Refining the relative arguments

einstein

 

What does it mean when someone claims that an argument is “academic”? Let’s turn to that most non-academic of sources for the definition. The best reply on Yahoo! Answers:

It means that there is no point in considering or discussing it because events have occurred to make it no longer relevant for discussion.

For example, I wanted to discuss with you how best to advertise a business, but as the business in question has now been sold, the matter is now academic.

And that is how I’d describe the debate that certain academic economists have reignited in the wake of the Enbridge Northern Gateway Pipeline conditional endorsement by the federal cabinet.

Let’s take a slightly different look at the new business reality. And let’s simplify assumptions about world demand/markets for bitumen vs SCO.

Simplifying assumptions

1) let’s assume both bitumen and SCO sell at the same world price (so light/heavy differential is zero).
2) Delivery point for shipping by pipeline is Edmonton
3) Destination is China refinery
4) Shipping to the US via pipelines/railcars is restricted or bottlenecked in the foreseeable future
5) The price for diluent is the same in China as it is in Edmonton and unconstrained

Question 1: Is there a business case for upgrading raw bitumen to synthetic crude oil in Alberta?

Analysis

In this case, the analysis comes down to transportation costs. And at a first cut, let’s assume shipping dilbit by pipeline and tanker has public support (or not overwhelming public opposition) – an assumption we will revisit later.

Options:

1) ship dilbit to St John, NB via Energy East and onto China via supertanker
2) ship SCO to St John, NB via Energy East and onto China via supertanker

3) ship dilbit to Kitimat via NGP and onto China via supertanker
4) ship SCO to Kitimat via NGP and onto China via supertanker

Shipping volumes of dilbit vs SCO

In this analysis, let’s use typical dilbit composition of 70% bitumen and 30% diluent by volume. So, to ship 1 barrel of bitumen requires 1/70% = 1.43 barrels of
dilbit

And for SCO, let’s use 14% shrinkage. So, 1 barrel of SCO requires 1/86% = 1.16 barrels of bitumen

Therefore, for every barrel of SCO, you need to ship 1.43 barrels of dilbit/barrel of bitumen x 1.16 barrels of bitumen/SCO = 1.66 barrels of dilbit.

Pipeline and tanker tolls

In this analysis, I’ll use the Scotiabank Commodities Report July 30, 2013 report and the graphic presented on page 2 as the first approximation:

Screen Shot 2014-07-05 at 2.13.51 PM

Energy East option
Accepting the tolls at face value, to ship one barrel (of dilbit or SCO) from AB to China via Energy East = $7/barrel for pipeline toll (Hardisty AB to St. John NB) and $5.25/barrel for tanker toll (St. John NB to China) = $12.25 /barrel.

Northern Gateway option

Similarly, the toll to China from Edmonton via NGP = $3.20/barrel pipeline toll & $3.00 /barrel tanker = $6.20 per barrel.

Shipping bitumen options

Revisiting the four options, costs in terms of shipping one barrel equivalent of bitumen:

1) To China via Energy East, dilbit = $12.25 /barrel x 1.43 = $17.52
2) To China via Energy East, SCO = $12.25 /barrel x .86 = $10.54

3) To China via NGP, dilbit = $6.20/barrel x 1.43 = $8.87
4) To China via NGP, SCO = $6.20 / barrel x .86 = $5.33

First cut

1. Q: You’re a bitumen producer in Alberta. How much would you be willing to pay the BC gov’t in a risk premium to ship dilbit to China via NGP (meeting BC Gov’t condition 5)?

Answer: You’d be willing to pay up to $8.65 per barrel ($17.52 – $8.87).

2. Suppose BC absolutely would not allow dilbit to be shipped through its province. And you are absolutely against paying the BC gov’t a toll – you want to keep all the money in the province.  How much would you be willing to pay to upgrade bitumen to SCO?

Answer: You’d be willing to pay up to $12.22 /barrel ($17.52 – $5.33) to upgrade bitumen to ship via NGP

 

When economists hand you a lemon, make lemonade

lemonade

What is the average person to make of all of this corporate tax cut talk coming from politicians and economists? Does it result in increased employment, increased investment, and where’s the promised productivity increases?

To try and make sense of it all, imagine you are back in a grade school home economics lesson – a case study with a character from the board game Clue, a kid from the Life cereal commercials, and a helpful neighbour from a national Canadian chain store: 

Professor Plum wants to teach his young son the economics of business. So he set Mikey (he likes it!) up with a lemonade stand on his front lawn. Dad will supply all the lemons, ice, glasses, hand juicer, and his sister agrees to squeeze the lemons. Here’s the deal: for every ten glasses of lemonade Mikey sells, he has to pay his younger sister Sally two, and Dad gets three in taxes, leaving five. 

Plum notices on his cycle to work another young man by himself who has a similar operation, but with an electric juicer. This rings a bell – an abrupt right turn and off to Walmart he rides, and places the new juicer in his front carrier for the return trip. He will rent the juicer back to Mikey – and teach him that elusive concept of how to increase productivity.  

First off, he offers it to Mikey for three glasses of lemonade profits. Mikey does the quick math. “For every ten sold, I now make five. If I rent the juicer it will cost me three. No more need for Sally, so I save two. But overall I’m down one. Nope. No deal” Mikey exclaims. All is going to plan. 

Lesson two. To induce Mikey to use the juicer (Sally has tennis lessons coming up) Plum cuts Mikey’s taxes to one from three– two more in Mikey’s cash box so he can now afford to rent the juicer. On his way to work he points to the electric juicer on the porch, and instructs Mikey to leave the money in the jar -three for rent and one for tax, leaving Mikey with six, and Sally off to play with her friends. 

When he gets home that evening (after a busy day of marking exams and commenting on twitter), he is shocked to find Sally still behind the lemonade stand and Mikey greeting him with a big smile on his face. The electric juicer sits unused in its box.

“You were trying to teach me a lesson in economics, weren’t you Dad?” “Well yes son, I was. So, why didn’t you rent my electric juicer?” “Because I finally figured out you were trying to trick me” Mikey exclaimed. “I did the math. Let me show you.” He places ten empty glasses in the centre of the table. “Before when I sold ten glasses of lemonade – I paid Sally wages” (he moves two to the left) “and you tax”(he moves three to the right, leaving five in the middle). He then gathers all ten glasses back into the centre. “Now, you cut my taxes” (he moves one toward Professor Plum) leaving nine. “I can either pay Sally two, or pay you three to rent the juicer. I’ll stick with Sally- leaving me seven. I’m ahead by two. Thanks Dad!”

Neighbour Bill, reminiscent of that Canadian Tire guy with all the gadgets, whispers to a dejected Professor Plum as he enters the front door, juicer in hand  “You should have told him the tax cut was conditional on the use of the juicer. By the way, my daughter Kim will be available to fill in when Sally is at camp – she has a bit of a crush on Mikey”.

Professor Plum, shaken, not stirred, raises his head and mutters: “Quit trolling me Bill!”