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John M. Devir
Who is the most unpopular American citizen in Canada? It depends on whom you ask. The average Canadian citizen would almost certainly say Gary Bettman, commissioner of the National Hockey League. He has been criticized for “Americanizing” hockey by expanding into non-traditional markets in the South and Southwest at the expense of more traditional markets in Canada and the Northern U.S., as well as his role in three labor stoppages. At this writing, the 2012-2013 season is in danger of being canceled (à la the 2004-2005 season) – it may be a long cold winter for hockey fans. If you asked the same question to political leaders or management teams within the Canadian energy sector, however, they might respond, somewhat surprisingly, President Barack Obama (with Bettman likely not far behind). The reason: Obama’s unexpected delay of a presidential permit for the Keystone XL pipeline in November 2011. It has been more than a year since President Obama’s controversial decision to delay approval for the permit for the construction of TransCanada’s Keystone Pipeline. At the time, President Obama suggested the delay was necessary to ensure all environmental issues would be properly addressed and understood, though we and others believe the “no-decision” was motivated primarily by the administration trying to maintain the favor of sections of the Democratic political base ahead of the November 2012 election. Additionally, by delaying construction of the proposed $7.5 billion, roughly 1,700-mile oil pipeline from Hardisty, Alberta to the U.S. Gulf Coast, U.S. railroads have benefitted as the primary source of transportation of crude oil from North Dakota to key demand markets in Oklahoma and Texas. Burlington Northern Santa Fe, owned by Warren Buffet’s Berkshire Hathaway, was among the big winners. None of the drama, bad press and “unintended” consequences of the Keystone XL delay were lost on our neighbors to the north.Our job at PIMCO has been to recognize the importance of this delay and how, over a long time horizon, it has dramatically altered the flow of crude oil and capital within the midstream energy sector – i.e., companies that transport product from the source and before end use. In this outlook we discuss the shift in Canadian energy policy that has occurred since the delay of Keystone XL, the potential impact on the United States’ ability to achieve energy independence over the next decade, and investor opportunities surrounding the pipeline projects that are being contemplated in the wake of these developments. Pipeline delay sparked dramatic shift in Canadian energy policy and capital budgets The delay in Keystone XL and the barrage of protests and negative press served as a major wake-up call in Canada. It was viewed as a slap in the face to the Canadian government and TransCanada Corporation; Prime Minister Stephen Harper has since publicly commented that Canada should be looking to expand export capability to growing markets in Asia-Pacific, or Canada will run the risk of stunting the development of its oil industry in Western Canada. As a result, a number of proposals have been made to build or expand pipelines to ship oil to the British Columbia coast, including Enbridge’s Northern Gateway Pipeline and Kinder Morgan Energy Partners’ Trans Mountain Pipeline expansion. However, these projects are certain to face considerable political and environmental hurdles from Canada’s First Nation communities. Assuming both of these pipelines were built and in-service by 2018, Canada would be capable of exporting close to 30% of its crude oil to Asia-Pacific.The North American energy boom: Do you believe in miracles?We believe the recent explosion in North American (which we define as the U.S. and Canada – two major producers with closely aligned markets) crude oil production is a “game changing” event which will have long-term impacts on global supply and demand and over the next 12 years lead North America to the Promised Land: energy independence. Based on current forecasts, North American crude oil production is expected to increase at an average rate of 6% per annum from 2012 to 2020. According to Bentek Energy, non-U.S., non-Canadian waterborne imports will decrease from approximately 50% of crude oil supply in 2010 to 14% in 2017 and to only 5% in 2022. Additionally, from 2012-2020 approximately half of all incremental global crude oil production – roughly 4.5 million barrels per day (bbl/day) – will emanate from North America. This projected growth will be particularly meaningful for the U.S. A recent report published by the International Energy Agency stated that rising oil output by the U.S. is “nothing short of spectacular” and will exceed that of Saudi Arabia or Russia by 2017. Based on current production forecasts, we believe U.S. energy independence is achievable by 2025 – though the U.S. will likely continue to import from Canada. This is certain to have dramatic ripple effects on U.S. manufacturing, foreign policy, defense spending, the U.S. current account balance and the nation’s looming budget deficit. Even if these growth expectations prove to be overly optimistic, onshore production growth in North America will provide a meaningful opportunity for the U.S. to dramatically wean itself away from non-Canadian waterborne imports.
“Converting existing pipe versus building new pipe is important because if you’re building new pipe you’re talking about trying to make a 10-year commitment that may not start for two to three years from now by the time it gets built. So you’re talking about a 13-year period, whereas conversions can happen faster than that, and that’s what producers want right now. They want near-term relief.”
Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities. PIMCO may or may not own the securities referenced and, if such securities are owned, no representation is being made that such securities will continue to be held.
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2014, PIMCO.
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