Keystone – a job killer?

It is likely that the Keystone pipeline will increase oil prices in the US and lead to loss of jobs.

The proposed Keystone pipeline advocated by TransCanada and oil sands producers in Canada has been promoted as a job generator for the US. TransCanada claims 13.000 jobs in construction and 7.000 jobs in manufacturing. While many construction jobs will be realized if the pipeline is built, its also highly likely the economy will shed far more jobs elsewhere, worsen the trade deficit and stifle economic growth.

While not an exact science, the correlation between the oil price and US GDP is historically strong and in particular when the non oil related economy is in poor shape. When more industry and households have to spend more money on fuel and oil related products, less is available for other products.

The world is essentially divided into two oil price markets, namely Western Texas Intermediate (WTI) for the US and the Brent index for the rest of the world. If the markets work as they’re supposed to, shifting oil supplies from oversupplied Oklahoma to the Gulf of Mexico and the world markets, it will harmonize the US oil price (WTI) with the world oil price (Brent). This is supported by statements from TransCanada’s Vice President Robert Jones who has said the construction of the pipeline would increase the cost of oil in the US.

Historically, but in particular over the last year, the US has been in a very good competitive position with significantly lower oil prices than the rest of the world. The weak dollar and labor markets also contribute to US competitiveness, but the oil price plays a very important role. The low oil and gas prices translates to a significant competitive advantage for factories, refineries and the transportation sector in the US – job generators far more important than a one-off spike in constructions jobs. Don’t get me wrong, putting steelworkers, welders and electricians to work is important, but if the US economy sheds tens of thousands of jobs in other sectors than pipeline construction due to a higher oil price, it may not be the best for the US economy while we’re just eyeing a glimmer of hope for economic recovery and lower jobless rates.

Over the last year, US exports of gasoline, diesel and other refinery products to Europe and Latin America have increased significantly, mainly because US refiners can produce gas and diesel with lower feedstock costs than the Europeans that are locked to the Brent world oil price. This is very good for the US current account and improves the trade balance while contributing to reducing the deficit. Add plastics, chemicals, asphalts and other products from oil entering the construction and manufacturing sector in the US, and the picture becomes more obvious. Moreover, transporting industrial and personal goods by truck, train or airplane will also become more expensive if the oil price goes up in the US. The Federal Reserve has said that a 10 $ price increase in the US will reduce economic growth by 0.5 %, but regardless of projections it’s common sense that when US goods and services become more expensive vs. foreign produced goods, US export will be reduced and jobs will be lost.

In January 2012, the US economy had a 10 $ per bbl advantage for Western Texas Intermediate (WTI) oil prices over most of the world. In 2011, US advantage was between 10-30 $ and has remained between 10 and 20$ bbl in 2012 and between 15 and 25 $ in 2013. Oil sands operators have stated that an important motivation for them is to get better paid for Canadian oil in the global markets. Keystone VP Robert Jones has said that the pipeline will increase the oil price at Cushing by 10 $ per barrel.

Assuming he is referring to the spread between WTI and Brent, it could be a lot more, but possible less if other factors such as reversing pipelines and oil supply are held back3. The difference between Brent and WTI was 30 $ back in November 2011, but reduced following Enbridge reversal of a pipeline on the east coast. One could argue that higher oil prices will lead to higher government take and corporate profits and as such trickle back into the economy, but with no guarantee that the oil companies in the US or Canada will recycle profits in the US. With the US government and most states having the lowest tax/government take among the world’s largest oil producers, the federal and state revenue impact will likely be much smaller than the pain a higher oil price would cause the wider economy.

Why will the oil price in the US go up you may ask? Oil from Canada is causing oversupply in some regions in the US and this trend is likely to continue unless the Keystone pipeline is built. Consequently when supply is more than demand, the oil price goes down. Along the proposed pipeline route, the oil price will be Gulf of Mexico Brent minus the cost of transport, which is likely to be small given the large volumes. TransCanada says an alternative is shipping oil to China but if so, the shipping costs will be high and perhaps maintain a lower oil price at the well head in the US and Canada. Another factor is that in liquid markets, with sufficient capacity to move products, marginal pricing sets the final price. With pipelines already going to the US from Canada, all oil in the US can theoretically be priced to Brent in the future. If Canadian operators can get 10 $ more per barrel, consumers in the US would indirectly pay Canada an estimated 600.000.000 $ per month given imports of 2 million bbls per day from Canada.

While many may be concerned with potential spills, high CO₂ intensity and water consumption, the Administration should also consider the merits of the pipeline in terms of US wide job impact, GDP, competitive advantage and trade balance as well as the gas prices. The debate is picking up again in Congress and while Republicans are launching attacks on the administration for increasing gas prices, they keep pushing for a pipeline that most certainly will lead to exactly what they argue against.

Finally, it seems the economy could be worse off with the pipeline as the regional oversupply of oil significantly helps the economy and US exports. At the very least, a decision on the Keystone proposal should be delayed until the US Government has done a full economic impact assessment of the pipeline.