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Exporting Energy Security

Keystone XL Exposed

An Oil Change International BriefngSeptember 2011



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transition towards clean energy. We are dedicated to identiying and overcoming political and

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©Oil Change International, 2011



1

Oil Change International

Among the most ot repeated talking points by in-

dustry and their allies is the idea that Keystone XL is

necessary or American energy security, and that its

construction will help wean America o its depen-

dence on Mideast oil. But the idea that Keystone

XL will decrease America’s dependence on oreignoil is demonstrably alse.

To issue a presidential permit to the proposed

Keystone XL pipeline, the Obama Administra-

tion’s State Department must nd that the pipeline

serves the national interest. This report demon-

strates compellingly why it does not.

On August 25, 2011, Robert Jones, a spokesperson

or TransCanada declared: “The U.S. has a decision

to make, [d]o they want to import oil rom Canada

or get conict oil rom OPEC nations?”1

On the surace this notion has a clear, i acile,

appeal. But an understanding o the changing

realities o the oil market in the United States and

globally, and a close scrutiny o the oil companies

that stand to prot rom the pipeline, reveal a com-

pletely dierent story. In act:

1. The Keystone XL pipeline is an export pipe-

line. The Gul Coast refners at the end o

the pipeline’s route are ocused on expanding

exports, and the nature o the tar sands crude

Keystone XL delivers enhances their capacity

to do so.

2. Valero, the top benefciary o the Keystone

XL pipeline, has recently explicitly detailed

an export strategy to its investors. The na-

tion’s top refner has locked in at least 20 per-

cent o the pipeline’s capacity, and, because its

refnery in Port Arthur is within a Foreign Trade

Zone, the company will accomplish its export

strategy tax ree.

3. The oil market has changed markedly in the

last several years, with U.S. demand decreas-ing, and U.S. production increasing or the

frst time in 40 years. Higher uel economy

standards and slow economic growth have led

to a decline in U.S. gasoline demand, while

technological advances have opened up new

sources in the U.S. Increasingly, U.S. refners

are turning to export.

TransCanada’s proposed Keystone XL pipeline is a $7 billion project to bring

heavy, sour crude oil rom tar sands production in Alberta, Canada to Port

Arthur, Texas or rening. It has sparked an ongoing struggle as advocatesand opponents o the project make their case in various ways to the Obama

Administration.

Overview



2

Exporting Energy Security: Keystone XL Exposed

These acts reveal the important truth that the

Keystone XL pipeline would not in act enhance

U.S. energy security at all. The construction o

Keystone XL will not lessen U.S. dependence on

oreign oil—rather, it will eed the growing trend o exporting refned products out o the United

States, thereby doing nothing to enhance energy

security or to stabilize oil prices or gasoline prices

at the pump. I completed, it will successully

achieve a long term objective o Canadian tar

sands producers—to gain access to export mar-

kets.

The oil market is undamentally global. The only

way to truly reduce our dependence on oreign oil

is to reduce our dependence on all oil.

This report looks at data rom the U.S. Energy Inor-mation Administration (EIA), corporate disclosures

to investors and oil market analyst reports. This

inormation should orm the basis o the Obama

Administration’s deliberations on the Keystone XL

pipeline. An honest assessment o the Keystone XL

project will show that the oil will be exported and

will not benet U.S. consumers or any reasonable

denition o the nation’s interest.



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This was not the case when the Keystone XL pipe-

line was originally proposed. However, since 2008,

oil market analysts have repeatedly asserted that

U.S. gasoline demand is in decline as a result o in-

creasing vehicle eciency.2 This trend has recently

been conrmed and reinorced by the introduction

o more stringent uel eciency standards.3

Keystone XL’s backers argue that Alberta’s oil is

needed to replace oreign imports. A related argu-

ment says that Keystone XL is essential to relieve

gridlock at the crossroads or U.S. oil trade, Oklaho-

ma’s Cushing hub. But these arguments don’t stand

up to scrutiny. In act, the purpose o the pipeline

is to give Canadian tar sands producers access to

international markets.

The Oil Market Today: FundamentalChanges

Since the early 1970s and the Arab oil embargo, the United States has aced

the same essential challenge regarding oil: rising demand in the ace o

declining domestic production. For the last two years, and or the oreseeable

uture, that dynamic has reversed: demand is in decline, while domestic supply

is rising. These two acts undamentally change the current and uture U.S. oil

market.

US Gasoline Demand Forecast 2010-2030 U.S. Domestic Crude Production 1990 - 2035

Source: Energy Inormation Administration.5

Source: Deutche Bank global Markets Research, 22 December 2010.4

0%

1%

2%

3%

4%

5%

6%

7%

2 0 1 0

2 0 1 1

2 0 1 2

2 0 1 3

2 0 1 4

2 0 1 5

2 0 1 6

2 0 1 7

2 0 1 8

2 0 1 9

2 0 2 0

2 0 2 1

2 0 2 2

2 0 2 3

2 0 2 4

2 0 2 5

2 0 2 6

2 0 2 7

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G as ol ine De mand ( Mb /d ) R HS T ota l VM T G ro wt h (Y oY ) LH S E c ie nc y I mp rov em ent (Y oY ) L HS

Decline in US demand

should accelerate

noticeably by the end of

the decade



4


Here are the key acts about the changing ace o

the oil market in the U.S. today:

Gasoline demand is declining due to increasing•

vehicle eciency and slow economic growth;

Meanwhile the surge in new shale oil production•

in North Dakota and Texas has led to the rst rise

in U.S. oil production since 1970 and is orecast

to continue or some time;

As a result o stagnant demand and the rise in•

both domestic and Canadian oil production,

there is a glut o oil in the U.S. market;

Reners have thereore identied export markets•

as their primary hope or growth and maximumprots;

The shale surge and the glut o oil is driving the•

oil industry to adapt America’s petroleum trans-

portation structure to a completely new reality:

oil and uel moving rom the heartland to the

coasts, instead o the other way round.

As a result o these new market dynamics, Cana-

dian oil, which is already fowing in on two new

pipelines, is competing with the new domestic oil.This is because a number o big reneries have

retted (or are in the process o retting) in order

to process the Canadian oil, which is dierent than

most o the oil in the United States.6 Once these

reneries are congured or the heavy sour rom

Canada, it is less protable or them to process the

light sweet oil being produced in North Dakota and

Texas.7

In short, Canadian tar sands producers are under-

cutting U.S. domestic oil producers, and Keystone

XL will only help to make that situation permanent.

Globally, the state o the oil products market is also

important to look at in understanding the attraction

o U.S. reners to export. Consider:

There is a shortage o diesel capacity in global•

rening thanks to high demand in Europe and

developing countries;

There is a long term shortage o rening capacity•

in Latin America;

As a result gul coast reners have been increas-•

ing exports o diesel to Europe and Latin Amer-

ica;

These structural dynamics are orecast by the EIA•

to be long term;8

In short, there are market undamentals at work

here that provide incentives or a company that is

properly positioned to rene the diluted bitumen

rom Keystone XL into diesel or export. Several

reners are positioned like this, in particular Valero.

“Middle distillates” include diesel, jet uel and heating oil. Source: EnergyInormation Administration.9

Recent middle distillate export increases mainly wentto Europe and Latin America



5


In 2009, TransCanada identied the six shippers, or

customers, who have signed condential long-term

binding agreements that according to TransCana-

da’s statements to Canada’s regulators, account or

76 percent o Keystone XL’s initial capacity.10

Port Arthur, Texas is the southern terminus o theKeystone XL pipeline and three o the shippers

have reneries located there—Motiva, Total, and

Valero. Two o the shippers are tar sands producers

in need o access to markets (Canadian Natural Re-

sources and Cenovus/Encana), and the nal one is

an oil trading rm specializing in export (Tragura).

The six shippers are:

Valero• : Valero—the largest exporter o rened

products in the United States—has a long-term

contract with TransCanada to ship oil on the

Keystone XL pipeline. It also has a contract with

Canadian Natural Resources to take 100,000 bar-

rels per day until 2030 via the Keystone XL pipe-

line. Valero has also stated that it has additional

contracts with other producers. The company’s

business model relies on capturing prots rom

low-grade heavy sour oil (such as dilbit rom

Keystone XL), with sales growth now ocused on

export markets. It is upgrading the Port Arthur

rening acility to process heavy sour oil into

distillate,11 or diesel, or export.12 13 14

TransCanada’s Business Model orKeystone XL

Generally, pipelines operate by shipping oil on what is known as the “spot

market”—selling space to whatever oil company is willing to pay the most in

a “cost o service” model. Keystone XL is dierent. Keystone XL is planned to

operate on a business model o long-term contracts with very ew shippers.Keystone XL’s unique contractual set-up allows us to reveal the ultimate ate o

the diluted bitumen (dilbit) the pipeline will deliver.



6


Motiva• : Motiva, is a joint rening venture be-

tween Shell, and Saudi Aramco and is in the

process o retting and expanding its renery

in Port Arthur.15 Shell has major stakes in the

Alberta tar sands.

Total:• Total has stakes in the tar sands and has a

newly-upgraded renery in Port Arthur.16

Canadian Natural Resources:• This major Ca-

nadian oil producer has new diluted bitumen

(dilbit) elds coming online but lacks upgrader or

rening capacity to handle anticipated volumes.

Cenovus/Encana:• Like Canadian Natural Re-

sources, Cenovus/Encana also has new dilbit

elds coming online but lacks upgrader or ren-

ing capacity to handle anticipated volumes.

Trafgura:• This scandal-ridden company is a

major player in Latin America petroleum trade.

It was at the center o the Iraqi Oil or Food

scandal and was ned one million euro or waste

dumping in the Ivory Coast.17 Its prime businessis import/export.18

Finally, the Motiva, Total and Valero reneries in

Port Arthur are within a Foreign Trade Zone, mean-

ing they are exempt rom customs duties on im-

ports and exports as well as various state and local

taxes.19 This amounts to a sizeable subsidy to the

oil industry to export rened oil products.



7


The tar sands-derived heavy sour crude that Key-

stone XL will deliver requires special equipment to

rene. Following a series o rets and upgrades,

Valero’s Port Arthur renery will be capable o

processing at least150,000 barrels per day o heavy

sour crude by late 2012. The renery is strategically

located near the proposed terminus o Keystone XL.

This slide outlines Valero’s strategy or the $1.5 billion hydrocracker at its PortArthur renery. It notes that the “main products are high quality diesel and jet uel or growing global demand” and that the renery is well located orexports. 21

Valero is able to process a very high proportion o

that heavy sour crude into diesel. Indeed, the up-

grades nearing completion at two dierent Valero

Gul Coast reneries involve hydrocrackers, which

can be calibrated to make 90 percent diesel.22

There is a surplus o diesel on the U.S. market dueto the much higher proportional demand or gaso-

line in the United States and the act that rening

crude oil results in a range o products, so that all

reneries are making diesel even i they are cong-

ured to prioritize gasoline.23

The Keystone XL pipeline would probably not have gotten o o the

drawing board without Valero. The rening company has the biggest single

commitment to the pipeline guaranteeing TransCanada a customer or at least

100,000 barrels per day, or 20 percent o Keystone XL’s capacity, until 203020.

The long-term binding commitments with Valero and ve other suppliers,reners and traders, the details o which remain condential, underpin the

commercial viability o Keystone XL.

Valero’s tar sands export strategy



8


However, in the global market, there is strong

demand or diesel because o the popularity o the

more uel-ecient diesel engine in passenger cars

in Europe and elsewhere. The growth market or

the global trade in petroleum products is domi-nated by diesel. Valero’s strategy o converting its

Port Arthur renery to maximize diesel production

through the processing o cheap, heavy sour crude

rom the Canadian tar sands is entirely ocused on

exporting the diesel into the global market.24

In this slide or investors, Valero outlines plans to export diesel and jet uelrom the U.S. Gul Coast while importing gasoline rom its newly acquiredrenery in the United Kingdom.25

Valero has also purchased a renery located in

Wales in the United Kingdom. The company stated

that it intends to import gasoline rom this renery

into the United States while exporting diesel and

other products rom its gul coast reneries.26 In

short, Valero’s strategy is to exploit arbitrage in the

Atlantic basin, selling gasoline into the U.S. market

while exporting diesel to Europe and both dieseland gasoline into Latin America.

The idea that Keystone XL enhances U.S. energy

security is undermined by Valero’s business model

that seeks to export products made with imported

oil while urther importing gasoline rom a third

country.

Not only is Valero increasing U.S. imports o oil

and gasoline, but it will also avoid paying tax while

doing so. The Port Arthur renery operates as aForeign Trade Zone (FTZ), which traditionally gives

tax benets to companies that use imported com-

ponents to manuacture items within the United

States.27 Usually reneries importing oil tax-ree will

still pay taxes when selling the rened products into

the U.S. market. By both importing into and export-

ing rom Port Arthur the company will avoid paying

tax on the product sales.

In sum, Valero appears to have positioned itsel

with a captive supply into an oshore tax-haven

where it renes product not or the United States,

but or oreign markets. Only the pollution stays

behind.



9


The additional crude (rom Keystone XL) strategi-cally aligns with our projects to increase ultra-low sulur diesel production at our Port Arthur refnery,which can process heavy eedstocks into cleanproducts.

Rich Marcogliese, executive VP andCOO, Valero Energy Corporation29

Long term, our strategy has always been to get Canadian heavy crude to the U.S. Gul Coast.

Bill Klesse, Chairman, CEO &President, Valero Energy Corporation30

Now, we also see long term that the Canadiancrude oil production will continue to grow. And even though this pricing and costs and all o that certainly are issues or the Canadian producers,part o our strategy is to bring Canadian crude oil to the U.S. Gul Coast. And as many o you that ol-low us know, we have been working with TransCan-ada and ConocoPhillips on the Keystone Pipelineproject to bring that type o crude oil, in our case,to Port Arthur, Texas. And we think that that will go.

Bill Klesse, CEO and Chairman, ValeroEnergy Corporation31

But the U.S. can compete and can compete espe-cially rom the U.S. Gul Coast in the export busi-ness… We have record exports coming rom theUnited States, now it’s over 800,000 barrels a day.Valero has been exporting over 200,000 barrels aday sending diesel uel to Europe. During the other season, we send diesel uel to South America (…)

So there is lot o change that’s happened in thisbusiness. Part o it has been refnery operationsin Venezuela and Mexico, some are not going tocome back anytime soon. Curacao, that refnery isdown. You just can look around a lot o places and see that there is an opportunity here to put prod-ucts into these markets…..

On our major projects, and we have more to show you on this, but we have our hydrocracker projectsthat we started. We actually ordered the equipment

in September o 2006. We stopped those projectsin 2009 because o the fnancial crisis recession.We’ve restarted those. We’re going to have thosefnished. The one at Port Arthur in mid-2012 and the one at St. Charles at the end o ‘12 and you’ll see here what a contribution they will make toour company. Because what they do and I’ll talk alittle more, but we primarily make diesel uel there… We want the diesel uel, because we see that’swhere the growth is…

Bill Klesse, Valero CEO and Chairman32

Now on the hydrocrackers, i you look at the world,diesel uel is growing at least two times aster thangasoline’s growing. It’s already a 25 million barrel-a-day business in the world versus gasoline in the 22 million or 23 million barrels a day. We’ve mentioned that the U.S. Gul Coast we believe we can export and i hydrocrackers, i we add one other point, youcan see that the diesel crack today is at least twicethe gasoline crack, maybe almost three times.

Bill Klesse, Valero CEO and Chairman33

Appendix:

Valero statements on refning Canadianheavy sour crude and exporting diesel

Valero’s own statements in regulatory disclosures and presentations to investors,

show that it plans to rene Canadian tar sands into uels or export. Valero is already

the largest exporter o petroleum products in the United States. In the rst quarter

o 2011, Valero exported 65,000 barrels per day o gasoline to Mexico and South

America and 165,000 barrels per day o diesel exports to Europe and Latin America28.

Valero expects its export trade to grow in coming years.



10


Endnotes1 http://uelfx.com/blog/2011/08/25/

pressure-builds-on-obama-to-reject-keystone-xl-pipeline/

2 Cambridge Energy Research Associateswere one o the frst to note the trend.See: http://www2.cera.com/news/details/1,2318,9568,00.html. Since then,the International Energy Agency hasnoted a declining demand trend or oilin the United States and OECD regionas a whole. See the World Energy Out-look 2009 and 2010 as well as the Me-dium Term Oil and Gas Market Report2010 and 2011. Also see the Peak OilMarket reports rom Deutsche Bank’s oilanalyst team: http://www.petrocapita.com/attachments/128_Deutsche%20

Bank%20-%20The%20Peak%20Oil%20Market.pd and http://bioage.typepad.com/fles/1223m-05.pd

3 http://www.whitehouse.gov/the-press-ofce/2011/07/29/president-obama-announces-historic-545-mpg-uel-ef-ciency-standard

4 http://bioage.typepad.com/fles/1223m-05.pd

5 Annual Energy Outlook, 2011. http://www.eia.gov/orecasts/aeo/index.cm

6 Crude oil is considered light i it haslow density or heavy i it has high den-sity; and it may be reerred to as sweeti it contains relatively little sulur or

sour i it contains substantial amounts o sulur.

7 Macquarie Equities Research, 10June 2011. U.S. Independent Refners:Why WTI crude price discounts willremain wide or years—it’s struc-tural. http://priceooil.org/wp-content/uploads/2011/08/Macq.US-Refners-06-10-2011-WTI-crude-price-discounts.pd

8 Drivers Behind Growing U.S. ProductExports & Shrinking Light-Heavy PriceDierentials. http://www.eia.gov/pub/oil_gas/petroleum/presentations/2011/aacsummit/aacsummit.pd

9 http://www.eia.gov/pub/oil_gas/petro-

leum/presentations/2011/aacsummit/aacsummit.pd

10 National Energy Board o Canada.Hearing OH-1-2009: TransCanadaKeystone Pipeline GP Ltd—Keystone XLPipeline. Sept. 15, 2009. https://www.neb.gc.ca/ll-eng/Livelink.exe?unc=ll&objId=550305&objAction=browse&sort=-name&redirect=3

11 The term “distillate” reers to diesel, jet uel, and heating oil.

12 Valero Energy Corporation. August2011 Investor Presentation. (See esp.

Slide 36.) Aug. 9. 2011. http://www.valero.com/InvestorRelations/Pages/EventsPresentations.aspx

13 Credit Suisse Group Energy Summit.

Valero Energy Corporation Transcript.

Feb. 10, 2011. http://www.alacrastore.com/research/thomson-streetevents-

Valero_Energy_Corp_at_Credit_Suisse_

Group_Energy_Summit-T3707584

14 Available at https://www.neb-one.gc.ca/ll-eng/Livelink.exe/etch/2000/90464/90552/418396/550305/556601/559187/564999/C-16-2_-_Writ-ten_Evidence_o_J.Malott_-_A1K7I5?nodeid=565000&vernum=0Last accessed on 29 August, 2011.

15 Shell Oil Company. Port ArthurRefnery. http://www.shell.com/home/content/aboutshell/our_strategy/ma- jor_projects_2/port_arthur/

16 Total Petrochemicals USA Inc. TotalExecutive Celebrates Transormation o Port Arthur Facility to Deep ConversionRefnery. May 5, 2011. http://www.to-talpetrochemicalsusa.com/press_room/May5Celebration_index.asp

17 http://www.guardian.co.uk/world/2010/jul/23/trafgura-dutch-fne-waste-export

18 http://en.wikipedia.org/wiki/Trafgura

19 U.S. Import Administration. U.S.Foreign Trade Zones: FTZ No. 116,Port Arthur, Texas. (Motiva Enterprises= Shell; Premcor Refning Group =Valero.) http://ia.ita.doc.gov/tzpage/letters/tzlist-map.html#texas

20 Government o Canada, NationalEnergy Board, Canada’s energy uture:inrastructure changes and challengesto 2020—an energy market assess-ment. October 2009. [‘CNRL and Valero have entered into an agreementwhere CNRL will supply crude oil to Valero refneries in Texas’]; Dow Jonesnewswires, Oil sands project delayscould be boon or US refners, 8 Janu-ary 2009. [‘Canadian Natural ResourcesLtd… agreed to supply ‘a major USrefner’ or 20 years via the Keystonepipeline. Several observers reckonthe partner is Valero Energy Corp’];

CNRL 2008second quarter results, 7August 2008. [CNRL has committed120,000 bpd to Keystone XL,100,000bpd o which it has agreed to supplyto ‘an unnamed Gul Coast refner’]---Gov o Canada report: http://www.neb.gc.ca/cl-nsi/rnrgynmtn/nrgyrprt/nrgytr/2009/nrstrctrchngchllng2010/nrstrctrchngchllng2010-eng.pd --Dow Jones report is on: http://www.downstreamtoday.com/news/article.aspx?a_id=14562&AspxAutoDetectCookieSupport=1 -- and CNRL’s 2Q-08

results are here: http://www.cnrl.com/upload/media_element/22/01/0807q2interimreport.pd

21 Valero Energy Corporation. August2011 Investor Presentation. Aug. 9.2011. http://www.valero.com/Investor-Relations/Pages/EventsPresentations.aspx

22 Valero, January 11, 2011. RefningTechnical Teach-in Transcript. http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDE3NDcxENoaWxkSUQ9NDMwMTE2FR5cGU9MQ==&t=1


24 See Valero Energy Corporation. August2011 Investor Presentation. Aug. 9.

2011. http://www.valero.com/Investor-Relations/Pages/EventsPresentations.aspx and Valero statements in investorpresentations in Appendix.



27 U.S. Import Administration. U.S.

Foreign Trade Zones: FTZ No. 116,Port Arthur, Texas. (Motiva Enterprises= Shell; Premcor Refning Group =Valero.) http://ia.ita.doc.gov/tzpage/letters/tzlist-map.html#texas

28 Valero Energy Corp at UBS Global Oiland Gas Conerence, 25 May 2011. CQFD Disclosure

29 4 September 2008. Session 1: Today’svision—tomorrow’s reality? Presentationgiven at the 40th Annual Engineeringand Construction Contracting Associa-tion Conerence in Scottsdale, Arizona.

30 Bank o America-Merrill Lynch RefningConerence, 10 March 2011. CQ FD

Disclosure.31 At Merrill Lynch Energy Conerence.3 December 2008. Voxant FD (FAIR DIS-CLOSURE).

32 Credit Suisse Group Energy Summit, 10February 2011.

33 Event Brie o Q3 2010 Valero EnergyCorp. Earnings Conerence Call, 26October 2010, CQ FD Disclosure.

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