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Why the Keystone pipeline would boost pump prices

Rising gasoline prices have helped proponents of a controversial pipeline proposal press their case that the project would help ease supply bottlenecks and lower prices for consumers.

They’re half right.

The proposed pipeline would relieve a glut of crude oil backing up in the Midwest and redirect those barrels to Gulf of Mexico ports. From there they could be shipped to world markets and repriced at higher global prices.

But that likely would mean higher prices for drivers in the nation's midsection, who currently are enjoying an unusual discount stemming from a lack of pipeline capacity.  

On Monday, TransCanada Corp., the company that wants to build the pipeline, said it would start construction of a southern leg while it tries to satisfy environmental concerns raised by the Obama administration that have blocked the longer northern leg.

Oil prices around the world have been rising steadily since October largely because of tightening sanctions on Iran being imposed by the U.S. and European countries over its suspected development of nuclear weapons.

"Basically, we're locked into what appears to be an end game with Iran in some form or another,” sad Dan Yergin, chairman of Cambridge Energy Research Associates. “The sanctions really start to kick in over the next several months, and the whole aim is to choke off Iran's oil revenues and that means choke off its exports."

The result is that pump prices have jumped 20 cents a gallon in the past month alone, according to data from the Energy Information Administration, and Republicans are beginning to use the energy inflation as a political talking point.

But the pain has been inflicted unevenly across the country, with consumers on the coasts paying much higher prices than those in the Midwest and Rocky Mountain regions, where supplies of oil are plentiful.

One reason crude is so plentiful in the Midwest is that new production technologies have boosted production in oilfields that were once thought to be exhausted or too costly to develop. After two decades of steady decline, total U.S. oil production began rising again in 2009, according to the EIA. Increased production from Canadian tar sands fields also has boosted Midwest supplies.

But as domestic and Canadian production have risen, pipeline bottlenecks have cropped up – especially over the 500 miles from Cushing, Okla., to Houston, the nation’s largest oil shipping port and home to about half its refining capacity.

“We lack infrastructure to catch up with the fact that there's been this big change in oil production,” said Yergin. “Eight years ago, North Dakota was not the fourth-largest oil producing state in the country. So we need new pipelines, and the lack of those pipelines -- the lack of catching up -- is reflected in the disparity (in prices).”

Until last year, the benchmark price of U.S. crude based on Cushing delivery, known as West Texas Intermediate, closely tracked the global benchmark, called Brent North Sea.

But in the past year, as rising supplies of captive Midwest supplies depressed prices, the gap widened to once-unimaginable levels. By last fall, the discount for West Texas Intermediate had widened to as much as $30 a barrel before shrinking back to about half as much.

CNBC's Eamon Javers reports on the high cost of oil and whether speculation is driving prices higher. Also, how to play oil's rise, with Dan Dicker, MercBloc president.

All of which has helped oil refiners in the Midwest keep pump prices lower than on the coasts, where refiners pay the higher Brent price, regardless of where the oil came from.

The regional difference in pump prices has been substantial. At the end of last month, the average price for a gallon of gasoline in the Rockies was 41 cents below the U.S. average -- the biggest gap since the Energy Department began tracking regional prices in 1992. 

That’s where the Keystone pipeline comes in.  Proponents of the pipeline have argued it will help wean the U.S. off foreign imports and lower pump prices. But rather than pushing Gulf Coast prices lower, it will let oil producers charge more for their crude.

TransCanada Corp. estimates the pipeline would boost sales of Canadian-produced crude by $2 billion to $4 billion a year, according to an assessment submitted to Canada's National Energy Board.

“The prices for those crudes in North Dakota and Canada will fetch closer to Gulf Coast prices, which are tied into the higher international market price,” said Tim Hess, an Energy Department analyst.

The reason is fairly simple. Even at maximum capacity, the Keystone line will move some 400,000 barrels per day of crude from Canada and the Midwest to global oil market. With the transportation discount removed, those barrels likely will be repriced to the higher global benchmark.  

And with or without the Keystone pipeline, the “Midwest discount” that consumers now enjoy may go away later this year.

To help alleviate the Cushing bottleneck, the owner of a pipeline that now flows north from Houston plans to reverse the flow in June. 

In a recent research report, analysts at Goldman Sachs predict the reversal of Enterprise Products' Seaway pipeline will help cut the spread between the price of U.S. and Brent crude to $5 a barrel in six months.

CNBC's Phil LeBeau and Jane Wells report where drivers are likely to pay the most for gasoline.