Pipelines and Fuel Prices – Dispelling the Myths

Posted on: Sunday, June 29th, 2014

There is a lot of talk these days about what the impact on fuel prices might be as a result of the proposed expansion of pipeline capacity, through projects such as the Keystone XL, Northern Gateway, Energy East, or the expansion of the Kinder Morgan Trans-Mountain pipeline. Proponents of these projects claim that more pipeline capacity will lower the price of products such as gasoline and diesel. Opponents claim the opposite – that fuel prices will inevitably increase as a consequence.

Neither is right.

It is well-known in the oil industry that refineries in Canada and the US with access to underpriced domestic crude feedstocks have been enjoying very good “crack spreads” (simple definition: profits), as a result of producing that underpriced crude, and selling the resulting gasoline, diesel etc., at higher market-driven – not cost-driven – prices. What those refiners also know is that the expansion of crude pipeline capacity will shrink those margins, albeit with the flip-side benefit of better crude revenues, for those that both produce and refine.

So, crude pipeline expansion will hurt some refiners, but that will not effectively cause an increase in the price of gasoline or diesel fuel. For example, in BC’s lower mainland, where one refiner has existing pipeline access to Alberta crude, wholesale gasoline already trades at market prices more or less at par with other markets in the Pacific Rim. In Atlantic Canada, where one refinery has been shipping underpriced crude from the mid-west, gasoline and diesel prices compete with those as far away as Rotterdam.

Consumers on either coast, or even in central or western Canada, do not benefit from the fact that nearby refiners’ input costs may be less than prevailing world crude costs. Refiners will always sell to the highest bidder; this actually insures that fuel supplies remain available for domestic markets. In other words, cheap crude oil, as a result of pipeline bottlenecks, really does not translate into cheap gasoline. Accordingly, pipeline capacity expansion, which will raise crude prices, will not effectively raise the already market-driven fuel prices.

The U.S. Gulf coast, where fully half of that country’s refining capacity resides, is currently exporting huge volumes of gasoline and diesel. Why? Because that underpriced domestic crude oil cannot be exported, due to restrictions on crude (but not refined) exports by the U.S. Government. USGC refiners don’t want those export restrictions lifted of course; it will kill their high crack spreads by raising domestic crude prices, while not being able to raise the refined product price which is already at tidewater, and therefore on par with external markets.

So, if pipeline expansion won’t raise fuel prices, will it lower fuel prices? Not really. More North American crude oil getting to “tidewater” – where it can then compete on the world markets – may have a modest dampening effect on world crude prices (global tensions notwithstanding), but the price impact would likely be modest at best. For the same reason the current tight supply (i.e. lack of pipeline capacity) has not given consumers a windfall benefit at the pump, more pipeline capacity will not do so either.

There may be good arguments for or against crude pipeline expansion, but the threat of higher – or promise of lower – consumer fuel prices, just does not hold up under close examination.

Michael Ervin is President of Kent Group Ltd., a consultancy specializing in the petroleum refining and marketing industry.