Majority of Western Canada’s crude oil exports to US not exposed to record high discount between WCS and WTI

Refinery outages will take care of themselves over the next month or two as maintenance is completed and facilities come back online

The discount for Western Canadian Select reached $65.17 Thursday, setting off alarm bells in downtown Calgary and a social media firestorm as opposition politicians blamed governments for industry woes, including wild claims of almost $50 billion losses. The truth, as always, is more complicated.

“Just got out of a meeting with senior energy industry leaders,” UCP leader Jason Kenney tweeted Friday. “Latest estimate is that today’s record price discount on our oil & gas represents an annualized loss of $46.6 billion to the Canadian economy, and $13.9 billion to Canadian governments.”

The key word in that last sentence is “annualized,” which projects one or two months of revenue pain over a full year, thereby exaggerating the impact.

But the financial impact for industry and revenues is not insignificant, either.

Source: US Energy Information Administration.

The heftiest contribution to recent record WCS discounts against the West Texas Intermediate benchmark is the number of Midwest refineries offline for maintenance.

According to the National Energy Board, 63 per cent of Canadian oil exports went to PADD II (Petroleum Administration for Defense Districts), which includes populous US states like Illinois, Michigan, and Ohio. PADD 1 (northeast) buys seven per cent.

Combined, refinery utilization in 70 per cent of Canada’s American market dipped from almost full capacity this summer to 73.3 per cent in PADD II and 68.9 per cent in PADD I.

Kevin Birn is the director of the IHS MarkIt Oil Sands Dialogue and monitors

“It all comes down to flexibility in the pipeline system.  Think of it like a straw, it only has one end and if you crimp that one end, you cannot push more into it.  In this way it isn’t sufficient just to have a pipeline, you need a pipeline system, with optionality so when one or more refineries go down the crude can flow around it,” he said in an email.

“This could be a West Coast access, but is also could be additional capacity in the system as a whole including additional southbound capacity.”

Alberta’s pipeline woes are certainly germane in this situation. The system is already full, forcing oil sands producers to send their growing supply via rail.

For instance, just a few weeks ago, Cenovus Energy inked a three-year agreement with CN Rail to ship 100,000 b/d of heavy crude oil from the Bruderheim Energy Terminal various refineries in the Gulf Coast (PADD 5), the largest concentration of bitumen processing facilities with almost 1 million b/d of capacity.

When the Keystone pipeline sprang a leak last Nov., the differential spiked at just under $40 from its historic level of $10 to $15, before falling again as the system was restored.

According to the NEB, the differential averaged US$22.50 between Jan. and April, while oil sands production rose five per cent in the first quarter of 2018. Pipeline takeaway capacity, however, remained constant.

Source: National Energy Board.

Once again, WCS prices were under pressure.

Birn says exposure to the differential is not uniform and there are many strategies that influence a producer’s exposure.

“For example, some producers have firm “take-or-pay” commitments which means they have purchased access to pipeline capacity on fixed terms in advance.  If you have this capacity those barrels would be leaving the market and obtaining better prices than the spot market. The amont of take-or-pay will vary from company to company,” he said.

Companies may have hedged their production (entered into futures or forward contracts, for instance, to sell their barrels at a pre-described price in advance).

“Of course, the longer the high discount goes on, the less likely companies will be able to enter into hedging agreements,” he said.

But the most common strategy for avoiding the differential is integration – buying refineries in the United States. Suncor and Husky own American facilities and, as a result, about 80 per cent of their production is protected from the differential.

“Owning downstream refineries allows companies to convert heavy oil to higher value refined products either domestically or downstream. Buying incremental refining capacity in Canada isn’t a solution because it would still face the pipeline problem, but if you have it already, it would be a smart strategy,” Birn said.

IHS MarkIt believes the majority of Western Canadian oil avoids the spot market – and the abnormally high discount – but can’t estimate amounts because many pipeline take-or-pay agreements are not public.

Kevin Birn, IHS MarkIt.

“Generally, we think larger companies – either with downstream refining, upstream upgrading, or large fiscal capability likely have some firm take-away – are less exposed than smaller firms,” Birn said.

“Consequently, smaller firms are less capable of weathering this volatility.”

Birn says that in the short-term, producers that are exposed to the differential have few options.

“Seeking additional storage is one, but storage is limited and would come at a premium at this point.  Rail is another that would help move individual producers’ incremental barrels to market, but if insufficient rail [capacity is available], the differential could still remain wide,” he said.

The refinery outages will take care of themselves over the next month or two as maintenance is completed and the facilities come back online, says Birn.

In the meantime, already stressed small to medium-sized Alberta producers will suffer even more, while big companies like Suncor, Cenovus, CNRL, Husky, and Imperial Oil will feel the pinch much less because they have more “levers” to pull that reduce the impact of the differential.

Chicken Little pronouncements from opposition politicians like Kenney don’t help a whit, especially his tweet calling for “economic nationalists” – a clear aping of Donald Trump and Steve Bannon populism that is roiling the United States – to “be storming the proverbial gates to demand coastal pipelines be built.”

The UCP leader can storm whatever gates he pleases and it won’t speed up consultations with BC indigenous communities or the NEB’s consideration of the environmental impacts of more West Coast oil tankers.

The Alberta oil industry is facing a difficult period that requires cool heads and a steady hand on the tiller while American refineries finish their maintenance and the Canadian government tries to get Trans Mountain Expansion construction re-started – issues over which the Alberta government has no authority.

Exploiting industry difficulties for political gain helps no one but Kenney and the UCP.

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