Markets hunger for Canadian bitumen, not refined oil

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What is it about Canada's natural resources that make normally sensible people take leave of their business and economic senses and clamour for policies that sound good, but a moment's analysis reveals as a fraud and a chimera?

Natural-resource nationalism, the idea that "our" natural resources should go through every stage of processing within Canada, is one such policy. People as diverse as author Jeff Rubin, West Coast newspaper publisher David Black, trade union leaders, consumer advocates and many others believe Canada is somehow "losing out" when it exports bitumen from the oil sands, for example, rather than refined products like gasoline and jet fuel. Many of them look at the discount on Western Canadian oil and, misunderstanding its significance, agitate for that oil to be shipped east where it will prove a boon for consumers.

Both ideas are quite wrong.

Take the oil sands, for example. The oil sands do not produce oil, but a tarry sandy substance called bitumen, which contains oil. To refine the bitumen, you need to upgrade it to a refinable state (so-called synthetic crude); that takes either an upgrader or a coker. To make refined products, then, is an expensive two-stage process compared with ordinary crudes that can go straight to refining.

Even that suggests that one crude is easily substitutable for another. Not so. Refineries are generally designed to handle a particular crude, or more often a blend of crudes with specific characteristics, like their sulphur content. To change from one crude to another often requires a complex and expensive refinery refit.

Put all that in the context of an open North American market for refined petroleum products in which demand has been falling, not rising, uneconomic refineries have been closing (four in North America last year alone) and those remaining have been increasing their capacity to capture economies of scale and compete with imports. Cheap refining capacity, in a perfect illustration of the power of globalization, has been under construction in Asia, with North America part of its target market.

The people who are promoting more refining in Canada are therefore doing so in the face of excess local refining capacity that is not especially competitive against rising Asian refiners. These are hardly propitious circumstances in which to build new refineries, or even to spend the billions necessary to wean Eastern Canadian refiners off imported oil and on to bitumen. There are no upgraders east of Alberta, and only one refiner, Imperial in Sarnia, Ont., has a coker.

By contrast, there is spare capacity on the U.S. Gulf Coast that already refines heavy oil products from places like Mexico and Venezuela. That is the business case behind Keystone XL and the rail and barge traffic moving our bitumen south. The case for spending billions to build new refining capacity in Canada is thus weak. If there was money to be made in more Canadian refining, companies would be willing to put billions into it. Instead they often struggle to keep open the refining capacity they have.

What about the idea that the discount that applies to Western Canadian oil products means that eastern consumers would benefit from cheaper gasoline if the oil could be brought east?

This misunderstands both the reasons for the discount and the nature of the market for refined products.

The discount simply reflects our inadequate infrastructure. If the oil cannot reach world markets, that creates a localized oil glut and brings down the local price. Remove the transport bottlenecks, however, get that oil to where the entire world can bid for it, and the discount unrelated to the quality of the petroleum itself will disappear.

That's what piping western oil to Montreal or Saint John does: Bring it to world markets because it can just as easily be exported as it can be refined locally. And if it is bitumen in the pipeline, the capacity to process it in the east doesn't exist in any case, except in Sarnia.

As for discounted crude resulting in cheap gasoline for consumers, it is a fiction. Gasoline and other refined products are commodities; those who make them sell them for the prevailing price in an increasingly global market. Cheap local feedstock thus improves the profitability of refiners, and any price differential between Eastern and Western Canada is explained almost entirely by taxes and transportation costs, not the cost of crude.

The failure of the National Energy Program taught us that we get the best value from our resources when we let markets, not politics, guide our decisions. Markets hunger for our bitumen. Refined products are a much different story.

Brian Lee Crowley (@brianleecrowley) is the Managing Director of the Macdonald-Laurier Institute, an independent non-partisan public policy think tank in Ottawa: www.macdonaldlaurier.ca.