advisor Mark Fulton. Some policy advisors have suggested that additional emissions linked to KXL could be subject to carbon offsetting, as the price of US State Department approval for the pipeline. The additional costs involved would further undermine its economic benefit.

”Oil sands are high-cost, high-carbon projects, being proposed at a time when both costs and emissions are under pressure to shrink; as such they should immediately hit an investor’s higher-risk screen,” warns James Leaton, Research Director at Carbon Tracker. “Efforts to stay within a carbon budget, increase fuel efficiency, reduce costs and improve air quality mean that if capital continues to flow into oil sands, the projects risk becoming stranded assets.”

Lewis and Fulton were, respectively, Head of Energy Research at Deutsche Bank and Head of Climate Change Investment Research at Deutsche Asset Management. Their report considers the implications for oil-sands producers with costs of $65/barrel and above. KXL would enable such producers to sell to US Gulf Coast refiners, at prices indexed to Maya/WTI rather than the lower-value Western Canada Select benchmark, generating a $20/barrel price uplift.

However, this uplift will be eroded by pipeline costs and diluent expenses to around $5.5/barrel, leaving only a few dollars margin to absorb any other factors, including production cost increases, carbon offset costs, and any future price discounts.

And the political green-light given by Keystone approval is likely to set off a burst of investment activity. The increased capacity and revenues the pipeline will bring will encourage equity analysts and credit rating agencies to mark up oil-sands producers, reducing their cost of capital and therefore encouraging further expansion. However, this in turn will put upward pressure on costs in Alberta, and soon exhaust the additional transportation capacity the pipeline would provide, further depressing prices.

The research also examines the alternative export route, of increased railway capacity, and finds that the economics look similarly challenged. Question marks also remain over the volume of railway capacity that can be brought on stream in the short-term. Moreover, to meet current industry growth projections, both KXL and substantial new rail capacity would be needed.

The analysis follows Carbon Tracker’s recent collaboration with CERES to co-ordinate a group of large investors to engage with companies on stress-testing their capital expenditure plans against a range of price and emissions scenarios. The KXL example demonstrates why investors need to press company management on their assumptions for their businesses.

Financial analysts at Citi , HSBC and Standard & Poor’s , among others, have all warned that, if oil demand falls in response to environmental regulation and energy efficiency – as is already happening in the US and Europe – oil sands projects are already among the most vulnerable.