The Keystone XL pipeline’s biggest challenge: math

The Keystone XL pipeline suddenly has a math problem— one that could upset the calculus behind the controversial project to pump Canadian tar sands bitumen to the Texas Gulf Coast.

First, there’s the market math, the fact that the world is currently producing more oil than it consumes. The oil boom in the U.S. has played a role in this market shift, but so has decreased demand in the U.S. and Europe.

Even as the U.S. has climbed out of recession, our consumption of oil products, such as gasoline, has remained flat. Americans aren’t driving as many miles and they’re driving vehicles that are, on average, more fuel efficient than at any time in history.

In other parts of the world, such as Europe, where the effects of recession remain severe, oil consumption has fallen by ten percent since its peak in 2006.

If it weren’t for the growth of consumption in developing countries in Asia, particularly China and India, we’d likely be living back in the days of the $20 barrel.

This market math spells real trouble for oil fields where the cost of production is high. Extracting and transporting the tar-like bitumen produced in Alberta is complicated and much more expensive than conventional oil. The recent drop in oil prices has all but closed the tap on the development of new tar sands projects. I was in Winnipeg this past weekend and the collapse of the Alberta oil patch was front page news. The Globe and Mail was filled with stories of delayed and cancelled projects in the tar sands region. Without a turnaround, and a significant increase in oil prices, production of tar sands oil will almost certainly decline.

And it’s not just tar sands. Oil companies, like Shell and Chevron, which had been eyeing major exploration efforts in the Arctic have shelved those plans. Suddenly, high cost production looks like a really bad investment.

Then there’s the climate math, which became a bit clearer with the publication last month of a new study in the scientific journal Nature. The study looks at all the known reserves of fossil fuels like coal, oil, and natural gas, and it compares those reserves to the amount that climate scientists believe can be burned between now and 2050 and still keep the planet’s warming to two degrees Celsius, or about 3.6 degrees Fahrenheit, which is the limit most of the world’s nations have agreed should not be breached.

According to the study, holding the line at two degrees C will require that at least 85 percent of the world’s coal reserves, 50 percent of the known natural gas and fully 35 percent of the already-known oil reserves will need to stay in the ground.

While major agreements to combat climate change have, so far, eluded the nations of the world, the stars are aligning to suggest that 2015 will be a tipping point in more ways than one. The momentum is building for a major climate deal in Paris this fall, and if the world finally gets serious about controlling carbon emissions, there’s going to be a whole new outlook in the oil patch.

Oil companies, like most businesses, are valued on the basis of their assets. An oil company’s primary asset consists of the proven reserves they have under contract. The prospect that climate change policy could force companies to leave as much as a third of that oil in the ground— essentially stranding these company assets— would have huge consequences for their balance sheets.

And the financial sector is beginning to take notice. In December, Bloomberg Business News ran a story titled: “Oil investors may be running off a cliff they can’t see,” which highlighted the rising concern by some investors that oil stocks may no longer be the sure bet they once were given the prospect of stranded assets.

At the same time, the Bank of England announced it was embarking on a detailed analysis of the possibility that oil stocks are significantly overvalued given the prospect of stranded assets.

Investors are signaling their verdict as well, as the stock prices for companies like Exxon Mobil and BP have slipped as much as 20 percent since the summer.

That’s only fueled the growing movement by larger institutions, like major universities, to divest themselves of fossil fuel industry stocks. While some universities, notably Harvard, have refused to take that step so far, arguing that the returns on oil sector stocks in particular have been strong over the years, that argument is likely to become a much weaker one depending on the outcome of climate talks this fall.

The sudden reversal in the oil fields undercuts yet another argument, one often used by Congressman Rick Nolan to justify his support of the Keystone XL pipeline. Nolan has long discounted the calculation of environmentalists who have argued that blocking construction of the pipeline would likely slow, or even halt, exploitation of the carbon-heavy tar sands bitumen. That’s because the pipeline, if built, would trim several dollars per barrel off the cost of transporting bitumen, helping to make it more competitive on the world market.

The drop in oil prices, combined with the prospect that the Keystone XL pipeline may never be built, could permanently shut the tap on tar sands investment. That’s why Nolan’s argument no longer makes sense. Without Keystone, the devastation of vast swaths of Alberta could quickly come to a halt, and this dirty, climate-ruining goo would stay in the ground where it belongs. On this issue, Nolan is clearly on the wrong side of history, as well as market math.

While a post-oil, post-coal world may seem a long way off today, we’ve seen dramatic technological and societal changes happen almost overnight before. Once a tipping point is reached, the old technologies can disappear quickly. And disruptive energy technologies are becoming more of a factor these days. The dramatic drop in the price of electricity-producing solar panels has left this technology— which had long been seen as a solution for the distant future— competitive with conventional forms of electricity today. Combine that with improved battery storage capabilities and the transition from vehicles that run on solar power rather than oil is technologically viable in the near term. Just last month, Chevrolet debuted the modestly-priced Chevy Bolt, which is expected to hit the marketplace as early as 2017, with a range of 200 miles per charge.

All it would take are solar-powered charging stations at workplaces, hotels, shopping centers, and homes, and demand for oil could begin to collapse.

That could be one reason that countries like Saudi Arabia are keeping their oil taps wide open even in the face of a worldwide glut. The Saudis are aware enough to realize that the age of oil will eventually be coming to a close, and if oil assets are to be left in the ground, they would no doubt prefer that those reserves belong to someone else.

By keeping the price of oil low, the Saudis are, by design, discouraging development of unconventional oil projects like the tar sands. Private companies, after all, don’t generally make expensive investments in ventures of questionable profitability.

And that could be the biggest threat to the prospect of the Keystone XL pipeline. Politics aside, in the end it just comes down to math.