What’s a “Fair Price” for Canada’s Oil? And What Happens if We Get it?

It's a phrase that has wafted up from the oil sands to the airwaves. It pops up in speeches by politicians and editorials by journalists: A "fair price" for Canadian oil. The key to this, we are told, is pipeline access to "tidewater" (another marketing term adopted by media and government).

The basic argument goes like this: A barrel of oil sands crude currently trades at a lower price than other global oil benchmarks. That price gap means Canadians are losing money on every barrel sold. Access to world markets will fetch higher prices, elevating our collective prosperity.

It's a persuasive story, tickling the part of the brain associated with loss aversion. No one wants to bleed money day after day. At the same time it paints a picture of one nation, our fortunes rising and falling in unity. It's good politics. But the reality is more complex. As individuals and businesses calculate whether the risks of these pipelines outweigh the rewards, three broad trends should be kept in mind.

First, what kinds of energy do those global markets want? Second, who can get it there at the lowest price? And most importantly, who wins and who loses if the price of Canadian oil climbs? The answers point to 2014 as a crucial year in the pipeline battle. That's because the window in which these projects are viable may be closing faster than we think.

Comparing apples

If an apple is light and sweet, an orange is more heavy and sour. That's the difference between Western Canada Select (WCS), blended out of oil sands bitumen, and West Texas Intermediate (WTI), the benchmark often cited on the news as "the price of oil." They're not the same product.

As the National Energy Board website explains, "all crude oil is not valued equally. Light oil that is low in sulphur (sweet) is more valuable to refiners than heavy oil with higher sulphur content (sour)." In a chemical sense, oil containing more carbon and less hydrogen delivers less energy — unless refiners inject more hydrogen molecules, which costs them money. So the price gap is partly due to geography, and partly due to a difference in quality.

University of Alberta environmental economist Andrew Leach explains it this way: "People could say, 'Oh, this hotel owner in Red Deer is really getting ripped off. He only charges $120 a night, versus New York, where it costs $500 a night. If only he could get world prices for his hotel room.' But that's not how it works."

Leach, who was appointed last year as the Enbridge Professor of Energy Policy at the Alberta School of Business, says "as far as the world price for Canada's oil, there's a lot of confusion created in general. People mix up geographic discount versus quality discount." Pipelines can help with one, but not the other.

The business case for a pipeline depends on what margins it can create for its clients, the companies shipping oil. The longer the pipeline and the more it costs to build, the more shippers pay to use it. Northern Gateway, for example, has jumped from a $5.5 billion project to $7.9 billion — money Enbridge will have to make back from its customers. On top of that, those producers are factoring in the costs of mining bitumen and diluting it for transport. The bottom line is the price of other countries' crude, against which, in a global market, Canadian oil must compete.

Maya, Brent, meet Barack.

Refineries equipped to handle light, sweet crude must be retooled at considerable expense if they're going to switch to heavy, high-sulphur oil — and vice versa. The argument for the Keystone XL pipeline is that it would carry Canadian crude to refineries on the U.S. Gulf Coast that are currently set up for heavy oil. But those refineries have another supplier, just a short tanker ride away.

Mexico's heavy crude, priced on the Maya benchmark, is chemically closer to WCS and arguably a better comparison for oil sands crude than WTI. Either way, Mexican producers are gunning for the same heavy-oil refineries. "Mexico is recovering from depressed oil outputs, in part due to low investment," says Werner Antweiler, Chair in International Trade Policy at UBC's Sauder School of Business. That's because last month, the country's new president broke a 75-year state monopoly on oil production, opening up underproducing fields to the world's energy giants.

"The shortest path is to refineries on the southern coast of the United States, meaning there could be even more of a glut in the North American market, driving down prices," says Antweiler. Meanwhile, thanks to hydraulic fracturing, the U.S. itself is in the middle of a oil-drilling renaissance. Pipelines and refineries are suddenly awash in lighter crude, from the Bakken formation.

With the U.S. lumbering toward energy independence, some lawmakers argue the country should focus on refining its domestic riches. Others say it's time to break a decades-old ban on exporting crude oil. That's right: Canada, which has no such law against exporting unrefined bitumen, could find itself competing with output from both Mexico and the United States.

Antweiler also points to Venezuela, another heavy-oil producer opening up markets after the death of Hugo Chavez, and even Iran — which could further add to global oil supply as sanctions lift. "These markets change, and they can change quite rapidly," says the economist. "When you speculate on these price gaps persisting, others see that too. Everybody is trying to go after these margins." As easier, higher-quality sources of crude come online, Antweiler is doubtful that prices for Canadian oil will climb for long. "Put it this way. The people who forecast oil markets have gotten it wrong more often than they've gotten it right."

Either way, the long-term trend starts to flatten. The International Energy Agency forecasts slowing growth in the demand for oil as climate change forces the adoption of more natural gas, renewables, and nuclear power.

Oil price differentials before and after the shale boom in the U.S. Kristen Smith, University of Alberta.

Winners and losers

Still, what if the best-case scenario described by politicians comes to pass? The pipelines reach salt water, tankers reach overseas customers, and suddenly the price of Canadian oil jumps. Who benefits then? Oil producers, says Andrew Leach, and government treasuries. But that money will not flow to all parts of Canada equally. "Oil sands royalties are ridiculously complicated," he warns. But the end result is predictably skewed. "Pretty much any way you model the benefit flows, it's all in Alberta. And though I loathe economic impact analysis, if you look at GDP or employment, a lot of it is still in Alberta."

That would be presumably help the province's long-governing Progressive Conservatives, who have drained the Alberta Heritage Savings Trust Fund and racked up a $2.8 billion dollar deficit, which they blame on the bitumen price gap — and massive floods last June.

As for federal taxes, Leach says "I can probably weave you an example where the federal government is better off either way, pipeline or no pipeline." He compares it to suddenly banning wheat exports. "Farmers would be mad and pasta producers would be overjoyed. Would that change the world price for pasta? Probably not. But you would see a transfer of wealth from the food producing sector to processing."

In other words, pipelines giveth jobs, but they also taketh away — in particular, at Canadian refineries. That's why unionized refinery workers pledge to employ civil disobedience if pipeline construction ever proceeds.

Who else loses? Former CIBC World Markets chief economist Jeff Rubin says everyday consumers. As Rubin wrote in the Globe & Mail, "connecting land-locked oil to an ocean is a great outcome for the Suncors, Shells, and Imperial Oils of the world, but what does it do for Canadians filling up at the pumps?" Rubin argues that "as more Alberta oil ends up on the high seas, the more Canadian oil prices will mirror the higher prices paid in the rest of the world. When the price of oil rises, clearly, the cost of gas at your neighbourhood station goes up as well."

Other economists, including Leach and Antweiler, say it's not that simple. However, most can agree on one result: as the price goes up, oil sands operations will expand. Bitumen is complicated and costly to extract. When the price of a barrel falls too far, the product is not worth mining. A report published in December by two former Deutsche Bank analysts calculates that break-even minimum at $65 per barrel. Werner Antweiler says even below $80, most deeper reserves are effectively locked away. But new export pipelines would prompt a surge in new production — at least until the next supply glut.

The showdown

Last month Bloomberg Businessweek magazine called Canada's oil sands a "shaky investment". State-owned Chinese oil companies are frustrated with the slow pace of pipeline approval, voiced most memorably by CNOOC executive Chen Weidong: "It’s the same situation as the leftover single women. It will be the same for the oil sands, they will be outdated." That was more than a year ago. If Chen was right, perhaps the window is already closing.

Certainly a sense of urgency is gripping both camps. On the one side are those with the most to gain from a hypothetical spike in WCS prices: foreign and Canadian-owned oil producers, pipeline companies, and Alberta politicians. On the other side are those who bear the most risk: First Nations, refinery workers, B.C. municipalities, the B.C. government, and citizens concerned about oil spills or climate change. Whether the pipelines are worthwhile depends on one's personal situation.

The proponents spend impressive sums to fund think tanks, ad campaigns, and lobbying — all of which helps push their language into the mainstream. Like a "fair price" for Canadian crude. But in a free market, fairness is determined by the buyer, not the seller. It's curious that journalists and government officials would feel bitumen needs their help to sell. The fact is, if crossing B.C. is not an option, the product will find buyers in other directions. Or it won't.