In early 2018, Canadian heavy crude grades were trading at over a $30/barrel discount to the global benchmark, Brent.
July 5, 2018In early 2018, Canadian heavy crude grades were trading at over a $30/barrel discount to the global benchmark, Brent, double the discount from 2017. While this discount has narrowed somewhat in the second quarter, it still remains high, reducing the benefit Canadian producers are experiencing from higher crude prices globally.
Exhibit 1
Canadian crude oil seeing deep discounts versus the rest of the market
There has been a general softening in all North American crude prices relative to Brent as production of light tight oil (LTO) continues to surge. However, other grades (such as Bakken and West Texas Intermediate (WTI) at Houston, Midland, and Cushing) have seen a decline more in the $2-3/barrel range. The additional discount that WCS bears comes largely from bottlenecks in logistics capacity to get it to the Gulf Coast market. These bottlenecks are the result of barriers to adding new capacity and issues maintaining volume through the existing system.
The TransCanada Keystone pipeline has been operating at 20% less pressure than normal, mandated by the Pipeline and Hazardous Materials Safety Administration (PHMSA) after the November 2017 spill which caused part of the pipe to be shut down for two weeks. Even with all other pipelines operating normally, increased production has led to a growing shortage of takeaway capacity.
Rail is the important source of swing transportation capacity, allowing producers to get crude stocks out of Canada despite the additional cost. Producers have been increasingly moving crude by rail in the past year, and we believe this trend will continue for at least another year, until more pipeline capacity is added.
Exhibit 2
Crude by rail an important source of swing transportation capacity
There are three main pipeline projects in the works add capacity for moving crude out of Canada. If completed, these would expand takeaway capacity by 1.8 million barrels per day.
§ Kinder Morgan’s Trans Mountain Expansion (Alberta to Washington State) will increase the pipeline system capacity by 590,000 barrels per day (b/d) to a total of 890,000 b/d when it is at full operation in late 2020. There is strong opposition to the project in British Colombia, and the federal government is seeking to push the project through by taking direct ownership of the project.
§ Enbridge’s Line 3 replacement project, which will rebuild a pipe in Enbridge’s Mainline system running from Alberta to Superior, WI. This pipeline has been operating at ~50% utilization due to integrity issues for the past several years, and the planned project would restore throughput to 760,000 b/d in late 2019.
§ TransCanada’s Keystone XL project, which is expected to add 830,000 b/d of capacity from Alberta to the Gulf Coast (via Nebraska). Keystone XL has faced many regulatory roadblocks, but just finished a successful open season and will continue to plow ahead with plans to be in operations in 2022 under the current US administration.
While we expect conditions are likely to improve with resumption of full flows in the current pipeline system, they do provide some important lessons:
§ Crude-by-rail continues to be an important as the swing transportation capacity, especially for the most land-locked production such as in Western Canada. Crude-by-rail served that function in the Bakken a few years ago when pipeline construction lagged production growth. Despite its higher cost, at times crude-by-rail is the only alternative to shutting in production.
§ Expanding pipeline capacity from Western Canada is critical to support growing supplies and to protect existing production during periods of short-term outages.