Will Keystone Increase the Price You Pay at the Pump?

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Will TransCanada's (NYSE: TRP) Keystone XL pipeline increase the price you pay at the pump? One study says it will. According to a report by the non-profit Consumer Watchdog, Keystone would increase the price of gasoline for millions of American consumers. Here's an excerpt:

"U.S. drivers would be forced to pay higher prices for tar sands oil, particularly in the Midwest. There, gasoline costs could rise by 20 cents to 40 cents per gallon or more, based on the $20 to $30 per barrel discount on Canadian crude oil that Keystone XL developers seek to erase."

The report has created quite an uproar. On Saturday, former Shell Oil President John Hofmeister responded to the study on Fox News

"It's absolutely ludicrous because it [Keystone XL] increases the supply in the U.S. by some 800,000 plus barrels per day of crude oil and that crude oil will flow right into Gulf coast refineries and into the U.S. system [...] We are suffering high gas prices because we don't have this oil flowing into the market." 

So which group is right? 

It's time to set the record straight

The first claim in the Consumer Watchdog report is correct - Keystone will raise crude oil prices in the Midwest. Double-digit energy production growth from the Alberta oil sands and the North Dakota Bakken have overwhelmed pipeline capacity in the region. Keystone will serve to clear up the supply logjam at Midwest energy terminals, and this will result in higher oil prices.

But do higher regional crude prices translate into higher regional gasoline prices? No - and in fact we can test this theory empirically. 

In mid-2011, a mid-continent crude glut led to significantly lower oil prices in the region. 

<img alt="" src="http://g.fool.com/editorial/images/59728/chart_1_large.png" />

Based on Consumer Watchdog's logic, lower crude oil prices would've translated in lower gasoline prices in the Midwest. Is that what we saw?

<img alt="" src="http://g.fool.com/editorial/images/59728/chart_2-1_large.png" />

No - the massive crude discount had almost no impact on regional gasoline prices. Refineries simply pocketed the difference. 

Why did this happen? Energy economist Andrew Leach has a great piece over at Macleans describing the economics behind this phenomena: 

"Since the refined product market in the U.S. is not as clearly differentiated by infrastructure as the crude market, the changes in crude costs to midwestern refiners changed their relative position among U.S. refiners, but did not impact the costs of the marginal barrel of refined product. As such, midwestern refiners were able to realize large increases in margins while consumers were still paying gasoline prices based on the higher cost production in other areas and export market prices." 

So could the Midwest refineries protect their record profits once the oil glut is relieved? Once again no - excluding transportation costs and taxes there's only one market price for gasoline. If Midwest refineries attempted to gouge consumers they would be priced out of the market and competitors would steal their business. 

This means the price you pay at the pump won't be impacted by Keystone. 

What does this mean for investors?

This discussion does illustrate the important implications Keystone will have on the North American energy market and the consequences for investors. If approved, the pipeline will have three major impacts for the oil patch:

First, Keystone will significantly reduce the margins for mid-continent refineries. For the Midwest's largest refiner Marathon Petroleum (NYSE: MPC), the pipeline will increase the company's input costs which can't be passed on in higher gasoline prices to the consumer. The company's profit bonanza will come to an end.

Second, higher Midwest crude prices will increase the prices that U.S. and Canadian producers receive for their product. Suncor (NYSE: SU) will be a big beneficiary. The company's oil sand operations produce 359,200 barrels of crude oil per day. In recent months Western Canadian oil has been discounted by as much as $40 per barrel to international benchmarks, and this has severely crimped the company's profitability. Keystone will end this problem.

Third, Keystone will have a small positive impact on the margins of refineries along the Gulf coast. Crude shipments from Canada will displace traditional imports that would've arrived via tanker.   

Foolish bottom line

Keystone won't impact the price you pay at the pump. But the project will have major implications for the energy industry. 

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Robert Baillieul has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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