Refinery capacity: Root cause or red herring in Canada’s gas price gap?

AACI | Vice President, The Regional Group of Companies Inc.
  • Jul. 30, 2014

John ClarkFor much of the year, the gap between American and Canadian gasoline prices has been at a record high. This is yet another illustration of why Canada must take action to secure its own domestic energy supply by bridging its East-West divide.

National Bank of Canada senior economist Krishen Rangasamy observed in May that the gas price gap has inflicted an unofficial “tax hike” on Canadians.

A hike, indeed: analyst estimates put the gap at around 30 per cent.

The most obvious impact is seen in Canada’s inflation numbers. Despite a soft economy and labour market, inflation hit a two-year high in June, defying expectations. Rising gasoline prices have been a key price driver for some time, but in the latest report, inflation was tracking upward in more than half of the categories that make up the headline inflation number, including gasoline.

The ripple effect

Now, you can argue that higher gasoline prices ripple through the broader economy – the costs of transporting goods rise, and these costs are then passed on to consumers.

This may explain why rising food prices have emerged as another symptom of the inflation rate, but the evidence is far from conclusive. The costs of other consumer goods, for example, such as furniture, digital tech and personal care supplies – all of which must incur shipping costs – were lower year over year in June.

But another place where the negative impact of high gasoline prices may be evident is in Canada’s retail sales numbers. These were up more than expected in May, but if one strips out sales of motor vehicles and auto parts, retail sales were in fact softer than expected. They were up by a mere 0.1 per cent for the month versus analysts’ expectations for 0.3 per cent.

In a Reuters report, BMO Capital Markets senior economist Benjamin Reitzes warned, “spending is rising faster than income, suggesting debt burdens continue to increase,” and attributed much of the gain in motor vehicle sales to aggressive dealer incentives, which he said only serve to drive debt accumulation.

All of this leads me to conclude: don’t be fooled by an apparently strong headline number. Look at the underlying fundamentals.

Do that, and it’s evident that Canadians, as individual households and as a nation, remain in a tenuous position made all the more challenging by that big, fat gasoline price gap.

Is refinery capacity the issue?

I first struck on this topic on the premise that Canada needs more refinery capacity for its crude, given how our vast geography makes us more dependent on energy than most other countries. Since the 1970s, the number of refineries in this country has dropped from about 40 to 19. This industry lost about 36 per cent of its workforce between 1989 and 2009, according to this 2012 Huffington Post story, which still holds up as a great primer on the subject.

More of our raw material is being shipped to the U.S. for refining. Plans to build a pipeline west to B.C.’s ports is predicated on the notion that it’s much more economical, and carries less financial risk, to ship the raw material to a ready market across the Pacific than it does to first refine it into a usable product here and then ship to the customer.

As light sweet crude, the easy stuff to process, becomes scarcer, and the oil sands bitumen, which requires a far more costly effort to turn into usable fuel, becomes Canada’s primary source, this economic argument only seems to be picking up steam.

That’s not to say there isn’t new refinery capacity coming online in Canada. In that HuffPost article, Ian MacGregor says, “Our kids want to work in high-tech industries. They don’t want to work with their hands. They want to have educationally and intellectually based jobs, and that’s what we produce when we refine this stuff.”

I don’t disagree. Of course, he is the chairman of North West Upgrading, which is a partner in a project that’s building a $5-billion oil sands upgrader – a bargain price as far as refineries go. But this project is relying on government subsidies to get done.

In that same article, Michal Moore, a professor at the University of Calgary’s Institute for Sustainable Energy, Environment and Economy, asserts that the U.S. has already cornered the refining market, and Canada is 20 years too late to consider bulking up its presence in this industry.

But it appears the refinery argument is a red herring, at least in terms of getting to the root of the real cause of that gasoline price gap.

It’s not about refineries. It’s about pipe and rail lines.

Energy East needs to get done

The thing is, Canada already refines more petroleum products than it consumes. But if you look at a pipeline map of North America, it’s clear everything is moving on a north-south axis.

Because of supply gluts in the mid-Western U.S., when crude from Western Canada is shipped south, it’s sold for less than what Eastern Canada refineries pay to import Brent crude from the Eastern U.S. This has been estimated to cost the Canadian economy about $19 billion a year.

It’s also a contributing factor in the gasoline price gap between Canada and the U.S. Advocates assert that more pipe/rail line infrastructure would get more oil moving and diminish the gap between what Canada’s Western producers get for their exports versus what our Eastern refineries pay for their imports.

All of which brings me back to something I wrote about last September – the imperative for Enbridge Line 9 to be refitted and expanded as part of the Energy East project. This would allow TransCanada Corp. to ship oil sands bitumen direct to Eastern Canadian refineries without having to go through the U.S.

For the good of our economy, I contend this is a greater priority than new pipeline infrastructure intended to ship more of our raw product to Asia or the U.S.

TransCanada expects, at last, to file its application for the $12-billion-plus Energy East project with the National Energy Board this month, after a lengthy consultation process to address concerns raised by various communities and environmental groups along the route.

Let’s cross our fingers for a smooth approvals process.

To discuss this or any other valuation topic in the context of your property, please contact me at [email protected]. I am also interested in your feedback and suggestions for future articles.

John Clark is Vice President with The Regional Group of Companies Inc. He has more than 33 years of experience in the real estate appraisal field, is a fully accredited…

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John Clark is Vice President with The Regional Group of Companies Inc. He has more than 33 years of experience in the real estate appraisal field, is a fully accredited…

Read more

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