Keystone XL Pipeline Benefits are Linked to the USMCA
Last month, the Ninth Circuit Court of Appeals dismissed a legal challenge to the construction of the Keystone XL pipeline. While opponents of the pipeline’s construction promise to continue their legal fight to block the building of the pipeline, the Court’s ruling substantially increases the likelihood that the project will be undertaken.
The Keystone XL Pipeline project is a major cross-border infrastructure initiative that will connect heavy crude oil production locations in Alberta, Canada to refining centers on the U.S. Gulf Coast. This expansion of pipeline capacity would be of enormous economic benefit to Canadian oil producers whose profitable exports to the U.S. have been throttled by pipeline capacity constraints.
It would also benefit U.S. Gulf Coast oil refiners that can more profitably refine heavy crude oils from Alberta than more expensive light crude oil produced in the U.S. At the same time, U.S. producers of light crude oil can export more of their product at higher prices than they receive from selling incremental barrels in the domestic market.
The construction of the Keystone XL Pipeline will also provide broader direct and indirect economic benefits to the U.S. and Canadian economies by reinvigorating the integration of the North American oil and gas sector. One major benefit is lower costs of petroleum products such as gasoline and fuel oil resulting from increased efficiencies in transportation and production. A second is increased security of supply which allows users of crude oil products, as well the U.S. government’s strategic petroleum reserve, to economize on inventories of petroleum and petroleum products.
Current threats by Iran to disrupt oil shipments through the Strait of Hormuz underscore the importance of having a secure and ample supply of North American crude oil. Indeed, security of supply was an important impetus for the creation of the North American Free Trade Agreement (NAFTA). That imperative seems to have been forgotten during the recent era of relatively low and stable crude oil prices.
The economic benefits of the Keystone XL Pipeline will be substantially diminished, however, if the U.S. Congress fails to approve the U.S. Mexico Canada Agreement (USMCA). While the USMCA does not contain a separate chapter focusing on energy, it retains key provisions from NAFTA that contributed to greater integration of the energy sectors of the North America neighbors, including increased trade in energy products among the NAFTA partners. For example, the USMCA will keep oil and gas products such as gasoline tariff-free. It will also reduce tariffs on thinning materials that help crude oil pass through pipelines running between Canada and the U.S.
Additionally, implementation of the USMCA by all three signatory countries will sustain and even improve the environment for capital investment in the North American energy sector. In particular, the USMCA maintains the investor-state dispute settlement process as it applies to U.S. oil and gas firms operating in Mexico. This legal provision reduces political risk facing U.S. companies investing in Mexico by allowing U.S. investors to sue for financial damages in the event of regulatory takings by the Mexican government. Reduced political risk should directly encourage capital investment by effectively reducing costs of capital for U.S. oil and gas companies doing business in Mexico.
Implementation of the USMCA might also indirectly stimulate capital investment by reducing tensions and uncertainties surrounding the North American trade and investment environment resulting from the rancorous negotiating process surrounding the USMCA. Tariffs imposed by the Trump Administration on U.S. imports of steel and aluminum from Canada and Mexico, as well as retaliatory tariffs on U.S. exports by the latter two countries created additional trade frictions that continue to weigh on business decision-makers contemplating how best to deploy financial capital to expand their business activities.
Failure of the U.S. Congress to approve the USMCA will significantly accentuate uncertainties about the future legal environment surrounding international business activities that currently plague corporate investors. These uncertainties have ratcheted up substantially in recent years. By way of illustration, since President Trump’s election in November 2016, an index (compiled by Northwestern, Stanford and University of Chicago academics) of U.S. trade policy uncertainty increased nearly five-fold relative to 2013-2015. This index shows no other comparable surge except from 1992-1994, which was associated with concerns surrounding the passage of NAFTA. Additional evidence shows that a substantial percentage of U.S. companies are reviewing, postponing or dropping planned capital expenditures as a consequence of trade policy concerns.
Any efficiency gains from further integration of the North American oil and gas sector will require substantial capital expenditures by the private sector. Ongoing uncertainty surrounding the implementation of the USMCA will therefore mitigate the economic benefits that might be otherwise be expected from the construction and operation of the Keystone XL Pipeline.
Steven Globerman is an Emeritus Professor of Economics at Western Washington University.