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Why the Seaway Pipeline Damages Hope for Keystone XL and Collapses the Brent-WTI Spread

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TransCanada may believe that the Keystone XL project is not lucrative enough to warrant construction of solely the Northern leg.

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Environmentalists have much more to cheer about than just the State Department's delay of TransCanada's (TRP) Keystone XL pipeline decision. The pipeline would have brought a greater volume of heavy Athabasca Tar Sands bitumen to US refineries. The climate-change crowd now has at least an extra year to make the case that bitumen is an unnecessary addition to America's energy architecture.

The added benefit comes from Enbridge's (ENB) $1.15 billion purchase of ConocoPhillips' (COP) 50% share in the Seaway pipeline. Enbridge and Enterprise Products Partners (EPD) decided to reverse the flow from South-North to North-South, further damaging TransCanada's proposal. Whoever is in the Oval Office in 2013 may view it as unnecessarily redundant, adding to the slew of reasons to impede its construction. The new direction of flow does exactly what Keystone XL's proposed Phase 3 would have accomplished. It directs oil from Cushing, OK (West Texas Intermediate's pricing point and, as of late, a source of a glut of supply) to Gulf Coast refineries in and around Port Arthur and Houston, TX. Keystone's presence may well be limited to the two already completed phases-Hardisty, Alberta to Patoka, IL (Phase 1) and Steele City, NE to Cushing, OK (Phase 2).

The Seaway switch does not specifically affect Keystone XL's Phase 4, from Hardisty, Alberta to Steele City, NE, later connecting to Cushing, OK. However, as a result of Nebraska lawmakers' success in re-routing the pipeline away from the Ogallala aquifer (that serves about 80% of the state's population), TransCanada may believe that the project, given the cost of re-routing, is not lucrative enough to warrant construction of solely the Northern leg. Instead, TransCanada may decide to find alternative markets to transport the Tar Sands oil into, such as Asia or PADD 5, comprised by the isolated Western United States.

Granted, for this series of events to occur, the Seaway pipeline would have to swiftly pass through regulatory approval and run at proposed capacity on schedule. The Enbridge / Enterprise joint venture is expected to heave 150,000 barrels-per-day (bpd) from Cushing to the Gulf by 2Q 2012 and possibly 400,000 bpd in 2013. Although Keystone XL was expected to bring 700,000 bpd along the same route, proposed expansions and parallel pipelines are positioned to absorb the remaining capacity.

The final straw for TransCanada would be a continuation of the trend of stagnant American oil demand. In November 2009, U.S. Liquid Fuels Consumption was 18.75 million bpd. As estimated by the Energy Information Administration (EIA) this month, the figure has only grown by 0.03 million bpd over the past two years to 18.78 million bpd.

The Seaway reversal creates several more winners and losers: Gulf Coast and Midwest refiners, respectively. ExxonMobil (XOM) is a significant beneficiary as it owns the two largest refineries in the United States, both of which are situated in the Gulf Coast: a 560,000 bpd facility in Baytown, TX, and a 502,000 bpd facility in Baton Rouge, LA. With decreased dependence on foreign imports that serve this region, companies can both benefit from cheaper domestic oil as well as avoid the political risk associated with imports. According to the EIA's data as of November 16, PADD 3 (Gulf Coast) required 7.510 million bpd of oil inputs on average in the past week, of which 5.568 million bpd (74.1% of demand) was supplied by imports. On the other end of the spectrum, in the Midwest, a majority of crude oil feedstock that enters British Petroleum's (BP) 405,000 bpd facility in Whiting, IN, is of the light sweet variety. Due to record low supply in Cushing tanks and the Seaway reversal, traders reacted in narrowing the Brent-WTI spread to as little as $8 this past week before settling at $9.89 on Friday afternoon. Only about a month ago, this spread was drifting dangerously close to $30. Refineries make money on the "Crack Spread" (see Investigating the Discrepancy Between Midwest and East Coast Oil Refineries: The Brent-WTI Spread) and the current trend leaves little room for Midwest refiners to take profits.

The Enbridge / Enterprise Products Partners joint venture also removes the proposed 800,000 bpd Wrangler pipeline from the mix, which would have also moved oil from Cushing to Gulf Coast refineries. In the past month, however, Magellan Midstream Partners (MMP) has announced its plans to satisfy the Gulf Coast refineries by reversing its Longhorn Houston-El Paso pipeline. This project would deliver an additional 225,000 bpd by mid-2013. At least for the next few months, markets should expect a decreasing trend of imports into PADD 3 (Gulf Coast) and a continuing decline in PADD 2 (Midwest) inventory supplies.

Although the fate of Keystone XL is still up in the air, the final decision will most likely depend on the contentious issue of whether increased pollution should be sacrificed for cheap oil and a greater sense of energy independence. As companies attempt to grab a foothold in the continent's mercurial energy infrastructure, the next three years of deals and regulatory measures will have an enduring effect on the oil markets.

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