Capacity shortages costing Canadian producers $100M/day

  • The Horizon Oil Sands bitumen extraction and upgrader plant is seen near Fort McMurray, Alberta on June 13, 2017. A lack of pipeline capacity is causing Canadian producers to take huge discounts on their oil at a cost of up to $100 million per day. (Photo/Larry MacDougal/Via AP)

If Canadian oil producers had the $100 million per day that one CEO estimates they are losing out on because they must sell their output at a painfully steep discount to U.S. crude, they could in just over a year’s time collectively pay cash to build the C$40 billion LNG Canada project.

Though only hypothetical and certainly unlikely, it’s a costly lesson for the producers in the law of supply and demand — and the laws and politics that make it hard to build new pipelines.

Pick a day, any day this month and West Texas Intermediate, the U.S. benchmark, has been around $70 per barrel. It was greater than $76 one day. Then pick a day, any day for Western Canadian Select, the benchmark for oil sands production. It hasn’t been greater than $30 all month; it was $24.22 on Oct. 11.

“It’s a crisis,” said Tim McMillan, chief executive of the Canadian Association of Petroleum Producers, as quoted in the Calgary Herald. “When we were canceling pipeline projects over the last decade, this was the end result we should have expected.”

Blame it on more than just insufficient pipeline capacity. It’s rising production in Alberta’s oil sands and maintenance at U.S. Midwest refineries that are among the biggest customers for Canadian crude. The inability to move the growing volume of crude to coastal export terminals is costing Canadian producers access to the global market and its higher prices.

“All of those things have culminated into a system that is completely overloaded,” Tim Pickering, founder of price-tracker Auspice Capital in Calgary, told the Canadian Press.

“We are basically giving this stuff away,” analyst Martin King of GMP FirstEnergy told a Calgary Herald columnist.

“Heavy-oil producers are getting 40 percent of what they normally would be paid if we had access to markets,” said Grant Fagerheim, CEO of Calgary-based Whitecap Resources, which produces about 60,000 barrels per day.

He estimates the price differential costs Canadian producers up to $100 million per day in lost revenue at current levels.

If the differential were to persist over a full year, the impact on provincial royalties would total about 9 percent of Saskatchewan’s entire budget for the current fiscal year, according to Bronwyn Eyre, minister of energy and resources.

“That’s money for hospitals and roads and social services,” he said.

The region’s pipeline system has the capacity to move about 4 million barrels per day, but that’s not enough. Analyst Kevin Birn of consultancy IHS Energy said Western Canadian crude supplies are expected to average 4.4 million barrels per day this year — most of it oil sands production — climbing to 4.7 million in 2019.

What doesn’t go by pipe moves by rail. Separate news reports by Reuters (2017) and the Canadian Press (2018) put the cost at between $12 to $20 per barrel to reach U.S. Gulf Coast refineries.

The volume by rail is growing — a lot. Before 2012, little oil was shipped by rail out of Canada. This past June, the country’s energy regulator announced a record-breaking average of 200,000 barrels per day by rail. The International Energy Agency estimates the average will reach 390,000 barrels per day in 2019.

If only there was more pipeline capacity to coastal export terminals.

“I refuse to believe that Canada as a country will not be able to get its act together and ultimately get these pipelines built,” Cenovus Energy CEO Alex Pourbaix told Bloomberg earlier this month. Cenovus is a major oil sands producer, at about 390,000 barrels a day in the second quarter of 2018.

“Right now, the Canadian oil patch is getting killed by the differential,” International Petroleum Corp. chairman Lukas Lundin told Bloomberg last week. “But over time, we think that’s going to change because there’s going to be some pipelines coming up.”

IPC this month announced a C$600 million takeover of a small Canadian producer.

“If you survive this short-term pain, the long-term gain is very big,” Lundin said.

After 10 years of political battles and litigation in the United States, TransCanada plans to start construction next year on its Keystone XL line. The $8 billion, 1,184-mile pipeline will move up to 830,000 barrels a day of Western Canadian production to a connection in Nebraska, where existing lines can carry the crude to the Gulf Coast.

It took a change in U.S. presidents for TransCanada to gain approval for the project. But Western Canadian oil producers also have their own politics to blame for a lack of pipeline capacity to overseas customers.

Kinder Morgan had worked several years to win approval to triple the capacity of its Trans Mountain line that moves oil from Alberta to a marine terminal near Vancouver, B.C., adding almost 600,000 barrels a day of new capacity.

But the weight of litigation, community challenges and opposition from the British Columbia government pushed the company to give up in May and sell not just the expansion project but the entire line and terminal to the Canadian government, which plans to assert federal control and move ahead despite provincial opposition.

Canada agreed to pay C$4.5 billion to Kinder Morgan and take over the C$7.4 billion expansion to ensure it gets built. The government figures it will later sell the operation to private investors and is telling its citizens the treasury will not lose any money on the flip.

Then there is a new problem. Canada’s Federal Court of Appeal ruled in late August that the National Energy Board failed to adequately consider increased oil tanker traffic in its 2016 environmental review of the expansion project. The court also ruled the government had failed in its responsibility to consult with Indigenous communities.

The government decided not to appeal the court ruling and gave the energy board 22 weeks to conduct a full impact assessment of the additional tanker traffic. The board’s assessment is due to the cabinet in February.

The court decision to halt approval of the pipeline was “disappointing, but by no means insurmountable,” Canadian Natural Resources Minister Amarjeet Sohi told the Canadian Press last month.

The NEB this month called for public comment on whether it should consider marine shipping issues out to the 12-nautical-mile territorial sea limit or to Canada’s 200-nautical-mile exclusive economic zone.

The National Energy Board received 123 applications to participate in its court-ordered environmental reconsideration. The board approved 98 intervenors, including the cities of Vancouver, Victoria and Burnaby; Indigenous groups from Alberta and B.C.; environmental groups; oil companies; and the governments of Alberta and B.C.

Larry Persily is a former Alaska journalist, state and federal official who has long tracked oil and gas markets and projects worldwide.

10/25/2018 - 8:27am