Am I the only one who sees the folly of new pipelines?

June 5, 2012     
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We have this myth in the oil industry that the players are all long-term investors. That is, they all look forward 20 years or more when deciding their investment plans. Really?

I suspect that the typical planning horizon in this industry is somewhat longer than that of a day trader, but not that much longer. When oil prices rise, massive new investments in the oil sands are announced. When oil prices collapse, investment plans are put on hold. Why this type of behaviour when what matters are future prices and demand? Short-term fluctuations should not have much impact on investment decisions unless future values are extrapolated from the most recent changes, which does appear to be the case.

I commented in an earlier blog on the implications for the oil sands and two proposed pipelines of an article written by Larry Solomon in the Financial Post. In that article, Mr. Solomon claimed that the US would become self sufficient in oil within this decade and that China had the potential to become self sufficient within 10 to 15 years. Interestingly, North Dakota has surpassed Alaska as the second largest producer of oil among all of the states. It is conceivable that North Dakota may one day pass Texas as the largest producer. The source of oil in North Dakota is shale.

If Solomon is right, then the US and Chinese markets for Canadian oil sands disappear within a relatively short period of time, at least well within a 20-year investment time horizon. So why are companies eager to invest tens of billions of dollars in pipelines and oil sands?

In an article in Monday’s Financial Post, Claudia Cattaneo wrote about declining oil prices. She noted: “The Canadian Association of Petroleum Producers is expected to make public Tuesday oil production forecast that will point to a continuation of aggressive growth, both from conventional oil and oil sands projects.” Obviously this Association, a mouthpiece for the oil industry, does not look at oil prices and ignores the fact that increased levels of production have nowhere to go without new pipelines. And even with new pipelines, there may be no markets for the projected increased levels of production.

Crude oil prices have dropped sharply in the past month, and it is conceivable that absent any turmoil in the Middle East they could continue to decline, although obviously not in a straight line. Indeed, I believe that it is more likely that crude oil prices will average closer to $70 a barrel over the remainder of this decade than they will average near $100 a barrel. If I am right, new oil sands projects become uneconomic. As Ms. Cattaneo pointed out: “According to the Canadian Energy Research Institute’s March supply cost analysis, the cost of producing oil from an integrated mining project adds up to $89.62 a barrel, making them uneconomic at today’s oil price.”

Thus, given the uncertainties about future oil prices and demand, does it make any sense to proceed with either the Northern Gateway or Keystone pipelines? My fear is that even if we can resolve the very important First Nations and environmental issues, the Canadian taxpayer will end up on the hook for these white elephants later this decade. Can we still spell “Mirabel”?

The opinions expressed in this blog do not reflect the views of either Global Brief or the Glendon School of Public and International Affairs.

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