Oil Companies Stake Future on Canada

Jul 10, 2007 (From the Wall Street Journal via Dow Jones Newswires)

The future of the U.S. oil industry arrived last year in Cushing, Okla., moving along at two miles an hour.

It was the first crude from the Albertan oil sands to reach as far south as the giant Cushing pipeline hub, one of the locations where global oil prices are set. To get there, the crude traveled through a pipeline that for decades carried oil in the opposite direction.

A month later, a second pipeline was reversed and Canadian crude reached all the way down to southeast Texas, the world's largest cluster of petrochemical plants and refineries and the traditional front door for much of the U.S.'s oil supplies.

The pipelines, operated by Enbridge Inc. and Exxon Mobil Corp., represent long-term, multibillion-dollar investments in infrastructure to enable Canadian crude to keep cars running on U.S. roads. But the shift requires billions of dollars in investment and could clash long term with efforts to curb global warming, and still won't be enough to quench the thirst for oil in the U.S., which consumes roughly one out of every four of the more than 80 million barrels produced daily around the world.

Currently, the U.S. pipeline grid is set up to import oil into the Gulf Coast. Some of that oil is sent north by pipeline or barge to refineries in the country's Midwest region. But global supplies are increasingly unreliable, as shown by Exxon's and ConocoPhillips's decision last month to leave Venezuela, a major crude supplier to the U.S., rather than give up lucrative projects there to a nationalization wave. Canada is a reliable exporter, free from the political turmoil that racks much of the oil-producing world.

"It's a big expansion of Canadian supplies into the U.S.," says Shirley J. Neff, president of the Association of Oil Pipe Lines. "There is no way a pipeline company will make an investment if it doesn't see a long-term supply source and a market that needs to be served over the long term."

Alberta's massive, gunky oil-sands deposits -- which yield a heavy oil that is dirtier and more difficult to turn into gasoline -- are about the same size as Saudi Arabia's but cost more to process and turn into fuel. The oil sands currently produce about 1.2 million barrels a day, but are expected to churn out 3.7 million barrels a day by 2020. Much of this new supply is expected to be exported to the U.S. However, rising costs and labor constraints could hamper production, and rising internal Canadian demand could affect export levels.

Producers are very interested in capturing more U.S. markets for Canadian crude. Although exact figures aren't compiled, the amount being spent on Canadian oil-sands development, new pipelines to bring the crude to the U.S. and to retrofit refineries is expected to top $15 billion a year through the middle of the next decade. This easily exceeds the amount being spent to build the U.S. ethanol industry, according to London-based consultant New Energy Finance.

"The people who understand the industry the best understand that long term the most substantive solution is in the oil sands," says Charles Swanson, managing partner in the Houston office of Ernst & Young. "The fundamental economics are stronger than the stuff we hear about today that is trendy and sexy," he says, referring to ethanol and other biofuels.

But that environmental push could pose a barrier. Extracting the heavy Canadian crude and turning it into gasoline requires more energy and produces more carbon dioxide, the main global-warming gas, than turning a barrel of conventional Texas light oil into gasoline. If regulators begin to tax carbon emissions, that would put gasoline from oil sands at an economic disadvantage, says Peter Tertzakian, chief energy economist with ARC Financial Corp., a Calgary, Alberta, private-equity investor.

The industry is also gambling that oil prices will stay high. If they collapse, expensive oil-sands projects may not pay off.

During the past year, Canadian crude has pushed deeper into the U.S. than ever before, capturing new markets, as traditional sources of supply for the giant Gulf Coast refining complex fall off.

Mexico, a major crude exporter, is facing falling output levels, led by the rapid decline of its giant Cantarell field. The growing Mexican economy is demanding more fuel, lowering export levels further.

Venezuela is in the process of booting out Western oil companies and its unpredictable leader is talking about shipping oil to China. Not long ago, plentiful Venezuelan crude traveled by pipeline into Illinois, where it was turned into gasoline for Midwestern drivers. Today, there isn't enough Venezuelan crude to create a need to pipe it to Illinois.

The rising tide of Canadian crude is subtly changing the political rhetoric in Washington. "Energy independence" is being redefined so that Canadian crude isn't really viewed as an import. "The desire for independence is due to political instability throughout the world and that doesn't apply to Canada," says Patrick D. Daniel, chief executive of Enbridge, the Calgary-based pipeline company.

In September, BP PLC said it would spend $3 billion at its Whiting, Ind., refinery so that as much as 90% of the crude it takes in will be Canadian. The next month, ConocoPhillips and EnCana Corp. said they would create a joint venture that matches oil-sands production with U.S. refineries. In May, Husky Energy Inc. bought a refinery in Lima, Ohio, for $1.9 billion. The company expects to spend an additional $2 billion to $3 billion to add equipment so the refinery can process heavier Canadian crudes.

Meanwhile, earlier this month, Enbridge and Exxon said they are considering building a pipeline from Illinois to the Gulf Coast, to help bring even more Canadian crude. Canada has a huge pool of untapped oil and the U.S. is the largest oil consumer in the world, says Enbridge's Mr. Daniel: "This really is a perfect marriage. We have two countries with the best relationship of any two countries in the world."

Copyright (c) 2007 Dow Jones & Company, Inc.