Last Friday, the U.S. State Department released its draft environmental review of TransCanada's proposed Keystone XL Pipeline. Its conclusions raised hackles on both sides of the controversy over the pipeline's construction, and left Keystone's ultimate fate hanging in the balance. The Obama administration's decision – which will come sometime after a 45-day public comment period – will have significant implications for investors.
Drill, baby, drill
Many companies stand to benefit from an increase in Canadian oil sands development. Weatherford International (NYSE: WFT ) , a multinational oil-field service company, derives about 9% of its revenues from Canada. Weatherford offers a variety of products to facilitate oil sands development, and has approximately 7% exposure to Canadian fields, according to investment analysts at Jefferies.
Precision Drilling (NYSE: PDS ) , Canada's largest land drilling contractor, makes rigs that are effective in developing unconventional resources. The company sees unconventional drilling as its primary opportunity in North America. Precision has 45% exposure to Alberta oil development, according to Jefferies analysts.
And then there's Valero Energy (NYSE: VLO ) , which would love the pipeline most of all. Valero has been a vocal supporter of Keystone XL. The company has plants that are configured to process heavy crude like the kind derived from Canadian oil sands. Pressure group Oil Change International (OCI) reports that in accordance with Valero's stated export strategy, the company "has locked in at least 20 percent of the pipeline's capacity." Furthermore, "because its refinery in Port Arthur is within a Foreign Trade Zone, the company will accomplish its export strategy tax free." (While Valero took issue with other elements of OCI's report, it did not dispute these points.)
The theory goes that the Keystone XL Pipeline will open up further development of Canadian oil sands, thereby benefiting companies such as Valero, Weatherford, and Precision. Proponents estimate that the pipeline would increase production by 50%, from 2 million barrels per day to almost 3 million. But here's the thing: The State Department doesn't think Keystone will increase oil sands development.
No impact – really?
The State Department's report finds that "approval or denial of the proposed Project is unlikely to have a substantial impact on the rate of development in the oil sands, or on the amount of heavy crude oil refined in the Gulf Coast area. ... [C]limate conditions during the 1- to 2-year construction period would not differ substantially from current conditions." Effectively what they're saying is that the Keystone XL Pipeline will neither contribute to climate change – which environmental groups fear – nor increase domestic oil production – which pipeline supporters say is the key to energy independence.
Unsurprisingly, many stakeholders dispute these conclusions. In a fascinating turn of events, both environmentalists and pipeline proponents are broadly making the same argument – that the Keystone XL Pipeline will have an impact. Greens emphasize increased emissions, while oil and gas interests highlight job creation and energy independence. Nobody likes the State Department's conclusion that the pipeline kind of doesn't matter.
The little engine that could
One of the lynchpins of the State Department's analysis is that rail transport of heavy crude from Canadian tar sands could be a viable alternative to the pipeline. Basically, the reasoning here is that if the pipeline doesn't happen, rail will, so the net result is a wash. If that analysis holds, Greenbrier Companies (NYSE: GBX ) – a freight car equipment maker – stands to gain handsomely if the Obama administration rejects the pipeline.
Demand has exploded for tank cars to transport crude by rail from Western Canada to U.S. refineries, and order backlogs are deep. Superstar investor Carl Icahn disclosed a 9.9% stake in Greenbrier last November, and Warren Buffett has put his money on crude-via-rail by way of a controlling stake in Union Tank Car and ownership of crude shipper BNSF Railway.
Jack Isselmann, Greenbrier's corporate relations director, thinks the company will prevail regardless of the pipeline's fate. "Our view is that some of the producers appreciate the benefits of crude by rail, and will stick to crude by rail, even if the pipeline capacity is online," Isselmann told the Financial Post.
The little engine that couldn't
Not everyone buys the rail alternative story. The Natural Resources Defense Council (NRDC) lays out a convincing analysis to the contrary. In a separate article, NRDC argues that one reason rail cannot supplant the pipeline is the fact that only a special type of rail car can be used to transport the bitumen from oil sands, and these are on an 18-month to 2-year waiting list for delivery. Greenbrier makes such cars. Seems the company should be in good shape for the near future, at least.
America, heck yeah!
Pipeline proponents argue that it will increase U.S. energy independence. American Petroleum Institute spokeswoman Sabrina Fang argues the Keystone XL Pipeline will "help reduce our dependence on oil from less stable parts of the world."
But I think OCI has it right on this one: "The oil market is fundamentally global. The only way to truly reduce our dependence on foreign oil is to reduce our dependence on all oil." As a long-term investor, I expect that our economy will continue shifting toward more sustainable energy sources. I'm not alone in betting that renewables will blossom in 2013.