Lure of Profits Spurs Oil Sands Pipeline Projects

November 28, 2011 at 05:00 AM EST

There's a pipeline race happening in the oil industry, and the winner will unlock huge profits.

You see, the Canadian oil sands are missing an efficient way to get the oil from the fields to the refineries and to the customers. That means profits are trapped in areas like the Athabasca oil sands of northeasternAlberta, Canada -- the second-largest crude reserves in the world with about 1.7 trillion barrels of oil.

That's why TransCanada Corp.'s (NYSE:TRP) Keystone XL pipeline, recently delayed for a year for further review by the U.S. State Department, has been such a big deal. The Keystone pipeline would bring the Canadian crude from Alberta to U.S. refineries, reducing the need for imports from distant and often unstable Middle Eastern countries.

But because the Keystone pipeline crosses an international border, the State Department must approve it,but the 1,700 mile route has raised environmental concerns.

Now several other companies have redoubled their efforts on similar oil pipeline projects, not only to move oil from Canada but also to relieve an oil bottleneck in Cushing, OK, that is helping depress prices of West Texas Intermediate (WTI) crude.

"The markets need a solution really badly to the Cushing problem," Lanny Pendill, senior energy and utilities analyst at Edward Jones told MarketWatch. "If Keystone gets deferred too long, it's highly likely that competing proposals will gain traction at TransCanada's expense."

Other companies did indeed react swiftly to TransCanada's setback.

Almost immediately after the announcement that Keystone pipeline would be delayed, Canadian pipeline company Enbridge Inc. (NYSE: ENB) said it had bought a 50% stake in the Seaway Crude Pipeline, which now carries oil from Freeport, TX, to Cushing. Enbridge plans to reverse the flow of oil next year. (Enterprise Products Partners LP (NYSE: EPD) owns the other 50%.)

"The producers think this is great, because now you have enhanced connectivity and enhanced transportation into the largest area and concentration of refiners in the U.S," Darren Horowitz, an analyst with Raymond James & Associates (NYSE: RJF), told Bloomberg.

Price Pressures The bottleneck at Cushing has been a major factor in opening a spread between the market price of WTI and Brent crude.

In September Brent was as much as $30 higher than WTI, although the gap has narrowed considerably since then. It was in the $11.50 range last week, but analysts at RBC Capital (NYSE: RY) see it lingering at $9 per barrel in 2012 and $7 per barrel in 2013.

Although many refiners have profited from the spread, it has cost the oil producers. Oklahoma oilman Mike McDonald estimated that a spread of $20 costs oil producers $2.9 million a day in his state alone.

In fact, although TransCanada wants to build the Keystone pipeline primarily to bring Canada's oil sands crude to the U.S. market, it said it may seek permission from the Obama Administration to start work on the portion that is to run from Cushing to Gulf coast refineries as soon as January.

Moving Canada's Oil Meanwhile, pipeline companies in Canada also are seeking to exploit the Keystone delay.

Enbridge already has said it is moving ahead with two other oil pipeline segments, Wrangler and Flanagan South, that together would connect the Canadian oil sands crude with refineries on the Gulf coast.

Neither is subject to State Department approval, as the portions that cross the border already exist. Flanagan South would run from Chicago to Cushing; Wrangler from Cushing to the Texas Gulf Coast.

The Keystone delay "definitely improves the prospects of the Wrangler project going forward," John Auers, senior vice president of Turner, Mason & Co., a Dallas-based pipeline and engineering consultancy, told Bloomberg.

But if the Keystone pipeline is delayed indefinitely, some of the Canadian oil sands production may end up headed in another direction.

Both Enbridge's proposed Northern Gateway pipeline, as well as Kinder Morgan Energy Partners' (NYSE: KMP) proposed expansion of its Trans Mountain pipeline, would move Canadian oil across British Columbia to export facilities directed at Asian markets.

The threat of losing a major portion of this vital supply of oil to Asia should spur the State Department to approve the Keystone pipeline, although few expect any action until after the 2012 elections. Most analysts believe U.S. President Barack Obama wants to put the issue on ice until then to ensure the votes of environmentalists.

Despite the delays, most experts believe the Keystone pipeline will eventually get built. In fact, most of the proposed oil pipeline projects will get built, not just because there's so much oil in the Canadian oil sands, but because there's also a lot of oil in places like the Bakken shale rock oil field in Montana and North Dakota.

Jackie Forrest, director of global oil for IHS Cambridge Energy Research Associates, said in a report earlier this month that multiple projects will be needed "in order to create enough takeaway capacity to prevent bottlenecks."

Who Wins? That's going to be good news for TransCanada when it does finally get the Keystone XL pipeline built and online. It will be great news for Enbridge, which clearly has plenty of oil pipeline projects that will take advantage of the growing production of oil sands and shale rock oil. And don't forget Enterprise Products Partners, which is working with Enbridge on several of these projects.

The oil producers with large stakes in the Canadian oil sands will also benefit handsomely. That list includes Suncor Energy Inc. (NYSE:SU), Canadian Natural Resource Ltd. (NYSE:CNQ), Royal Dutch Shell Plc (NYSE ADR: RDS.A), Marathon Oil Corp. (NYSE: MRO) and ConocoPhillips (NYSE: COP).

For the refiners, the added pipeline capacity is a bit of a mixed blessing. They'll have access to a reliable source of oil (many Midwest refiners now process oil from Mexico and Venezuela), but as the Brent-WTI spread closes, the higher cost of the crude will squeeze profits.

Refiners affected by the pipeline include HollyFrontier Corp. (NYSE: HFC), Valero Energy Corporation (NYSE: VLO) and Western Refining Inc. (NYSE: WNR).

However, Money Morning readers interested in the most promising way to profit from the vast Canadian oil sands need to take a look at our premium service, Private Briefing. This stock owns the controlling shareholding in one of the key Athabasca projects and is ramping up production there.

For more information on how to sign up forPrivate Briefing,click here.

Once you sign up, just pull up the Nov. 22 research report titled"The Oil Stock That's "Too Good to Ignore."That report will tell you all you need to know about this intriguing profit play.

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