Keystone be darned: Canada finds oil route around Obama

So you’re the Canadian oil industry and you do what you think is a great thing by developing a mother lode of heavy crude beneath the forests and muskeg of northern Alberta. The plan is to send it clear to refineries on the U.S. Gulf Coast via a pipeline called Keystone XL. Just a few years back, America desperately wanted that oil.

Then one day the politics get sticky. In Nebraska, farmers don’t want the pipeline running through their fields or over their water source. U.S. environmentalists invoke global warming in protesting the project. President Barack Obama keeps siding with them, delaying and delaying approval. From the Canadian perspective, Keystone has become a tractor mired in an interminably muddy field.

Crude on the Move

In this period of national gloom comes an idea — a crazy-sounding notion, or maybe, actually, an epiphany. How about an all-Canadian route to liberate that oil sands crude from Alberta’s isolation and America’s fickleness? Canada’s own environmental and aboriginal politics are holding up a shorter and cheaper pipeline to the Pacific that would supply a shipping portal to oil-thirsty Asia.

Instead, go east, all the way to the Atlantic.

Thus was born Energy East, an improbable pipeline that its backers say has a high probability of being built. It will cost C$12 billion ($10.7 billion) and could be up and running by 2018. Its 4,600-kilometer (2,858-mile) path, taking advantage of a vast length of existing and underused natural gas pipeline, would wend through six provinces and four time zones. It would be Keystone on steroids, more than twice as long and carrying a third more crude.

Supertanker Access

Its end point, a refinery in the blue-collar city of Saint John, New Brunswick, operated by a reclusive Canadian billionaire family, would give Canada’s oil-sands crude supertanker access to the same Louisiana and Texas refineries Keystone was meant to supply.

As well, Vladimir Putin’s provocations in Ukraine are spurring interest in that oil from Europe and, strange as it seems, Saint John provides among the fastest shipping times to India of any oil port in North America. Indian companies, having already sampled this crude, are interested in more. That means oil-sands production for the first time would trade in more than dribs and drabs on the international markets. With the U.S. virtually its only buyer, the captive Canadians are subject to price discounts of as much as $43 a barrel that cost Canada $20 billion a year.

And if you’re a fed-up Canadian, like Prime Minister Stephen Harper, there’s a bonus: Obama can’t do a single thing about it.

Done Deal

“The best way to get Keystone XL built is to make it irrelevant,” said Frank McKenna, who served three terms as premier of New Brunswick and was ambassador to the U.S. before becoming a banker.

So confident is TransCanada Corp., the chief backer of both Keystone and Energy East, of success that Alex Pourbaix, the executive in charge, spoke of the cross-Canada line as virtually a done deal.

“With one project,” Energy East will give Alberta’s oil sands not only an outlet to “eastern Canadian markets but to global markets,” said Pourbaix. “And we’ve done so at scale, with a 1.1 million barrel per day pipeline, which will go a long way to removing the specter of those big differentials for many years to come.”

The project still faces political hurdles. U.S. and international greens who hate Keystone may not like this any better. In Quebec, where most new construction will occur, a homegrown environmental movement is already asking tough questions.

Special Relationship

Still, if this end run around the Keystone holdup comes to fruition, it would give a lift to Canadian oil and government interests who feel they’re being played by Obama as he sweeps aside a long understood “special relationship” between the world’s two biggest trading partners to score political points with environmental supporters at home.

It will also prove a blow to the environmentalists who have made central to the anti-Keystone arguments the concept that if Keystone can be stopped, most of that polluting heavy crude will stay in the ground. “It’s always been clear that denying it or slowing Keystone wasn’t going to stop the flow of Canadian oil,” said Michael Levi, senior fellow for energy and environment at the Council on Foreign Relations.

Keystone Delays

This Canada-only idea surfaced in the days after Obama’s surprise Nov. 10, 2011, phone call informing Prime Minister Harper that Keystone was on hold. Harper, who had vowed to turn his nation into an energy superpower, responded with a two-track strategy: Get in Obama’s face on Keystone and identify other ways out for Canada’s land-locked oil sands, which, at 168 billion proven barrels, contain the third-largest reserves in the world.

Keystone remains bogged down, awaiting the outcome of litigation in Nebraska. Last year, Obama gave a speech at Georgetown University and said he wouldn’t approve Keystone if it would significantly exacerbate carbon dioxide emissions.

The pipeline to the Pacific, known as Northern Gateway, looks increasingly iffy due to opposition from aboriginal groups.

TransCanada is thus expected to file an application to build Energy East with Canada’s National Energy Board in the coming days, according to people familiar with the plan. Approval may come in early 2016. “This is almost certainly the most important project TransCanada has right now in our portfolio,” said Pourbaix.

Culture Shift

While Republicans continue to make Keystone approval an issue of the mid-term congressional elections, its fate has become less fraught for Canadians. Make no mistake –- they still want it approved under the theory that oil sands reserves are so vast that it will require multiple large pipelines to develop them properly. In the interim, they have already begun to deploy alternatives to get Alberta oil to market, moving 160,000 barrels a day to the U.S. by rail.

Canada needs another oil export pipeline by 2018 or output may be squeezed, Martin King, a commodity analyst at FirstEnergy Capital Corp. in Calgary, said today in a presentation.

“That’s crunch time,” King said. “Supply growth in the oil sands is certain to 2020.”

‘Real Shift’

Reflecting this new post-Keystone mood, Harper told a British business audience in September that the U.S. “is unlikely to be a fast-growing economy for many years to come” and after a hundred years of trying to maximize exports south, it’s time for “a real shift in the mindset of Canadian business culture.”

Which is what Energy East represents. Yet before it emerged as a standard bearer of this shift, it had to survive a rough gestation. Harper himself was slow to warm to it. Others declared it “stranger than science fiction.”

And then there were the mutual suspicions of the oil producers of the west and the refiners of the east to overcome. The inside story of how this developed into an unusually broad political consensus was put together after interviews with more than 50 industry and government executives who have been in and around the often tense negotiations.

No History

One initial difficulty: The Calgary-based oil patch and New Brunswick’s Irving Oil Ltd., operators of Canada’s largest refinery and 900 service stations in eastern Canada and New England, had virtually no history with each other. Alberta oil had never flowed farther than Montreal. They were petroleum potentates operating in separate spheres who might as well have been in separate countries.

The Calgary crowd had a lot to learn about the Irvings. Besides extensive Canadian holdings ranging from timber to tissues and shipbuilding to radio stations, this clan of aw-shucks billionaires from the poorest region of the country supplies 60 percent of the gasoline in the greater Boston area. They are the fifth-largest private landholder in the U.S., with tracts sufficient to cover four-fifths of Delaware. Their fortune has been calculated by Bloomberg News at more than $10 billion.

Falling Out

For Arthur Irving, who gained control of the family oil assets after a falling out among his brothers a few years earlier, word that an eastward pipeline was afoot was a godsend. It held out the promise of a career-capping crowning achievement, not to mention long-term profits -– if only the oil executives from the west saw it his way.

They didn’t. Arthur Irving and his company had quickly sown discord in Calgary with their steadfast resistance to commit to take a set number of barrels from Energy East, according to people with knowledge of the controversy. As far as the oil producers could discern, Arthur wanted the option to take crude at will, as he had done for years in picking the most favorable sources of foreign oil at a given moment. Before they would entertain a decades-long arrangement, the producers insisted Irving would have to put skin in the game.

Even more critical was the terminal, from where much of the pipeline capacity would be exported. The Irvings dominated traffic in and out of the port of Saint John. The Calgary producers bristled that Irving was demanding too much money for putting their crude “the last mile” through his sprawling facility.

More Sway

The oil drillers also worried that Irving Oil, situated alone at the end of the line, would hold too much sway over them. They wanted more than a single outlet. Many preferred stopping the line in Quebec and exporting on smaller ships from there, cutting Irving Oil out altogether, or at least reducing its leverage.

According to people close to the talks who aren’t authorized to speak, Arthur Irving, in turn, was livid that TransCanada, in a bid to pacify the producers, was weighing an export terminal of its own — right on his home turf. The Irvings depended on the port like no other, loading and unloading about 400 ships a year. Arthur couldn’t stomach the idea of outsiders operating there.

It was in that frame of mind that on June 18, 2013, the then-82-year-old was in Toronto on business with Paul Browning, the new Irving Oil chief executive officer. His frustration burbling away, Irving decided he needed the assistance of one person.

Right Man

When they called that morning, Frank McKenna was at his desk at the Toronto-Dominion Bank headquarters. Irving and Browning hurried over. Irving had come to the right man. McKenna had staked first claim as the project’s philosophical father. On Nov. 28, 18 days after Obama’s call to Harper, McKenna — stunned like many Canadians at the Keystone delay — floated the notion of going east in an op-ed in the National Post newspaper. He liked the “nation building” politics of linking Alberta’s prosperity to Atlantic Canada’s potential. “The Keystone XL delay has shocked us,” he wrote. “Hopefully, it has also energized us.”

McKenna, vice chairman of TD, began working the phones. With six years under his belt at Canada’s largest bank and a board seat on one of Calgary’s most successful energy companies, he knew the inner workings of Alberta’s oil patch almost as well as his native New Brunswick. By evening, with advice gleaned from McKenna, Browning boarded a flight to Calgary on a mission to put things back on track.

Shale Boom

Just as Obama’s delays on Keystone was worrisome for the Canadians, so was America’s shale boom. Irving Oil’s CEO at the time of Energy East’s conception, Mike Ashar, and TransCanada’s Pourbaix could foresee the disruption pounding their businesses and had even discussed the concept of shipping oil east.

Pourbaix had come to appreciate that shale gas, by depressing prices, was discouraging new gas investment in Alberta while the Marcellus and Utica formations in Pennsylvania could compete to supply the lucrative Ontario market. Together, these developments would curtail usage of the company’s historic gas mainline from Alberta to Montreal — an ambitious and controversial nation-building exercise of its own in the late 1950s.

Growth Projections

Energy East offered potential salvation by converting that gas line — which would comprise two-thirds of the route — to take advantage of “the incredible growth projections” for the oil sands, said Pourbaix. “Even with Keystone, even with Gateway, it was becoming quite clear that producers probably needed another way to get their oil to market.”

On the other end of the country, Irving Oil fretted that its refinery was starting to be elbowed out by U.S. Midwest and Gulf Coast competitors. Long accustomed to picking and choosing among imported crudes, it now watched as rivals profited from access to cheaper shale and oil sands production from the interior of the continent.

“We went from being an advantaged refiner from a crude supply point of view to being disadvantaged,” Browning, who succeeded Ashar, said in an interview in August. (Two weeks after that interview, he would, without explanation, depart the company after only 16 months on the job.)

The Irvings had a lot on the line. Their empire dated to 1924, when K.C. Irving began building out from the foundation of his father’s general store in Bouctouche, New Brunswick. Soon, he operated filling stations and car dealerships and snapped up timber lands and shipbuilding yards.

Chevron Partner

In 1960, he opened a refinery on the Saint John waterfront in a partnership with Standard Oil Co. of California, a predecessor of Chevron Corp. (CVX) The Irvings took full ownership of the facility in 1988, investing heavily over the years in expanded capacity and state-of-the-art technology.

In 2000, Arthur handed the controls to his son Kenneth, a 17-year veteran of Irving Oil. Kenneth, now 53, built a liquefied natural gas import terminal on the Saint John waterfront with Repsol SA (REP) and announced plans in 2006 for a second refinery, with BP Plc coming aboard as a partner in the C$8 billion project.

After the recession hit in 2008, the Irving world changed radically.

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