U.S. must adapt to new energy landscape

Large storage tanks sit on the southern bank of the Schuylkill at the Sunoco refinery. Such East Coast refineries must use pricey imported crude. MICHAEL BRYANT / Staff Photographer
Large storage tanks sit on the southern bank of the Schuylkill at the Sunoco refinery. Such East Coast refineries must use pricey imported crude. MICHAEL BRYANT / Staff Photographer
Posted: May 21, 2012

The development of Canada’s tar sands and North Dakota’s Bakken oil shale region have profoundly transformed the U.S. energy landscape. U.S. and Canadian oil production has risen 11 percent since 2010 and could rise by as much as 50 percent over the next decade. More plentiful North American supply has lowered costs for some U.S. refineries, but mainly in places such as Oklahoma and Illinois, where it can be shipped via the Keystone pipeline.

But there are no pipelines to carry this oil to the U.S. coastal refining hubs. Thus refining costs in the Midwest have fallen far below those in coastal cities such as Philadelphia.

You can see the problem in the difference between the two main types of crude oil traded on global futures exchanges. Brent crude, which comes from the North Sea near Britain, has traded for significantly more than has West Texas Intermediate, the benchmark for North American crude oils.

Because Midwestern refineries use crude that follows the WTI price, their owners have reported large profits over the last year. Meanwhile, East Coast refineries, such as the former Sunoco and Conoco plants near Philadelphia, have been mothballed, because expensive crude imports rendered them unprofitable. Without adequate pipeline links to the rest of the country, Pennsylvania, New Jersey, and Delaware refineries must rely in large part on more expensive imported crude from Europe and Africa.

East Coast refineries are also set up to produce gasoline as their major product, demand for which is likely to be flat at best over the next decade as Americans shift to more fuel-efficient vehicles. Demand for heating oil, by contrast, is likely to grow modestly, while diesel will remain a fuel of choice for commercial trucking.

At the same time, growth in global oil output will come increasingly from places that primarily produce heavy, sour crude, including Canada, Saudi Arabia, and Latin America. East Coast refineries that are less able to process this crude oil will benefit little from rising supply and continue to pay premiums for light, sweet crude from Europe and Africa. Such thinking likely influenced Sunoco’s decision to sell or close its Philadelphia refinery this year.

With fewer refineries on the East and West Coasts, gasoline prices for the majority of U.S. consumers are likely to rise. Reliance on imports also reduces U.S. energy security and makes pump prices potentially more volatile, raising the risk of energy price shocks to the economy.

When markets fail to serve the national interest, government must step in. It has done so many times in connection with the nation’s energy and transportation infrastructure, providing loan guarantees for nuclear power, awarding tax credits for oil drilling, and building the interstate highway system. It should do so again so that oil can be piped from the center of the continent to refineries on the East and West Coasts.

A pipeline from the oil transshipment hub of Cushing, Okla., to Los Angeles could make midcontinental oil supplies available to West Coast refiners; similarly, a pipeline from Chicago to Philadelphia would give East Coast refineries access to oil from Alberta’s tar sands and North Dakota’s Bakken shale. Growth in Canadian and U.S. oil production will ensure that these pipelines run at full capacity.

Such pipelines would be a costly investment, requiring federal incentives to bridge the gap between private resources and the public interest. While the government should not spend more than is needed, it needs to do as much as is necessary to integrate the nation’s energy markets.

Government support could be modeled on the Obama administration’s proposed national infrastructure bank. Washington would partner with private investors to provide cheap long-term financing, loan guarantees, or a small amount of equity. The government would also accelerate the approval process, minimizing investor uncertainty.

Integrated regional energy markets would mean lower and more stable gasoline prices on the East and West coasts and increased U.S. energy independence. There would be fewer refinery closures, more jobs in pipeline construction, and, as a side benefit, higher prices for crude produced in Canada and North Dakota.

If the government found it necessary to own a minority stake in the new pipelines, it could earn revenue via pipeline transportation fees and could divest its interest once the pipelines were built.

As U.S. and Canadian oil production accelerates over the next decade, government must adopt forward-looking policies to maximize the benefits of the new energy landscape.

Chris Lafakis is an economist at Moodys Analytics. E-mail him at chris.lafakis@moodys.com.

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