It seems like a common sense argument to state that a raw resource becomes more valuable if it is manufactured into a refined product. Yet this assumption remains a controversial one in 2018, especially when it comes to crude oil and pipeline politics. Stewart Muir shares his research.
British Columbia's premier, John Horgan, has been arguing that oil pipelines are bad if they result in a "raw" commodity, crude oil, being exported because it means exporting manufacturing jobs that should be kept at home.
This is a widely heard viewpoint that resonates for many. It plays particularly well among blue collar workers dismayed at the long-term decline of domestic factory jobs. Some environmentalists have taken it up as well, supposedly on the basis that a refined product is going to be safer for marine transportation.
I used to be swayed by those arguments. However, in acquiring more knowledge over the past several years, I've come to see the situation very differently and I'm going to lay out below how I came to this understanding. Given what's at stake in the current pipeline conflict, I'm hoping this can be a useful contribution to the discussion.
One of the first questions to ask in understanding this viewpoint better is whether there are enough refineries in Canada already. Almost immediately we can see that it's not simply a question of how many, but where they are located. The current situation is that Canada has 14 full refineries and two asphalt refineries:
The big refineries are mostly in the east. Those in central and eastern Canada mostly process lighter crude oils, with western refiners more focused on locally available oil sands crude.
Because of Canada's relatively small population, the high capital demands and long-term payback period for refining are problematic. Canadian refineries are smaller because of the country's smaller scale, and overall they are running below capacity. Consumption of refined products is under pressure from improving vehicle fuel efficiency. Not exactly conditions for an investment bonanza. Says the Canadian Fuels Association: "Recent studies by the Conference Board of Canada and Baker & O’Brien demonstrate that, overall, Canadian refineries are already in a tough fight to remain competitive and economically viable."
The refineries in western and central Canada receive the majority of crude oil via pipeline, according to the National Energy Board (NEB), with smaller volumes transported by rail. In Atlantic Canada, most of the crude oil is delivered by tanker with smaller volumes transported by rail.
Canadian refineries have different characteristics depending on their location. Generally, refineries are located on major waterways, near major cities or near crude oil production, for these reasons according to the NEB:
- Being on a major waterway gives a refinery access to offshore crude oil as well as export market access for its refined products.
- Being close to a large city provides a market and lowers the cost of transportation.
- Being close to crude oil production gives a refinery ample local supply at low transportation costs.
This is true internationally as well. For example, a new $45 billion refinery proposal in India is sited close to Mumbai in a state with 114 million people. Rather than purchase gasoline, diesel, kerosene etc. and ship it in separately from faraway refineries, the proponents seem to believe it will be more efficient to create such diverse products close to where they will be consumed.
One of the domestic trends in Canada is toward bigger, and fewer, refineries. Until last year, no new refinery had been built in 30 years. Two distinct trends can be seen in the chart here:
As this shows, the average capacity per refinery in Canada has increased while there has been a decline in the number of total refineries. In recent years, three refineries in the east closed, for a whole host of reasons given by the NEB:
- Age and complexity
- Changing environmental regulations for gasoline
- Overall declining demand for refined petroleum products
- A broad, long-term trend of smaller refineries closing and consolidating in favour of larger, more complex ones.
One project did buck the trend. In late 2017, the Sturgeon Refinery located northeast of Edmonton began operations. Its end purpose is to process diluted bitumen into ultra-low sulphur diesel fuel and other high-value products, including diluent. The dilbit for the plant will come from the Alberta government and Canadian Natural Resources. (As of December 2017 the plant was not fully built out and could only process synthetic crude oil, not bitumen.)
At present, there isn't much refining capacity in Canada for heavy oil, or for bitumen. As a result, we have to export most of the bitumen, which is actually a good thing because being able to get into new markets beyond the United States is how we can increase the market value of the commodity. The pie chart below left shows that of all the oil bought by Canadian refineries to turn into other products, just 6 per cent was bitumen.
The chart above right shows that raw bitumen production overall, irrespective of its destination, is much greater than that. Why don't refineries use more of such a plentiful commodity? Oil refining is a capital-intensive business, and the more recent rise of bitumen production in Canada means that older plants designed for lighter crudes are not easily adapted. Planning, designing, permitting and building a new medium-sized refinery is a lengthy process, according to the CFA, and costs billions.
It's not as if nobody has been trying to build a new refinery in British Columbia. Far from it. Over the past five years, two major refinery proposals have been brought forward on the British Columbia coast. I know of one other early-stage concept that has been talked about. Yet in no case has the necessary capital come together, as yet, to allow any of them to move forward. I'm not saying there is no potential in those propositions. Given the right conditions, they might very well become viable, and it would be great for Canada if that happened. But for the moment it is nonsensical to say a new refinery is waiting in the wings if only the Trans Mountain pipeline could be cancelled.
There is quite a bit of irony in seeing a premier oppose a pipeline project whose investors are practically begging for the chance to put their dollars to work, while at the same time he is touting the appeal of projects for which support is nowhere to be seen, to serve a domestic market that is declining.
It's worth reflecting on whether some of those purporting to be in favour of BC export refineries are genuinely in favour, or merely say they are in an attempt to draw away public support for the pipeline twinning. After all, adding refineries would mean increased total emissions output and they still require pipelines. Pipeline opponents are usually climate activists who insist on prohibition (while vehemently opposing innovation) to solve the very real problems resulting from greenhouse gas emissions. To think that they would genuinely maintain support for new refinery projects after killing the pipeline project is too much of a stretch. It's hard to believe a seasoned politician like Premier Horgan would be treating this at face value.
However, there is a more general question here as well. It revolves around how hard we need to try to add more value to the types of export commodities that continue to form the basis of our economy. I don't question the sincerity of those who genuinely believe that the more value you add, the more money you'll make.
Isn't that pine table at Ikea a better representation of economic efficiency than the log it came from? Shouldn't we be, as a nation, trying to be the table guys, not the log guys? Makes sense, right?
As one who has found it hard to resist the logic of that statement, I finally had to admit a few years ago that I was quite wrong about it, and here's why.
The real economic richness of the Canadian resource sector is rarely to be found in the more visible forward extensions of the value-added chain, i.e., closer to the end consumer. Rather, the value of our abundance is experienced in the opposite direction, back toward the land where Canada alone has dominion.
Plenty of countries will compete for the iPhone factory that assembles raw materials into a smartphone, or a log into an Ikea table, but few are able to supply those materials, especially in sustainable and socially just ways.
It is in the exploration, mapping, regulation, extraction, primary processing, transportation, and marketing of resource commodities that Canada is able to focus on the fattest end of the profitability scale. These are knowledge and technology specializations that occur inherently in open societies like ours. And those activities are by their nature going to be performed closer to the original resources, as opposed to consumer-oriented manufacturing that can occur anywhere in the world that commodities can be shipped to. That is why I placed quotation marks around the word raw at the start of this article. By the time a Canadian commodity reaches a port, it might look "raw" to the untrained eye, but in fact it has already been imbued with an extraordinary amount of economic value of a type that simply cannot be replicated anywhere else.
The thinker who first opened my eyes to this phenomenon was Philip Cross, the former chief statistician of Statistics Canada. In 2013 when I launched Resource Works, we asked him to produce our first study of the resource economy, and I can recommend the resulting Higher Ground report for those who want to see it for themselves. (It went over so well that we also asked him to join us in the capacity of senior research fellow.) His 2015 paper for the Macdonald-Laurier Institute developed some of these ideas more fully.
A big thing I learned from Philip was that the people who are in closest proximity to primary resources are also the ones who stand to benefit the most. We have a monopoly on that – everyone else has to compete for thinner profits further along the value chain. It's a beautiful situation for Canada that many critics of the resource sector fail to appreciate. Moreover, it is particularly true for indigenous Canadians, a great many of whom live in the rural areas where essentially all resource extraction occurs. For evidence of this look no further than the mining industry (a category that includes the surface mining of bitumen), which is Canada's greatest employer of First Nations.
Another important realization is that Canada is one country but we sell resource commodities to many countries, and each country has its own internal markets driving how imported inputs are used. The motivation of the importers will be to manufacture various refined products technically precise local specifications.
Placed in perspective, the flaws of the anti-export argument jump out.
Isn't it a bit odd that lots of people want to have this discussion about crude oil, but I've never heard anyone argue that we have to stop exporting our "raw" wheat (15.3 million tonnes in 2016) because we need to get into the flour business instead (we're already in it, by the way, producing 200,000 tonnes of flour a month – just as we're already in the refinery business).
Nor is anyone insisting that exporting $2.73 billion worth of "raw" copper ores and concentrates, as British Columbia did in 2016, is a bad idea that should be banned.
Crude oil is needed in the same way that wheat and copper are needed. The values the world attaches to Canadian resource commodities generally are positive ones: reliable in both supply and makeup, safe, clean, ethically produced and environmentally efficient, and competitively priced. We should be aiming to ensure that Canadian crude oil, which is on the threshold of becoming a part of Canada's global export mix thanks to the pipeline twinning, is understood in its proper context.
When it comes to building new refineries in Canada, it has to be acknowledged that demand for refined petroleum products has been "flat to declining and is forecast to continue on this path," in the words of the Canadian Fuels Association, which points out that this is also true in virtually all OECD nations. That proposed refinery near Mumbai, on the other hand, will service a nation that is soon to be the world's most populous and continues to emerge from a long-term state of energy poverty that is being progressively relieved as better, cleaner, more economical fuel solutions are put into place on a massive scale. Countries that step up to be their suppliers of primary energy are the geopolitically relevant nations of the future. Canada can deal itself into this dynamic, or it can choose to sit on the sidelines.
Canada can try to insist that foreign countries buy gasoline from us rather than crude oil, but in the real world that is not what is happening. Supplying crude oil to growth countries like India, so that they can deploy their own natural efficiencies like lower cost labour, is a sure way for Canada to build on its own strengths.
Stewart Muir is the executive director of the Resource Works Society.