Is the discount on Canadian oil justified? Not a chance

Source: ARC Financial Institute

Demand for Alberta heavy crude oil is growing at the very time pipeline projects have been delayed

In any war, truth is one of the earliest casualties, and it’s no different when it comes to the battle over pipelines and energy in Canada. Case in point: the talking point, frequently invoked by anti-pipeline activists, that suggests Canadian heavy crude is so undesirable, and so globally uncompetitive, that pipelines like TMX aren’t even needed in the first place. The facts don’t actually support this narrative, but that hasn’t stopped dozens of people like Will Horter, the former Dogwood Initiative executive director, from using it anyways.

“The price for a barrel of oil depends on many factors: the type of oil, the difficulty and cost of refining it, as well as the cost, distance and method needed to transport it,” Horter wrote recently in the National Observer. “These factors are what drive the price of Canadian oil down, not a discount. Yes, oil sands crude typically sells for $15 to $25 less than lighter oil, but it’s because it’s an inferior, heavier oil that is more expensive to transport and refine.”

Bitumen from the Alberta oil sands.

Horter is referring to the recent ballooning of the price differential between Western Canadian Select (the heavy crude benchmark) and West Texas Intermediate (the US light sweet crude benchmark). And he is correct about Alberta bitumen and heavy crude being more expensive to transport and refine.

What he’s objecting to is Alberta Premier Rachel Notley’s assertion that over the past few months heavy crude prices have been even lower than than usual because pipelines projects like TMX and Enbridge’s Line 3 replacement in Eastern Canada, have been delayed.

“Tack on the higher costs of refining the complex, sulphur-rich hydrocarbons in heavy oil and there you have it: the price differential explained, without resorting to whining about Canada or Alberta being picked on,” he says. “Alberta Premier Rachel Notley and Prime Minister Trudeau’s manipulation of the word ‘discount’ to describe the price differential between heavy Canadian oils and lighter oil down south is Big Lie #1.”

Big Lie #3, according to Horter, is that the 525,000 b/d TMX pipeline from the Edmonton area to Burnaby, BC is the answer to the problem of a wider than normal discount.

“Canadian discount boosters claim that the Trans Mountain pipeline is essential to access new markets in Asia to create competition. Competition, they argue, will drive up prices” he says. “The reality is that there is no backlog of oil waiting to be shipped to Asia.”

Here’s the biggest flaw (there are many) in Horter’s argument: the WCS/WTI discount or differential has two primary drivers, not just one.

The first is a lower grade and higher transportation costs that create an historic discount in the $10 to $15 range. The second is occasions when there is more oil than the existing pipeline system can handle.

For instance, in mid-November, 2017 the Keystone pipeline leaked and was shutdown for a time, then allowed to pump under lower pressures and volumes. As a result, the discount widened to $27.34 in February, 2018 before returning to normal levels in May as Keystone returned to full service.

Keystone pipeline
A leak in the Keystone pipeline last November shut down the Alberta to US pipeline.  Once repairs were complete, US pipeline safety regulators imposed pressure restrictions on the pipeline and reduced shipments of crude were allowed to continue.  On Tuesday, the restrictions were lifted.  DroneBase photo via Associated Press.

But then the discount began to widen again in July and August as new production, primarily from the oil sands, overwhelmed the pipeline system again.

By the fall, that discount had widened even further, with Alberta producers selling at spot prices often less than the cost to produce the oil. About 270,000 b/d was leaving the province by rail and storage levels sat at 35 million barrels, twice the normal amount.

Some producers began to voluntarily shut in production, preferring to take a small loss by keeping it in the ground rather than a larger one by almost giving it away to buyers.

Notley estimated the crude oil oversupply to be 190,00 b/d.

She mandated a production curtailment of 325,000 b/d, effective January 1, that would also slowly return storage levels to normal. The move temporarily lowered the WCS/WTI discount to around $15, but later in the month it had risen again to over $21.

Contrary to Horter’s claims, there is clearly a backlog of oil waiting to get to market, whether that be in the US or new markets like Asia.

Next year doesn’t promise to be much better.

While the Alberta government expects the curtailment to drop to 90,000 b/d over the course of 2019, some producers (like energy giant Suncor) are expecting higher production and it’s not clear what effect that might have on the oversupply. New shipping capacity won’t be available until December, 2018 when Line 3 adds 375,000 b/d and Notley expects the first of the locomotives and oil tanker cars (Alberta is spending $2.6 billion over three years to add another 120,000 b/d) to come into service.

Does Alberta need TMX? Or are Notley, Prime Minister Justin Trudeau, Finance Minister Justin Trudeau, and the Alberta industry “telling fibs,” as Horter claims?

Let’s do the math.

Trans Mountain Expansion will ship 525,000 b/d. Given the legal challenges it currently faces, construction won’t be completed until 2022 or 2023 at best.

Source: ARC Financial Institute.

Since raw bitumen must be diluted around 30% with a light hydrocarbon to flow in a pipeline, the current 190,000 b/d oversupply requires 247,000 b/d of pipeline space, already two-thirds of Line 3. In an Energi News interview, Scotiabank economist Rory Johnston estimated that rail transport will grow to 400,000 b/d by the end of 2019, including the Alberta government’s contribution.

Line 3 plus rail should provide about 647,000 b/d of new shipping by 2020.

That’s transportation. What about crude oil production?

The Canadian Association of Petroleum Producers forecast Western Canadian crude oil supply to rise by 700,000 b/d by 2020 from 2017 levels; add 30 per cent diluent and that number rises to 910,000 b/d.

Most of that production will come from the oil sands, whose projects require billions in capital investment, as well as five to 10 years of planning, regulatory review, and construction. Turning off the taps isn’t an option for most of those projects, it’s simply too late in the process.

The 247,000 b/d oversupply plus 1 million b/d of new oil sands production equals 1.247 million b/d.

Subtracting new shipping from oversupply plus new supply leaves Alberta short about 600,000 b/d.

In other words, more than the capacity of TMX.

And that only gets Alberta to 2020.

Oil production is forecast to rise another 700,000 b/d from 2020 to 2030. Industry is hoping the 830,000 b/d Keystone XL to the US Gulf Coast will be ready around mid-decade.

Stitching together a narrative that purports to show Alberta doesn’t need more pipelines is easy, any propagandist can do that, but it takes a book to refute a pamphlet when the counter-argument is weighted down with facts and data.

Unfortunately for Horter, his facts and data, slight as they are, don’t stand up to scrutiny.

Tomorrow: facts and data demonstrate that global demand for heavy crude oil is growing at the same time that Alberta’s competitors have less supply to offer customers. The medium to long-term future looks rosy for Alberta – if it can get its oil to market.

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