2012-27-e

The Economics of North American
Pipeline Projects: The Race to the Sea
Publication No. 2012-27-E
23 April 2012
Mathieu Frigon
Francis Perreault
Industry, Infrastructure and Resources Division
Parliamentary Information and Research Service

The Economics of North American
Pipeline Projects: The Race to the Sea
(Background Paper)
Library of Parliament Background Papers provide in-depth studies of policy issues.
They feature historical background, current information and references, and many
anticipate the emergence of the issues they examine. They are prepared by the
Parliamentary Information and Research Service, which carries out research for and
provides information and analysis to parliamentarians and Senate and House of
Commons committees and parliamentary associations in an objective, impartial
manner.
Publication No. 2012-27-E
Ottawa, Canada, Library of Parliament (2012)
HTML and PDF versions of this publication are available on IntraParl
(the parliamentary intranet) and on the Parliament of Canada website.
In the electronic versions, a number of the endnote entries contain
hyperlinks to referenced resources.
Ce document est également publié en français.

LIBRARY OF PARLIAMENT i PUBLICATION NO. 2012-27-E
CONTENTS
1 INTRODUCTION....................................................................................................... 1
2 MARKET DIVERSIFICATION ................................................................................... 1
3 TRANSPORTATION INFRASTRUCTURE............................................................... 2
3.1 Economic Factors .................................................................................................. 2
3.2 Expanding the Pipeline Infrastructure.................................................................... 4
4 REFINING INFRASTRUCTURE ............................................................................... 5
4.1 Refiners’ Profit Margins.......................................................................................... 5
4.2 Other Factors in Expanding Refining Capacity...................................................... 6
4.2.1 Proximity to Markets........................................................................................ 7
4.2.2 Current Capacity and Infrastructure Costs...................................................... 7
4.2.3 Outlook Regarding Demand for Refined Products.......................................... 7
5 THE FUTURE............................................................................................................ 8

LIBRARY OF PARLIAMENT 1 PUBLICATION NO. 2012-27-E
THE ECONOMICS OF NORTH AMERICAN
PIPELINE PROJECTS: THE RACE TO THE SEA
1 INTRODUCTION
In current North American petroleum markets, there exists an economic
phenomenon that can be called “the race to the sea” – the pursuit of means to
efficiently ship oil extracted from the continental interior to the Canadian and
United States coasts.
This paper provides an overview of some economic aspects of this phenomenon:
• the reason for this race to the sea, which could also be described as the
importance of diversifying the market for crude oil from the continental interior,
including from Alberta;
• the effect of fluctuating prices on the infrastructure for transporting oil to markets
(pipelines), including expansion projects; and
• the economic factors governing decisions concerning oil refining infrastructure
and their effect on the route and the form that oil from the interior takes in order
to reach markets.
The last section of this paper takes a brief look at where the current race to the sea
may lead.
2 MARKET DIVERSIFICATION
The sea provides an important access route to world markets for petroleum
producers, in large part because marine transportation is highly economical. This is
an important consideration for producers in several inland areas in Canada and the
United States that need to dispose of their production in markets where the demand
is greatest. Alberta provides a good example of this reasoning.
By international standards, Alberta is rich in oil resources. Since production greatly
exceeds local demand, if it were not possible to export oil outside the province, oil
from Alberta would sell at a lower price and as a result, production would be lower.
For this reason, the Alberta oil industry depends on access to lucrative world markets
for its economic health.1
In addition, because Alberta production of crude oil represents a relatively small
portion of global production, its presence on world markets, while important, is not
significant enough to have a detrimental effect on international oil prices. In short, the
Alberta petroleum industry – and the province as a whole – has an economic interest
in assuring that its oil has the best possible access to global markets.

THE ECONOMICS OF NORTH AMERICAN PIPELINE PROJECTS: THE RACE TO THE SEA
3 TRANSPORTATION INFRASTRUCTURE
Oil must be transported economically if global market access is to be profitable. If
transportation is too expensive, any price advantage from access to the global
market would be completely offset by transportation costs.
Where reaching the sea or other markets by an overland route is concerned, the
most efficient way to transport significant volumes of oil is by pipeline. This method is
essential to Alberta – and generally speaking to any oil-producing area where marine
transportation is not an immediate option – if it is to take advantage of international
trade opportunities.
In the past, pipelines have been used primarily to carry Alberta oil to the U.S. market
(see Figure 1 and section 4.1 of this paper).
Figure 1 – 2008 Supply and Disposition of Canadian Crude Oil, and Pipeline Projects
Source: Map prepared by Emmanuel Preville, Library of Parliament, using data from National
Energy Board, Canadian Pipeline Transportation System – Transportation Assessment,
July 2009.
3.1 ECONOMIC FACTORS
In general, the North American pipeline infrastructure allows for the aligning of the
price of crude oil located inland (the “landlocked price”)2
with the price of oil on the
coast (the “waterborne price”).3
While the infrastructure cannot be changed
significantly in the short term,4
market conditions inland and on the coast can change
very quickly.

When the transportation infrastructure and market conditions are out of sync,
differences can develop between the landlocked price and the waterborne price, and
they can persist. This can cause market supply conditions for crude oil to change
significantly and can lead to adjustments to the transportation infrastructure. These
adjustments usually cause the price difference to retract.
For example, until the late 1990s, oil extracted from the interior of North America was
carried east to Montréal refineries via Sarnia, Ontario. However, in 1999, the
waterborne price was below the landlocked price, and this factor contributed at least
in part to having the direction in which oil was transported reversed: oil imported from
overseas was instead carried west from Montréal through Sarnia to the interior. This
occurred because it made more sense for the Montréal refineries to get their supply
from imports at the lower waterborne price rather than at the North American
landlocked price, and it made more sense to send imported overseas oil to the
interior North American market, where the return was higher at that time, given the
strength of the landlocked price.
More recently, however, increased oil production in the North American interior (see
Figure 2) has created a relative oil surplus in inland markets compared with coastal
markets and has led to a drop in the landlocked price.
Figure 2 – Trends in Oil Production in Saskatchewan, Alberta,
North Dakota and Montana
Sources: Saskatchewan and Alberta: Statistics Canada, Table 126-0001, “Supply and disposition of
crude oil and equivalent, monthly (cubic metres × 1,000),” CANSIM (database); and North
Dakota and Montana: U.S. Energy Information Administration, Independent Statistics &
Analysis, “Crude Oil Production,” Petroleum & Other Liquids.
0
10,000,000
20,000,000
30,000,000
40,000,000
50,000,000
60,000,000
70,000,000
80,000,000
barrels/month
Saskatchewan Alberta North Dakota Montana

As shown in Figure 3, current market conditions are the opposite of those present in
the late 1990s: the landlocked price (e.g., Oklahoma and Alberta) is now much lower
than the waterborne price (e.g., Louisiana and North Sea).
Figure 3 – Recent Trends in Landlocked (Oklahoma and Edmonton)
and Waterborne (Southern Louisiana and North Sea) Oil Prices
Sources: Oklahoma and North Sea: U.S. Energy Information Administration, Independent Statistics
and Analysis, “Spot Prices,” Petroleum & Other Liquids; Alberta: Natural Resources Canada,
Crude Oil Prices: 2012; and Louisiana: Louisiana Department of Natural Resources,
Louisiana Average Crude Oil Prices (Dollars per Barrel). .
As in the late 1990s, this price difference poses a challenge to the existing
transportation infrastructure. Among other things, the current pipeline capacity does
not allow producers in the interior to take full advantage of coastal market conditions.
It can be said that producers in the interior are, to a certain extent, captives of the
existing pipeline infrastructure.
3.2 EXPANDING THE PIPELINE INFRASTRUCTURE
It comes as no surprise, then, that several pipeline projects have been developed, all
to increase the flow of oil from the interior to the coasts. These projects include the
following (see Figure 1 for the geographical location of these projects):
• Keystone Gulf Coast Expansion Project (also known as Keystone XL): This
two-part project involves running a pipeline connection from Hardisty, Alberta, to
an existing pipeline between Steele City, Nebraska, and Cushing, Oklahoma.
Another section would start in Cushing and end near Port Arthur, Texas, on the
Gulf of Mexico.
60
80
100
120
140
$US/barrel
Oklahoma (West
Texas Intermediate
light sweet crude oil)
Alberta (Edmonton
Par light sweet
crude oil)
North Sea, Europe
(Brent light sweet
crude oil)
Louisiana (south
Louisiana light
sweet crude oil)

• Northern Gateway Project: This pipeline would run from Bruderheim, Alberta, to
Kitimat on the coast of British Columbia.
• Kinder Morgan (TMX2, TMX3 and Northern Leg expansion project): This project
would increase the capacity of the Trans Mountain pipeline system, which
transports oil and refined products from Alberta to the west coast.
• Reversing the Montréal–Sarnia pipeline flow (Line 9): The flow of the
Montréal–Sarnia pipeline would be reversed so that oil would flow from Sarnia to
Montréal, re-establishing the conditions in effect before 1999. Only a partial
reversal of the pipeline flow (from Sarnia to Westover, Ontario) is currently under
study.
• Reversing the Portland–Montréal pipeline flow: This project would reverse the
flow of the Portland–Montréal pipeline so that oil would run from Montréal to
South Portland, Maine.
If these projects are carried out, they could reduce the oil supply on the inland market
and increase it on the coastal market. This could bring the landlocked price more
closely in line with the waterborne price, meaning a higher landlocked price, notably
on the Edmonton market.
4 REFINING INFRASTRUCTURE
If pipeline transportation is an important element in the “race for the sea,” and, more
generally, in the marketing of petroleum by landlocked areas like Alberta, refining is
another. The economic factors that govern the choice of refinery location also often
dictate the route oil takes to market, as well as the form in which it travels – that is,
whether it will be unrefined (i.e., crude oil) or refined (gasoline, diesel, butane, etc.),
the latter having more value added.
Among these factors, as explained earlier, one that is likely to affect decisions on
where refining takes place is the difference between the landlocked price and the
waterborne price, and in particular, how that difference affects refiners’ profit
margins. However, other factors play an equally important, if not more important, role
in this decision.
4.1 REFINERS’ PROFIT MARGINS
Profit margin is the concept that is key to understanding decisions to expand refining
activities. Since costs other than that of crude oil are fairly stable in the short term,
changes in a refinery’s profit margin are mainly the result of changes in the gross
margin, which is the difference between the price of finished products and the price
of crude oil.5
Because the landlocked price is currently lower than the waterborne price, inland
refineries have a higher gross margin than refineries in eastern Canada and the
northeastern United States, which are subject to the waterborne price (see Figure 4).
The higher gross margins encourage maximum use of the existing refinery
infrastructure located inland and could, if they remain high, encourage investment in
additional refinery capacity.

Figure 4 – Recent Trends in Refiners’ Gross Margin,
Edmonton and Montréal
Sources: Natural Resources Canada, “Average Wholesale (Rack) Prices for Regular Gasoline
in 2012,” Energy Sources; Natural Resources Canada, Crude Oil Prices: 2012; and
authors’ calculations.
According to recent U.S. data, the national utilization rate of refining capacity has
hovered around 85% since 2010. This average hides significant regional disparities
that reflect the impact of current profit margins: for the period in question, the
utilization rate was about 75% on the east coast (PADD 1) 6
and more than 90% in
the Midwest (PADD 2).7
In addition, several major refineries recently closed in the
northeastern United States,8
while refinery use and capacity increased in the
continental interior (particularly among midwestern refineries).9
4.2 OTHER FACTORS IN EXPANDING REFINING CAPACITY
Higher gross margins in the continental interior could, in principle, encourage the
expansion of refining capacity in the interior, particularly in Alberta and the
U.S. Midwest. But we cannot assume that this will necessarily lead to the
construction of new, large-scale refineries, since some economic factors do not
favour such construction. Among those factors are the advantage of carrying out
refining activities near markets and the cost of constructing new refineries,
particularly when the capacity of the current infrastructure and possibilities in the
sector are taken into account.
0
5
10
15
20
25
30
cents/litre
Montréal refineries gross margin
Edmonton refineries gross margin

4.2.1 PROXIMITY TO MARKETS
Refiners usually prefer to expand their activities as close as possible to target
markets, in other words, closest to the demand for refined products. One of the
reasons for this preference is that transporting these products is more expensive and
less efficient than transporting crude oil, owing to a variety of factors.10
The current
refining capacity reflects this situation.
For example, a comparison of Canada’s western provinces with the U.S. Midwest
(PADD 2) shows that more than 85% of the demand for refined oil products comes
from the Midwest. Accordingly, most of the diluted bitumen from oil sands
(non-upgraded bitumen, often equated with extra-heavy oil) is exported to the United
States (particularly to the Midwest) to be processed into refined products.11
In addition, refiners in the Gulf of Mexico (PADD 3) have fairly inexpensive access to
the important pool of consumers in the northeastern United States through a network
of refined products pipelines. Such a network is not available to refiners in the
landlocked Canadian West,12
which is another argument against building refineries in
Alberta, for example.
4.2.2 CURRENT CAPACITY AND INFRASTRUCTURE COSTS
Constructing new refineries is very costly.13
In the current context, spending on such
construction does not seem likely, since the existing infrastructure meets the refining
needs of the North American market. In particular, the U.S. Midwest has a significant
capacity to process heavy oil from the oil sands. This regional capacity (generally
associated with the coking capacity) is close to 375,000 barrels a day (2011 figures).
When refineries along the Gulf of Mexico (mentioned above) are also taken into
consideration, capacity reaches nearly 1.7 million barrels a day, or slightly less than
the total capacity in all of Canada.14
Furthermore, many North American refineries are owned by a small group of
integrated large multinationals that are also involved in oil sands extraction – in the
Midwest, in particular, the multinationals account for 58% of local refining capacity.15
For these major players, building a new refinery in the continental interior would likely
mean closing a coastal refinery, and from a business perspective, this approach
seems to make less sense than transporting crude oil to existing refineries through a
modified pipeline infrastructure.
4.2.3 OUTLOOK REGARDING DEMAND FOR REFINED PRODUCTS
The economic outlook does not favour investment in the construction of new
refineries in North America, given that the demand for fuel is expected to level off or
even decline over the long term. Consistent with the expected evolution of market
demand internationally, the trend is toward a consolidation of the existing refining
capacity in North America and Europe, and the development of new capacity in
Asia.16

5 THE FUTURE
Pipeline projects to transport crude oil, often seen as market diversification projects,
can be considered a “race to the sea” offering the prize of enabling producers in
Alberta and other landlocked regions to take advantage of favourable market
conditions on the coast.
Ultimately, development of the oil pipeline infrastructure will likely cause the price of
landlocked oil to align with the waterborne price of oil and slow down the race to the
sea, if not bring it to an end. This price rebalancing would enable refineries in eastern
Canada to compete on an equal footing with those in the continental interior
regarding the price of raw material (i.e., crude oil). The resulting standardization of
refiners’ profit margins across North America could also stop the current trend of
refining capacity moving from the coast to the interior.
Finally, it should be noted that the price realignment could occur even before pipeline
projects materialize. This is because the market price of oil usually reflects not only
current market conditions but also available information on future conditions,
including the impact of commissioning new pipelines. Price rebalancing could
therefore take place as soon as economic actors are convinced that future pipeline
capacity will be sufficient to ensure an efficient arbitrage between the waterborne
price and the landlocked price.
NOTES
1. At a macroeonomic level, this access also leads to an increase in exports and
investments and therefore an increase in the gross domestic product.
2. The North American landlocked price is represented in Canada by the Edmonton Par
price on the Edmonton market and in the United States by the West Texas Intermediate
price on the Cushing, Oklahoma, market. It is worth noting that market conditions can
vary greatly in the continental interior and lead to significant differences in various
landlocked prices. For example, if there is insufficient pipeline capacity between
Edmonton and Cushing at any time (e.g., should a pipeline be temporarily shut down), a
price difference could develop between the two markets.
3. The waterborne price is usually represented by the North Sea Brent price, which is the
benchmark price for the Atlantic Basin. The southern Louisiana price can also be used as
the benchmark for the waterborne price.
4. Modifying the pipeline infrastructure is a slow process mainly due to the significant
investments required and the regulatory approval process.
5. The profit margin is calculated by subtracting all refinery costs (crude oil, labour,
depreciation, interest, etc.) from the price of the finished products. The gross margin is
calculated by subtracting only the cost of crude oil. Since costs other than that of crude oil
are fairly stable in the short term, changes in the gross margin are seen as an excellent
indicator of changes in a refinery’s short-term profitability.
6. The acronym “PADD” (Petroleum Administration for Defense District) refers to the
division of the United States into five regions for the allocation of fuel, adopted during the
Second World War.

7. See U.S. Energy Information Administration, Independent Statistics & Analysis, “Weekly
Inputs & Utilization,” Petroleum & Other Liquids.
8. See Canadian Association of Petroleum Producers, Crude Oil: Forecast, Markets &
Pipelines, June 2012, pp. 13–20; and Anthony Andrews, Robert Pirog and Molly F.
Sherlock, The U.S. Oil Refining Industry: Background in Changing Markets and Fuel
Policies, Congressional Research Service, 2010, pp. 2–12.
9. For a list of the main expansion projects for refineries and refining capacity between 2006
and 2012, see National Energy Board, Table 2.1, “Refinery Expansions and
Partnerships,” in Canada’s Energy Future: Infrastructure Changes and Challenges
to 2020, 2009, p. 9.
10. Canadian Petroleum Products Institute, Submission to: Standing Committee on Natural
Resources, 2012, p. 4.
11. See National Energy Board, “Statistics,” Crude Oil and Petroleum Products.
12. The current capacity of pipelines crossing the Canada–U.S. border in the West is
primarily devoted to transporting crude oil, not refined petroleum products, from north to
south.
13. See, for example, Canada Petroleum Products Institute (2012), p. 3: “Refining is a capital
intensive business – a new refinery would cost about $7-billion to build, not including land
acquisition costs.”
14. For more information, see M. C. Moore et al., “Catching the Brass Ring: Oil Market
Diversification Potential for Canada,” SPP Research Papers (School of Public Policy,
University of Calgary), Vol. 4, Issue 16, December 2011, pp. 9–16.
15. See U.S. Energy Information Administration, Independent Statistics & Analysis,
“U.S. Refineries Operable Capacity,” Oil: Crude and Petroleum Products Explained –
Refining Crude Oil.
16. See British Petroleum, BP Energy Outlook 2030 (BP Statistical Review), January 2011,
p. 28.

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