Profit potential in proposed pipeline through Kansas

10/13/2011 12:00 AM

11/10/2011 4:24 PM

A controversial oil pipeline that would run from Canada to the Texas coast could increase the price Kansas producers get for their oil by 20 to 30 percent.

The $7 billion, 1,700-mile Keystone XL pipeline is now under consideration by the U.S. State Department because it crosses the U.S.-Canada border. The department hopes to make a decision by the end of the year.

Environmental groups are trying to block it, saying the Canadian tar sands oil it carries make the pipeline particularly prone to spills. The concerns have gained traction among legislators in Nebraska, where the pipeline crosses the critical Ogallala Aquifer.

The route also cuts across Kansas — through Washington, Clay, Dickinson, Marion, Butler and Cowley counties — on its way to the Port Arthur, Texas, area.

The two sides have fought over what the actual direct economic benefit of the pipeline would be.

If the Keystone XL fails to get approval, other companies are planning to step in to solve the problem.

If such a pipeline is built, it would create winners and losers in the Kansas oil industry.

The winners would be Kansas producers, who would be able to sell their oil at prices closer to the world prices. Producers pumped about 40 million barrels of oil out of Kansas in 2010.

The losers would be refiners who are now making unusually high profits buying Canadian and Midwestern oil at reduced prices and selling gasoline and other products at world prices.

Kansas consumers, said Jim Williams, an analyst with oil and gas consulting firm WTRG Economics, would be largely unaffected because they already pay a national price for gasoline, diesel and other petroleum products.

"The impact will be huge," Williams said. "Kansas producers and the guys who build pipelines will benefit; consumers won't be hurt, and the refiners have to go back to normal profits."

Cushing bottleneck

The success in extracting oil from the tar sands of Alberta — plus the growing oil flow from the massive Bakken Shale fields of North Dakota and Montana — have overwhelmed the existing pipeline system in the central United States and the pipeline hub at Cushing, Okla., a town between Tulsa and Oklahoma City. Much of the oil from Oklahoma and west Texas also flows through Cushing.

There is not enough pipeline capacity between Cushing and the refineries on the Gulf Coast. Some must be trucked south.

The result is that Midwest refiners pay significantly less than the world price. The difference is significant.

The spot price for the benchmark West Texas Intermediate crude was about $85 a barrel on Wednesday. Kansas Common is always priced lower than WTI because of transportation costs, and on Wednesday was at about $74.

The price for the world benchmark, Brent Crude, was $111 a barrel on Wednesday.

Ed Cross, president of the Kansas Independent Oil and Gas Association, said Kansas producers see upsides and downsides to the Keystone XL.

The upside, of course, is higher prices from the equalization of markets. But producers understand they won't be getting the well-publicized prices of oil futures traded on the New York Mercantile Exchange.

"Nobody will get $108 a barrel," he said. "The farther away they are, the more transportation cost."

But they also see a potential threat. Plentiful Canadian oil brought by the first Keystone pipeline helped drive the price differential in the first place.

Local producers are particularly interested in seeing that the Cushing-to-the-Gulf piece of the Keystone XL is built first — before another pipeline bringing more Canadian oil is built — as pipeline owner TransCanada has promised.

If the Keystone XL doesn't gain approval, other companies are proposing new or newly repurposed pipelines to ease the bottleneck. A proposed Cushing to Texas pipeline would probably move into the next phase of planning if the Keystone XL dies and take two to three years to plan, engineer, acquire land and build.

Refiners

Midwestern refiners are some of the big beneficiaries of the oversupply at Cushing.

Frontier Oil, which owns the El Dorado refinery, merged this spring with Holly to form HollyFrontier, one of the largest independent refiners.

HollyFrontier, based in Dallas, owns five refineries in the Midwest and Mountain West. It is the most profitable independent refiner per barrel in the nation, according to a presentation its president, Mike Jennings, made to analysts in September.

In the presentation, Jennings said his company has benefited from buying low-cost crude and selling into a market relatively isolated from competing refiners.

Over the past five years, the company has averaged $3.52 net income per barrel of crude capacity, about twice the industry average, he said. This year, it is closer to $6 per barrel of capacity.

"The historical performance being produced by the company right now is, frankly, off the charts and that is the neat place to be," he said during the presentation, which was recorded.

Other refiners in the state are the NCRA refinery in McPherson and the Coffeyville Resources refinery in Coffeyville.

Some of the money they've accrued in recent years has gone back into upgrading their plants.

The El Dorado refinery has spent millions to install equipment needed to handle more of the high-sulfur "sour" crude oil from Canada.

Jon Callen of Edmiston Oil took a philosophical tone about the lost revenue. Prices go up, prices go down. He said the world price isn't the real price, either. It's based on Libya being out of production and fear of other supply disruptions in the Middle East.

And it's not as if Kansas oil producers aren't making good profits off of $74 oil.

"I suppose, for me, personally, it doesn't mean anything," Callen said. "As an oilman, what somebody does on the other side of the world isn't that important."

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