Editor's Note: Having probed the political and economic drivers of the Keystone XL Pipeline debate, our guest commentator, a seasoned energy industry insider, reveals which companies will benefit the most if the project goes forward - and which will thrive if it doesn't. Money Morning readers have a unique opportunity to exploit these insights for profit - whether the pipeline is approved or not.
You might think the entire oil and gas industry is behind the Keystone XL Pipeline. And at the surface level that may be true. After all, the big oil industry lobby, the American Petroleum Institute (API), has spent millions promoting it through advertising and outreach to members of Congress. API are the folks who brought us all of those pro-Keystone commercials a few months ago.
Since API represents the industry, with over 600 members, the project must be good for everyone in the energy space, right?
Not so fast. There will be some big winners if the pipeline proceeds - but a lot more will be either unaffected or potentially hurt by more oil sloshing into the U.S. market.
A Boon for Super Majors and Bust for Independents
You can begin to parse the winners from the losers by looking at which companies have the most sway within API. Annual dues for its hundreds of members vary dramatically... very dramatically. According to Washington Post reports, the institute's flagship members such as Exxon pay more than $20 million per year.
Considering the Post estimates that the institute brought in just $133 million in total dues as recently as 2012 (plus about $29 million in certification fees), Exxon Mobil Corp. (NYSE: XOM) and its "Seven Sisters" peers like Chevron Corp. (NYSE: CVX), ConocoPhillips (NYSE: COP), Royal Dutch Shell Plc. (NYSE ADR:RDS.A), and BP Plc. (NYSE ADR:BP) are the companies that really pull the API's strings.
There is a separate organization, the Independent Petroleum Association of America, which more accurately reflects the views of America's independent energy producers. These are smaller companies that account for the bulk of the jobs in the industry and are bearing the brunt of the crude price collapse.
While IPAA has lent token support to the passage of Keystone in the past, the Association primarily focuses these days on lifting the U.S. ban on crude exports and on fighting Federal regulation of fracking. IPAA executives recently traveled to Capitol Hill to lobby Congress personally regarding the former, and has sued the Department of the Interior over the latter.
As for Keystone, the IPAA hasn't said boo in years, and it appears not to have formally weighed in to Congress regarding its recent effort to force President Obama to approve its construction.
Why would the industry's super-majors have an apparently different view on Keystone and its near one million barrels per day of new production, when the pipe clearly appears poised to exacerbate oversupply? Aren't they still oil producers, and wouldn't they be hurt by Keystone as badly as their smaller counterparts?
Not necessarily. There are some very significant differences between the Exxons of the world and the likes of small independents such as Matador Resources Co. (NYSE: MTDR). For one thing, the majors produce oil and gas all over the world. This means they are not nearly as exposed to the price of U.S. crude as 100% domestic-focused independents.
Even more pertinent to an analysis of Keystone, some of them have rather significant holdings in Canada. In fact, according to the Canadian Association of Petroleum Producers, again speaking with The Washington Post in early 2014, a full 29% of total Canadian oil sands production belongs to American-owned companies, which consist almost entirely of super-major API backers such as Exxon (via its Imperial Oil subsidiary), ConocoPhillips, and Chevron.
Another 10% belongs to European companies, again primarily super-majors such as Shell and France's Total SA (NYSE: TOT) (also an API member). So close to half of all of Canada's oil sands production can be linked to the giants of the industry which essentially control API.
As of year-end 2013, Alberta estimated total Canadian oil sands production at 2 million barrels per day, so in a coincidence that would be funny were it not so sad, the roughly 40% API stake in the oil sands would come to around 800,000 barrels per day. A familiar number, no?
While it would be a stretch to suggest that the super-majors had a hand in planning Keystone's capacity in order to precisely extract their own production, the bottom line is that unlike shale wells, oil sands projects are major undertakings with millions and millions in sunk capital.
As a result, their owners are unlikely to shut down development or production until prices improve, and Western Canada oil prices have sunk even lower than U.S. crude - in recent weeks, Western Canada Select (WCS) traded at close to a $15/barrel discount to the already depressed U.S. benchmark WTI, or roughly around $30/barrel.
A major reason for this discount is the comparatively isolated location of the oil sands, so creating a fast-track like Keystone to alleviate local bottlenecks and send Canada's oil gushing to the Gulf Coast would serve to increase local prices in Canada - but no doubt at the expense of prices for American oil in the Gulf Coast.
The Advantage of Integration
There is one other significant way in which the independent drillers that make up the backbone of America's oil and gas industry differ significantly from the big boys - refining.
While American independents generally stick to drilling, producing, and in some instances transporting hydrocarbons, most of the majors including Exxon, Shell, and their gigantic colleagues are largely "integrated" with refining and petrochemical facilities.
Refiners get to play the spread between the price of oil and the price of gasoline and other refined products. And while gasoline has come down at a healthy clip since the oil price collapse, it has not fallen to the same degree as oil. That's because, unlike domestic crude, refined products can be exported so the price we pay at the pump competes with higher global prices.
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Gasoline is seeing yet another price boost going into summer driving season. Diesel prices have also been strong, driven by global demand. Refiners on the Coast benefit by being able to buy cheaper than average U.S. oil (which trades at a significant discount to the Brent global benchmark because of our current oversupply situation) and turn it into diesel, which they can sell on the world stage at more lucrative global prices, maintaining their profits despite the decline in oil prices.
If these trends persist, say by continuing to flood the Gulf Coast with crude at an even faster rate than natural production rates can grow, the party just keeps going for refiners and the major integrateds. And bringing this back to the jobs argument once again, while it is a positive to support the Gulf Coast and broader American refining industry, Keystone would not be likely to create many, if any, refining jobs.
Refineries cost billions of dollars, and new ones are not frequently built. Even when new refineries are added, the number of jobs they create compared to the massive amount of capital required to build them does not amount to much.
Again comparing this negligible positive jobs impact to the thousands of jobs being sacrificed weekly in the oil patch suggests that the harm could be greater than the benefit. Generally speaking, rather than facilities growth and job creation, the net effect of keeping crude prices low for refineries is a surge to the companies' bottom lines, resulting in little job creation but giving nice returns to shareholders.
And once again, not surprisingly, the Gulf Coast refining complex, which seems best positioned to benefit from the combination of downtrodden domestic prices and more competitive product prices available via export, is dominated by the same API-controlling major oil companies discussed above.
None of this has been intended as a screed against Keystone itself. At the very least, there seem to be some solid energy security benefits associated with replacing imports from OPEC with imports from a strong ally like Canada.
What this analysis has been intended to achieve is to showcase the extremely dubious nature of the job creation argument the Right has primarily relied upon to justify Keystone. Once this is clear, a closer look at the real reasons politicians are fighting so hard, and the stakeholders poised to benefit, helps create clarity for investment opportunities.
If you think Keystone is ultimately going to be approved, you could do worse than look at integrated oil majors like Shell, Exxon, Chevron and the other companies discussed above, particularly the ones with both Canadian oil sands production and Gulf Coast refinery exposure.
Independent refiner Valero Energy Corp. (NYSE: VLO), up about 16% year to date, also has a strong Gulf Coast presence and should be better positioned option if oil remains at depressed levels or falls further, since unlike many of the other companies discussed above it does not itself drill for, or bear the costs of, oil production.
Conversely, if you believe Keystone will fail, this could be good news, and a good opportunity, for many of the smaller upstream companies which have been hemorrhaging jobs and slashing their growth plans over the past several months.