Analysis: Spills flame Canadian oil debate, but won't curb flows to U.S

Two high-profile oil spills won't stem the now-record flow of Canadian oil into the United States, despite the frenzy that the spills triggered among friends and foes of the Keystone XL pipeline to the main U.S. refineries.

The fate of Keystone remains undecided, yet Canadian crude will become an increasing part of the U.S. energy mix, despite growing competition from new U.S. production.

U.S. thirst for Canadian crude has shot up nearly 30 percent over the past five years as refiners opt to buy from the north instead of bringing in more expensive OPEC oil, thanks to a boom in production from the vast Alberta oil sands.

Midwest refiners have invested billions of dollars to tweak plants to take more of the heavy crude from the region, and a small but growing network of rail routes have sprouted up to augment existing pipelines.

So even as environmentalists seized on oil spills last week in Arkansas and Minnesota to warn about the impact of expansion in the tar sands -- the world's third-largest crude deposit -- it appears only a crash in the price of oil or unexpected regulation will derail the growing energy interdependence.

"Short-term, this is not good for producers, it's not good for Canadian oil going south, it's not good for Keystone," John Stephenson, vice-president and portfolio manager at First Asset Investment Management in Toronto said of the two spills.

"But I think the reality is this oil is going to make it south of the border, quite likely by rail or one of the other pipelines across the Canadian-U.S. border, so I see it as a short-term hiccup at worst."

Canada's black gold has allowed the Obama administration to crow about dwindling reliance on oil from less-friendly suppliers in the Middle East and elsewhere. In addition, a glut of the Canadian heavy oil has tempered higher gasoline prices, especially in the U.S. Midwest.

That may trump increasingly bad PR for Canada's oil, much of which is produced by energy- and carbon-intensive methods such as mining or steaming, making it a prime target in the battle over policies to fight global warming.

Yet the growing role of Canadian crude in the U.S. economy cannot be denied. Overall U.S. oil imports fell to 8.5 million barrels a day last year from over 10 million in 2007, but supplies from Canada jumped to 2.4 million barrels a day, from just under 1.9 million, over the period, according to the U.S. Energy Information Administration.

That puts Canadian crude at nearly 29 percent of foreign supplies in the United States, despite the remarkable increase in U.S. domestic light oil output from regions such as the North Dakota Bakken that has fueled predictions of North American energy self-sufficiency in 15 years.

In fact, the two types of crude compete little for refinery space, as Canada's heavy crude is being directed at U.S. Gulf Coast plants that are configured to process heavy oil, which now arrives in dwindling volumes from Venezuela and Mexico.

"If that's the case, then Obama's left with not an energy choice -- he's left with a geopolitical choice," said Michal Moore, director of energy and environmental policy at the University of Calgary's School of Public Policy and a former California energy regulator.

"Do you want to piss off Canada by not letting oil into the refineries that can handle it most easily? I don't know how he makes that judgment but I will say that this doesn't help."

Other refiners have also invested to process more feedstock from Canada, with BP sinking $4 billion into its Whiting, Indiana plant to take more of the heavy, sour oil.

In addition to heavy tar sands oil, Canada also exports large volumes of conventional lighter crude.

In January, the U.S. imported over 1.5 million bpd of heavy Canadian crude, defined by the Canadian Association of Petroleum Producers as having an API Gravity of less than 27 degrees, and nearly 1.15 million bpd of lighter, easier to refine oil, according to the EIA.

PIPELINE, RAIL ACCIDENTS

Last week's spills both involved oil from Canada.

On Friday, Exxon Mobil Corp's aging Pegasus pipeline ruptured in Arkansas, forcing a cleanup of thousands of barrels of heavy Canadian oil that leaked into a suburban neighborhood.

The incident followed an oil spill in rural Minnesota on Wednesday after a Canadian Pacific Ltd train derailed. The tanker-car leaked several hundred barrels of Alberta crude and reignited concern about oil moving by train as pipeline capacity lags production growth.

Producers shipped about 45,000 barrels of Canadian oil into the United States by train last year, up from almost nothing just five years earlier, based on Reuters calculations of data from Canada's National Energy Board. Current shipments could be as much as 150,000 barrels a day, estimated Steven Paget, analyst at FirstEnergy Capital Corp.

The spills are the latest in a string of problems for shippers of Canadian crude that have inflamed the debate over the oil sands. The largest spill was the Enbridge Inc line break in Michigan in 2010, which sent more than 20,000 barrels of Canadian oil into the Kalamazoo River system.

U.S. regulators last month ordered Enbridge's U.S. affiliate to do more cleanup at the site, pushing the bill to near $1 billion.

TransCanada Corp , backer of the long-delayed $5.3 billion Keystone XL pipeline to Texas refineries from Alberta, and the line's supporters, say oil spills highlight the need for safer energy infrastructure rather than a shift from pipelines.

"I don't think it will have an impact (on Canadian exports and the approval of pipelines). Look, it's being seized on by those who oppose hydrocarbon development, but if you follow their logic to its conclusion, what they're saying, I guess, is they don't want to see any pipelines built," Canadian Natural Resources Minister Joe Oliver said of the Arkansas spill.

"It's not because of Canadian crude that there was a spill. It was an old pipeline, more than 60 years old."

Oliver has led Ottawa's intense lobbying campaign in favor of the 830,000 barrel a day Keystone XL project, which will take Canadian crude to Gulf refineries. Washington is set to decide on the line this summer and it could be in service in 2015.

PRODUCTION PREDICTION

All predictions are for a steady climb in Canadian production, explaining the industry and government's quest for new markets in the United States and non-traditional areas such as Asia, one of the biggest drivers engines of world oil demand growth.

Canada's National Energy Board has predicted output will average 3.6 million barrels a day this year, up 12.5 percent from 2012, putting it nearly 400,000 barrels a day ahead of No. 2 OPEC producer Iraq's current output.

The industry sees a jump in output to 4.7 million barrels a day by the end of the decade, with new pipelines such as Enbridge's contentious Northern Gateway to Canada's Pacific Coast and TransCanada's Energy East line to the Atlantic provinces planned to move much of the increase.

Last week, Wood Mackenzie, the energy research firm, predicted output of bitumen from the oil sands, will increase by 540,000 barrels a day over the next two years.

Almost three-quarters of that will come from projects that have already been approved and have a break-even oil price below $60 a barrel, WoodMac said. The current price for Canadian heavy oil is about $80 a barrel.

(Additional reporting by Scott Haggett in Calgary and Patrick Rucker in Washington; Editing by Janet Guttsman, Matthew Robinson and Leslie Gevirtz)