Keystone XL and lower oil careful what you wish for

Oil traders are watching today’s vote at the US House of Representatives on the long-awaited bill approving the Keystone XL oil pipeline, transporting crude oil from western Canada to the US Gulf Coast.

The chorus in favour of alternative energy sources has grown loud, to the extent that the resulting decline in energy prices is hurting producers and exporting nations. Loonie traders have seen the currency fall 7% as oil lost a third of its value.

This month’s mid-term elections sweep by the Republican Party of both the House and Senate boosted hopes for big oil that the long-delayed pipeline could finally win approval from US lawmakers. The US Senate is expected to hold its own vote on the Keystone XL in December.

One month ago, it was widely perceived that the pro-business, pro-oil Republicans will successfully pass the bill in both chambers of Congress, forcing President Barack Obama to accept it. The environmentally-friendly Obama administration has stalled making a decision on authorising the pipeline since 2008, when TransCanada, the pipeline owner first submitted its request for a permit.

Keystone XL: not so fast

Yet, if the Democrat-controlled Senate (until year-end) does vote on the bill in December, the Republican supporters of the pipeline will hope for sufficient Democrat votes to obtain overall majority. A small majority (less than two-thirds) at the Senate may still be vulnerable to a Presidential veto, while a majority of greater than two-thirds is unlikely.

Keystone XL would carry bitumen oil from the oil sands of Alberta to Nebraska juncture, where it will connect with other pipelines in the Midwest of the US and Gulf of Mexico. But the risk of pipeline shortages between Alberta and the US has further escalated amid the 30% plunge in oil prices, which makes it difficult to cover the escalating costs of new pipelines, particularly development of oil sands projects.

The International Energy Agency warned yesterday that a prolonged decline in oil prices could hit investment in new supplies, reinforcing the world’s dependence on MidEast oil.

Lower oil prices – careful what you wish for

The fall in oil and gasoline prices is undoubtedly helpful for consumers while the shale boom single-handedly revived US ‘manufacturing’ as well as stabilised the US trade balance. But if prices drop and remain below $75, the costly shale drilling projects may not survive.

Up North, Canadian oil may applaud Keystone XL’s passage, but if the benchmark Western Canada Select oil trading remains below $60.00/barrel (it is down 30% in four months), eroding exports receipts will continue to hit the loonie – as seen in the chart below.

Where’s my surplus?

A year ago, most currency analysts were busy lauding the positive impact that Keystone XL would have on the Canadian dollar once the project was approved. Indeed, Canadian crude exported to the US, Europe and even Asia would be a boost for Canada’s exports but only if the oil price is right.

Canada’s declining budget surplus announced yesterday may also cap offset any knee-jerk reaction in the CAD resulting from this week’s US Congress vote. Loonie traders are grappling with Ottawa’s projection of next year’s federal budget surplus, at $1.9 billion –40% less than had been expected.

And, when we compare the $1.9bn to the $6.4bn surplus that was projected in February, CAD bulls may say it’s because of the Conservative government’s recently announced family-friendly tax and benefit initiatives, which will consume an estimated $27bn from public coffers between 2014-15 and 2019-20.

The combination of cheaper oil and easy fiscal policy may be good news on the first page of the papers, but CAD traders betting on a neutral Bank of Canada and fiscal rectitude will disappointed when trading it against the USD.