Pipeline Economics: China Needs Oil, and Canada's Got It

The UC Berkeley economist Brad DeLong has said that Deng Xiaoping may have been "quite possibly the greatest human hero of the 20th century." It's a tough-minded, utilitarian judgment; DeLong knows that Deng, as leader of China, ordered the Tiananmen massacre of 1989. In the other pan of the balance, however, is the successful transformation of China into a free-market industrial power. That transformation, over three decades of Deng's leadership, multiplied per-capita GDP 50-fold and lifted somewhere between 200 million and 400 million people out of poverty.

The revolution is still ongoing, and it runs on oil. Enter Canada. Hearings into Enbridge's proposed Northern Gateway pipeline, which would link the town of Bruderheim, Alta., to the Pacific Rim at Kitimat, B.C., are being held now in Alberta and will soon shift to British Columbia. The B.C. phase of the hearings will see Enbridge challenged on whether it can successfully protect B.C. wildlands and the port of Kitimat from environmental disasters like the spill that affected the Kalamazoo River in Michigan in 2010.

But in Edmonton, the topic of discussion has been the basic economic rationale for the pipeline. Put in its simplest form: China needs oil, and Canada's got it. In truth, however, that pretext could be stood on its head. Canada needs alternative markets for its oil, and China is the obvious one. Right now, the oil sands are more or less forced to take a U.S. Midwest price for their product. With the sudden reflation of U.S. oil reserves, Alberta has been getting an increasingly raw deal. Enbridge consultant Neil Earnest explained to hearing attendees at a Holiday Inn in south Edmonton that it costs about $7 in pipeline tolls to move a barrel of Western Canada Select crude to the Gulf of Mexico. "But the price [of WCS] today at Edmonton is not the Gulf Coast price minus $7," he explained. Owing to the huge oversupply of crude in the U.S., "it's the Gulf Coast price minus $30."

That spread is already eating into Alberta's treasury: when the government issued its first-quarter financial update Aug. 30, non-renewable resource revenue was down $900 million from the estimate in the 2012 budget. That figure is not for the full year; it is $900 million gone astray in just three months.

The existing pipe links between Edmonton and the Gulf Coast are full—and if and when the Keystone XL line is built, that is expected to fill and remain full, too. That leaves the marginal barrel of Alberta oil competing in a Midwestern market increasingly awash in oil from the burgeoning Bakken area of Montana and North Dakota, oil that is being transported expensively by rail (and probably anything else that rolls and holds liquid) to American and foreign markets.

The obvious solutions lie to the east, in the central Canadian market, and to the west, in the Pacific Rim countries. That is basically code for "China," since other east Asian countries are not expanding refining capacity. China is not only building as fast as it can; it is building the kind of upgrading and desulphurization that Alberta's bitumen requires, being conscious that no one producer will be able to meet its medium-term needs.

The problem with the eastern outlet, according to Enbridge, is that Canadian refining capacity is barely profitable—it is geared for light Brent crude from the North Sea, and it is already more than enough to meet regional fuel needs. The market doesn't seem interested in building new capacity (especially given the regulatory hurdles). China is, for practical purposes, closer and technically more attractive to the oil sands than Toronto or Montreal—if Northern Gateway gets built.

So how much is access to that market worth? Enbridge hired Calgary economist Robert Mansell to do a "public interest benefit evaluation" for the review panel, and Mansell, in turn, plugged price estimates from another consultant into a Statistics Canada model of the economy. Northern Gateway, he says, would yield about half a percentage point in added annual GDP between the pipeline's opening and 2048; about 900,000 man-years of employment, including 400,000 in Alberta and a quarter-million in B.C.; and over $98 billion in government revenue, almost half of which would go to Ottawa.

These represent comparisons, Mansell adds, with a fairly conservative "base case." In the no-Gateway scenario, the model assumes that Keystone XL will go ahead, that there will be enough rail capacity to move excess Alberta oil to some markets, and that the oil sands would not be "shut in" by political action. If any of these assumptions changed, the Northern Gateway relief valve would become all the more valuable. Perhaps the biggest problem with the model, one nobody raised at the Holiday Inn, is that it envisions continued growth and political stability in China. Chairman Deng, after all, is not running the show anymore.