Little did we know when we published our article in the last issue of the Musings dealing with the looming deadline for the State Department to decide whether or not to ok the construction of TransCanada’s (TRP-NYSE) proposed Keystone XL pipeline project, designed to bring as much as 1.1 million barrels a day (b/d) of oil sands bitumen to the U.S. Gulf Coast refining center that the outcome would be known within 96 hours. 

The Keystone pipeline construction decision deadline had galvanized the environmental movement to mount a vigorous opposition to the “dirty” oil sands output.  Importantly, the pipeline became the rallying symbol for the movement to re-energize its long-term opposition to fossil fuels.  While trying to erect hurdles for the increased use of traditional fossil fuels, the movement is also working hard to tilt the energy playing field in favor of green energy sources through legislated mandates and government subsidies. 

In our Musings article, we dealt with the politics surrounding the pipeline decision as President Barack Obama had only recently waded into the debate and declared he would be making the final decision in contrast to the process that called for the State Department to render the final ruling.  As we said in the article, this was a surprising declaration by the President as it not only altered the process but eliminated his ability to duck the political fallout from a ruling that went against one of his two large political constituencies – union workers and environmentalists.  We opined that President Obama was likely to seek to delay the decision, but if push came to shove, we thought he would veto the pipeline. 

Our belief coincided with views expressed by Wall Street Journal columnist Kimberly Strassel, who recently had written a column outlining why she expected that President Obama would decide against building the pipeline.  Her reasoning was that Mr. Obama’s political campaign had determined that his environmental supporters, who tend to dominate the liberal left, are the ticket for his re-election and not the unions.  While the President enjoys strong union support, the construction workers are primarily concentrated in three Rust Belt states - Michigan, Ohio and Pennsylvania.  The President probably believes his auto bailouts will help him win union support in Michigan and possibly in Ohio, and by encouraging increased natural gas drilling in Pennsylvania he could blunt any negative union reaction to a decision against building the pipeline. 

On the positive side of Mr. Obama’s re-election strategy, we would not expect the administration to take any drastic actions to slow down shale gas drilling in Pennsylvania or in the Utica formation in Ohio.  We further believe that the administration won’t make any moves that would hurt the auto industry, and if anything, it will provide even greater support for electric vehicles and the car battery manufacturers Mr. Obama is counting on to add all those green jobs. 

Ms. Strassel’s column pointed out that the Obama re-election strategy appears to be focused now on putting together an Electoral College majority that could be attained without the votes from those three large Rust Belt states.  This strategy means that President Obama has to strengthen his credentials with the liberal left, which means he has to act in order to win over the environmentalists.  Rejecting the Keystone pipeline would be, and was, such an action.

During President Obama’s interview several weeks ago with an Omaha, Nebraska television station reporter he stated that the State Department would be sending its recommendation about the pipeline construction to him in a couple of months and he would then make the final decision.  That statement signaled to us that the State Department would not meet its late November deadline for rendering its final decision.  Within days of that interview, the State Department’s Inspector General (IG) announced he would examine the details involved in the selection process for the consulting firm that reviewed the pipeline proposal from an environmental viewpoint.  This review was being initiated because of concerns the consulting firm was compromised because it had listed TransCanada as a client.  Almost immediately following the IG’s announcement, the State Department disclosed the details of the selection process showing that the consulting firm never worked directly for TransCanada, but actually had worked five times in recent years for federal agencies reviewing pipeline construction projects proposed by TransCanada.  The company provided a description of the credentials required from consultants in order for them to be able to adequately evaluate the pipeline construction project.  That information was supplied to the State Department.  Armed with that information, the State Department issued a request for consultants interested in performing the analysis.  According to our information, there were five consulting firms that submitted bids.  One of the five was disqualified for failing to meet the necessary requirements.  The State Department selected the winning firm from the remaining four qualified firms.  The fact that the selected consulting firm had reviewed prior TransCanada projects may have influenced the State Department’s selection, but that could have been because it saw the consultants experience as improving the review’s speed and quality.

Environmental groups have obtained a number of State Department emails related to the selection of the consultant under a Freedom of Information inquiry.  One of these emails shows that representatives of Cardno Entrix, the consulting firm hired, were present at a meeting with TransCanada officials, the company’s chief lobbyist and State Department officials.  They believe this email shows that the selection process was compromised. 

Remarkably, the night our Musings was published, we had the opportunity to have dinner with the TransCanada official who has been heading up the Keystone pipeline project.  Without commenting on what we had written, we asked his take on the developments and likely outcome, which proved to be remarkably similar to what we had suggested.  In the course of our dinner conversation, we learned many additional details and heard stories about conversations with various government officials, politicians and others that occurred during the process.  We also were apprised of a number of facts about the pipeline and the Nebraska aquifer that were brushed aside or distorted by environmental opponents. 

Exhibit 1.  Keystone XL Pipeline Route

Source:  The New York Times

With the IG’s claims having been largely dismissed by the State Department’s reciting of the facts about the appointment of the consulting firm to review the project, the announcement of the delay in rendering the decision rested on the view that the agency needed to consider rerouting the pipeline in order to minimize the risk of environmental damage to the Ogallala aquifer.  This rerouting decision came despite the State Department having indicated it found the final pipeline route selected to be the least environmentally damaging of the seven routes examined.  The decision would appear to have been made in recognition of the political landscape President Obama is confronting. 

The funniest yet saddest aspect of this approval process was watching the explanations by politicians and government officials trying to justify the view that the outcome wasn’t about politics.  In fact, some of the claims actually strengthen the view that the decision was ALL about politics.  For example, a spokesman for the National Resource Defense Fund, speaking on a Sunday television talk show the weekend immediately after the decision, praised President Obama’s action to kill the pipeline.  The last we knew, the President wasn’t involved in the State Department decision – or was he?  Moreover, the pipeline project hasn’t been killed, even though opponents would like us to believe that to be the case.  The decision whether to approve or disapprove construction of the pipeline has only been delayed. 

There was also vehement denial from State Department representatives that neither the President nor politics were involved in its decision.  If that is true, why did President Obama tell his TV interviewer that he would make the final determination once the State Department rendered its judgment?  Under the steps of the approval process, once the State Department announced its decision any of the 15 agencies impacted by the pipeline project could appeal, which automatically would send the controversy to the White House.  So, did President Obama know that at least one agency would appeal whatever the State Department ruled?  It sure sounds so.  Did that message get to the State Department who didn’t want to see its approval decision overridden because of the international fallout?  Maybe that is why the IG announced he would review inconsistencies with the approval process.  One need only understand that in politics the rule is that the more vehement the denial, the more true is the claim.  It is convenient the State Department’s approval decision now won’t be announced until sometime after the 2012 election, and most likely not until early 2013 due to the required environmental review. 

President Obama said the following after the State Department announced its decision.  “I support the State Department’s announcement today regarding the need to seek additional information about the Keystone XL Pipeline proposal.  Because this permit decision could affect the health and safety of the American people as well as the environment … we should take the time to ensure that all questions are properly addressed and all the potential impacts are properly understood.  The final decision should be guided by an open, transparent process that is informed by the best available science and the voices of the American people.”  President Obama’s statement makes him appear to be the moderate while making sure all the interests are taken into account.

The latest twist in the approval saga is that TransCanada reportedly now is willing to discuss moving the pipeline route to avoid the environmentally sensitive sandhills and the Ogallala Aquifer in Nebraska.  We don’t know whether the company is hoping that their offer will speed up the approval process, but our understanding is that any significant deviation from the original route will require a full environmental review of these new areas to be crossed by the pipeline.  Reportedly one of the routes the State Department reviewed in its appraisal paralleled the existing Keystone pipeline.  So why should a review that follows that route require 18 months?  Since TransCanada has invested nearly three years of management time and expense, it is not surprising the company would be reluctant to just walk away immediately following the State Department ruling.

TransCanada’s president and CEO, Russ Girling, pointed out an obvious fact about the pipeline decision, but one often overlooked by the media and those objecting to the pipeline.  “If Keystone XL dies, Americans will still wake up the next morning and continue to import 10 million barrels of oil from repressive nations, without the benefit of thousands of jobs and long-term energy security.”  This is one of the largest shovel-ready construction projects that would employ 13,000 construction workers and 7,000 manufacturing workers – high-paying jobs this economy needs right now.  Now political concerns have sacrificed these jobs in the name of re-election politics.

While the next phase of the pipeline approval process in the United States is just beginning, the most critical issues about the future of the pipeline project may now have to be decided by Canada.  Globe and Mail columnist Claudia Cattano wrote about her interpretation of the fallout from the decision.  As she put it:

“Now, the consequences are huge.

“The delay in making a decision, which could still turn out to be a no, threatens the whole project as shippers line up alternatives.

“It threatens oil sands growth plans because pipelines are expected to fill up in the next couple of years.  It emboldens environmentalists to oppose other pipeline projects to stall the oil sands, but also other energy projects that don’t fit its green agenda. It sours Canada/U.S. relations and it hurts both the Canadian and the U.S. economies.

“It means huge losses for Canada and for producers because lack of pipeline capacity has resulted in a discount for oil piling up in the U.S. The delay has put greens at the wheel of a major economic sector.”

U.S. West Texas Intermediate oil prices appear in recent days to be closing the gap with international crude oil prices that have existed all this year due to the glut of oil in the midcontinent region.  The price move has been in response to proposed steps to reverse the flow of the Seaway Pipeline, a major crude oil pipeline that extends from the Gulf Coast to the midcontinent region after its purchase by Enbridge, Inc. (ENB-NYSE).  The proposal is for 150,000 barrels per day (b/d) by mid 2012 with an increase to as much as 400,000 b/d by early 2013.  For Canadian oil sands producers, if there is a convergence between WTI and Brent crude oil prices, as has been the historical pattern, they will not lose as much money shipping their oil to the U.S. versus selling it to Asian or European customers. 

Shortly after the State Department’s announcement, Canadian Prime Minister Stephen Harper, who was attending the Asian-Pacific Economic Cooperation summit in Honolulu, Hawaii, spoke to reporters.  He said, "This does underscore the necessity of Canada making sure that we are able to access Asia markets for our energy products."  Mr. Harper went on to say, "And that will be an important priority of our government going forward."  Mr. Harper told the reporters that he had made that point in a meeting the day before with Chinese President Hu Jintao.  The Canadian government does not want to have limitations placed on the development of its natural resources as it would have a negative impact on government income earned from royalties plus it would hurt the earnings prospects for oil and gas producers, which in turn could impact jobs and income tax revenues for various governmental entities. 

We understand a foundation established to promote increased trade between Asia and Canada will be issuing a report next month that will argue for a transportation corridor to the west coast for oil and gas pipelines to allow for faster approval of new lines to move hydrocarbons to Asian markets.  At the moment there are concerns about securing approval from the many British Columbia communities that any new pipeline would pass.  Also, there are issues with the Kitimat terminal location as ships must travel 40 miles through a narrow and twisting channel requiring tug escorts, reminiscent of Valdez, Alaska, and the Exxon Valdez oil spill.  Once a ship leaves the Kitimat terminal, it has to pass through Queen Charlotte Sound, a notoriously rough body of water. 

An alternative pipeline export route would involve utilizing excess natural gas pipelines in the east and constructing some new pipeline sections in order to get the oil sands output to the Canadian East Coast allowing for it to be exported globally.  This route would be a second all-Canada option, but importantly it would increase Canada’s flexibility to sell oil sands output worldwide. 

Exhibit 2.  Kitimat Terminal Opposite Queen Charlotte Islands

Source:  www.Google.com

As political judgments have ruled out any near-term expansion of U.S. import capacity for Canadian oil sands output that is under expansion, the Obama administration has determined that the U.S. will continue to be dependent upon oil from less politically stable countries.  This policy means we may be facing greater risk of higher oil prices than we would have if more of our imported oil came from Canada.  Don’t forget, however, that high oil prices help the green energy agenda because those expensive fuels would be more competitive with traditional fossil fuels.  With the Keystone pipeline decision, the U.S. is firmly on the road to a less secure energy future.