Calculating The Impact Of The Keystone Pipeline

Frank Holmes
updated | Author's Website

Global markets have been tough in 2011 but I look forward to a strong 2012. To kick the year off, we’ve scheduled a special webcast with John Mauldin and our investment team to discuss our outlook for the coming year.

Make sure to register and add it to your calendar.

Mauldin is a wizard when it comes to markets and his annual outlook pieces are a perennial “must read” for global investors. His Thoughts from the Frontline e-newsletter is also distributed weekly to more than 1 million readers.

In this week’s edition, Mauldin shared his thoughts regarding the Keystone Pipeline that I thought you might find interesting. He begins with a short discussion from his book, Endgame, on the budget balance struggle that countries face when the private sector is deleveraging, and continues with a candid commentary on America’s dependence on energy and the impact of the proposed pipeline:

The desire of every country is to somehow grow its way out of the current mess. And indeed that is the time-honored way for a country to heal itself. But let’s look at yet another equation to show why that might not be possible this time. It is yet another case of people wanting to believe six impossible things before breakfast.

Let’s divide a country’s economy into three sections: private, government, and exports. If you play with the variables a little bit you find that you get the following equation. Keep in mind that this is an accounting identity, not a theory. If it is wrong, then five centuries of double-entry bookkeeping must also be wrong.

Domestic Private Sector Financial Balance + Governmental Fiscal Balance – the Current Account Balance (or Trade Deficit/Surplus) = 0

(By Domestic Private Sector Financial Balance we mean the net balance of businesses and consumers. Are they borrowing money or paying down debt? Government Fiscal Balance is the same: is the government borrowing or paying down debt? And the Current Account Balance is the trade deficit or surplus.)

The implications are simple. The three items have to add up to zero. That means you cannot have surpluses in both the private and government sectors and run a trade deficit. You have to have a trade surplus.

Thus the problem of Greece, with its massive trade deficit and huge fiscal deficit. They have no choices but default or depression.

The U.S. has two main sources of its trade deficit: energy and China, in roughly equal proportions. If we reduce our energy dependence, we can get the trade deficit below 2% of GDP.

The China problem is not simply one of reducing our trade deficit with China, as much of what China makes and sells to the U.S. is sourced in countries outside of China. While the final manufacture is perhaps in China, the bits and pieces come from other parts of Asia. The true cost of a product from China is less than 20% actual Chinese value added. An example is the Apple iPhone, which is assembled in China but whose most costly components come from elsewhere in Asia. Direct Chinese costs are less than 4%, but the entire amount is “attributed” to China in calculating the trade deficit.

The real problem is the demand in the U.S. for cheaper goods. If the U.S. were to pass a tariff on Chinese-manufactured goods, then production and buying would shift to other countries without the tariffs. Markets look for the lowest-price source. For a tariff to be truly effective, it would have to be on the product and not the source country. And the only way to do that is to start a trade war. That is typically not a good way to promote free markets and general prosperity. Think Smoot-Hawley in the 1930s.

On the other hand, the U.S. can do something about its energy dependence. We are blessed with abundant energy, if we simply exploit it in a responsible manner. And doing so would directly create hundreds of thousands of jobs, many of them quite high-paying, and many more hundreds of thousands of jobs servicing those employed and their companies.

Which brings us to the rather strange case of the Keystone XL Pipeline project. For non-U.S. readers, this is to be a 1,700-mile pipeline designed to connect Canada’s oil production in the province of Alberta with the U.S. Gulf Coast. The various government agencies of the current U.S. administration approved the project, after exhaustive environmental impact analyses. President Obama overruled his subordinates, postponing a decision until 2013, after the next election. Even though labor unions (normally thought of as Democratic and Obama allies) actively supported the project (as it means lots of jobs), various environmental lobbies were against it, and Obama apparently gave into them. (That is not just my opinion, but widely assumed, even by Democratic supporters.)

This issue has raised a few questions from international readers, wanting to know why so many people (the large majority of US voters, if polls are right) are seemingly willing to hurt the environment simply for the purpose of transporting oil. Wouldn’t a new pipeline create a whole new host of environmental dangers? What were we thinking?

As it turns out, a new pipeline is not all that radical. If you drive in the U.S., you cannot go ANYWHERE for any length to time without crossing dozens of pipelines that already exist, especially in the corridor where they want to build the Keystone XL pipeline.

Let’s look at two maps. The first is a map of natural gas pipelines in the U.S. To say it looks worse than your grandmother’s varicose veins is no exaggeration. It is hard to find a state that does not have a natural gas pipeline. Without them the U.S. would simply come to a grinding halt. (The source for this map is a governmental agency, the U.S. Energy Information Administration.)

Pipelines in the U.S. map 122111

 

The next map is just the major oil pipelines. If you were to add in all the small (8-inch or less) lines connecting minor oil fields, you could not distinguish between the lines in certain areas, as we will see in the third chart.

Crude Oil and Refined Products Pipeline

This next chart I throw in because it also shows the rather extensive pipeline system in Canada. This chart combines commodity pipelines of all kinds. The point is that we have the technology to build pipelines safely and in an environmentally reasonable way. When was the last time you heard of a serious pipeline disaster, or even a small one? Yes, the BP oil rig certainly comes to mind, but that was human error and not the fault of technology. Just as the large majority of airplane accidents are pilot error, you do everything you can to minimize the impact, and require safety procedures. But people screw up every now and then.

PennWell MAPSearch Pipeline Coverage

This is not to dismiss the problems and environmental concerns of drilling for petroleum products, or mining for various minerals. There needs to be strict controls on all such activities, with real penalties. You can see from the maps that my home state of Texas has a lot of pipelines and wells. The problems with pollution in the early development phase here in Texas were well-known. Now there is a very aggressive and popular regimen of control of drilling and transportation of oil and gas. We have to live next to the wells and pipelines. No one wants their water or land destroyed.

Now, let’s circle back to the Keystone Pipeline. We started this section with a reference to trade deficits. And this is Canadian oil, not U.S. oil. So it does not help our trade deficit directly, although a large portion of U.S. dollars that go to Canada come back to the U.S. Canada is far and away our largest trading partner and major energy supplier.

The problem is that the opposition is mainly of the “I don’t like any carbon-based energy” variety. Whether it is coal or oil or natural gas, it is not as “clean” as solar or wind.

The problem is that solar and wind simply cannot produce enough energy without huge government subsidies, at least with current technology (although that will change over time). In the meantime, if we want to balance our budget in the U.S. (and we must!), we are going to have to become energy independent as one part of the solution. In the short term (10-15-20 years), that means carbon-based energy. If we can produce our energy in the U.S., and we can, then why not create the jobs here rather than elsewhere, if jobs are our #1 political concern, as they seem to be, according to the polls? Further, in the short term, as Mexican production is falling rather fast, we are going to need that Canadian oil if prices are not going to rise.

(Note: in my book, I actually call for a slowly rising energy tax on gasoline usage, to be solely used for rebuilding our decaying infrastructure, so I am not against higher prices per se. I just want the reason for higher energy costs not to be shortages. But that’s another story for another day.)

In the “payroll tax cut” bill that will be passed in a few days here in the U.S., Congress will require the President to make a decision by the end of February on whether to allow the Keystone project. I hope they do pass it, and I hope he does decide to allow it.

But let’s not think that this one more pipeline is going to destroy the environment of the U.S. It might create competition for some U.S. producers, but if you can’t live with competition then you’re in the wrong country.

The U.S. is in a very deep hole. We need to stop digging and start figuring out a way to climb out. The world is sadly going to see what happens when Europe has to resolve its current crisis, one way or another, and what that will mean for world GDP growth. Then, I am afraid, Japan will be the next crisis in waiting.

The world can ill afford for the U.S. to be the third major economy to implode. The world is far too connected to shrug off such problems.

Register for Outlook 2012 Webcast

Follow the event on Twitter #Outlook2012

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. The following securities mentioned in the article were held by one or more of U.S. Global Investors Fund as of September 30, 2011:  Apple.

By clicking the links above, you will be directed to a third-party website. U.S. Global Investors does not endorse all information supplied by this website and is not responsible for its content.

You may also like: