Keystone XL Is Far From Certain

The state of Nebraska just cleared one of the last hurdles for the Keystone XL pipeline, potentially ending a decade-long saga over the 1,700-mile pipeline.

The Nebraska Public Service Commission, a five-member regulatory body, voted 3-2 in favor of the project, which would give TransCanada permission to build the pipeline through the state. Nebraska had been the last thorn in Keystone XL’s side after the Trump administration gave the greenlight earlier this year.

But while the approval is a massive victory for TransCanada – the company’s share price surged nearly 2 percent immediately after the announcement – it is still not 100 percent certain that the pipeline will move forward. TransCanada still needs to make a final investment decision on the project, and the oil market is dramatically different than it was a decade ago when the project was initially drawn up.

In the intervening years since TransCanada originally proposed Keystone XL, U.S. oil production has grown by more than 80 percent, from just over 5 million barrels per day to about 9.6 mb/d today. There has also been a massive buildout of oil pipelines in the U.S., taking crude from the Bakken and the Permian to refineries on the East and Gulf Coasts. The urgent need for Keystone XL is questionable.

For Canada, however, the need for pipelines is more evident than ever. Western Canada Select (WCS), a benchmark for heavy crude from Alberta, routinely trades at a discount to WTI. However, that discount has worsened because of pipeline bottlenecks. Bloomberg Gadfly points out that there is a shortage of pipeline capacity from Canada equivalent to about 330,000 bpd this year, a deficit that will balloon to 700,000 bpd by 2019 as more oil sands projects come online at a time when all major pipeline projects have suffered from serious delays. WCS is now trading at a massive discount even to heavy crude from Mexico – the latter has a much easier time getting to refineries in Texas and Louisiana.

The only options for Canada’s oil producers are the Trans Mountain expansion, which will triple the line’s existing capacity from 300,000 to 890,000 bpd, taking Alberta to Canada’s Pacific Coast and Enbridge’s Line 3 expansion to Wisconsin, which will boost the pipeline’s capacity and is much more likely to move forward. The third and last option for Alberta is Keystone XL.

The problem is that the business case for all three pipelines is questionable. If all three were constructed, there would be a surplus of pipeline capacity in 2021 at about 700,000 bpd, according to Bloomberg Gadfly. There seems to be room in the market for two of the three proposed pipelines, but not all three. That should give TransCanada pause because it is proposing an entirely new pipeline while the Trans Mountain expansion and the Line 3 replacement would merely add on to existing projects.

“We definitely need two of these pipelines by around 2025 and after that it depends on the supply outlook,” Mark Oberstoetter, an analyst with Wood Mackenzie, told Reuters earlier this year. “There’s not an evident need to get three or four pipelines built.”

Adding to the uncertainty is the volume of interest downstream from refiners on the Gulf Coast. In June, the Wall Street Journal reported that TransCanada was struggling to find enough buyers to justify building Keystone XL. The company wants commitments for 90 percent of the pipeline’s’ 830,000 bpd of capacity, but as of mid-year that was proving difficult. TransCanada sounded more optimistic on its third quarter earnings call, telling investors and analysts that it expected the same amount of interest as it had back in 2008 when the project was originally proposed.

Adding one more complication is the fact that Nebraskan regulators approved an alternative route for the pipeline through the state, not TransCanada’s preferred route. The company is now “assessing how the decision would impact the cost and schedule of the project,” Russ Girling, TransCanada’s chief executive officer, said in a rather guarded statement.

Independent credit analysts are not exactly keen on the project. “While today’s Keystone XL pipeline approval is an important milestone, it does not provide certainty that the project will ultimately be built and begin operating,” said Gavin MacFarlane, a vice president at Moody’s Investors Service. “Pipeline construction would negatively affect TransCanada’s business risk profile through increased project execution risk, and would likely put pressure on financial metrics.”

At the same time, environmental groups and local communities opposed to the project are not about to give up. They have promised to continue litigation to prevent TransCanada from breaking ground. The fact that the Nebraska approved an alternative route, not the hotly contested route proposed by TransCanada, actually opens up the project to further litigation. Environmental groups claim that the alternative route has not been properly studied. Adding to their fury is the spill from the Keystone pipeline just last week, which saw more than 200,000 gallons of oil spill from the pipeline in South Dakota, shuttering a large section of the conduit for days.

In short, despite Monday’s victory in Nebraska, there are still several major hurdles before TransCanada can break ground on Keystone XL.

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