The Fuse

OPEC Deal and New Pipeline Approvals Throw Lifeline to Canadian Oil

December 02, 2016

The collapse of oil prices since 2014 inflicted a lot of damage on the industry, but oil producers in Canada’s oil sands have suffered much worse than most other places. Alberta’s oil sands are expensive, the province has been frustrated by a shortage of pipeline capacity and Canada’s extra heavy oil often sells at a discount to more widely-traded global benchmark prices.

But the fortunes for many oil sands producers have taken a turn for the better in the past few weeks. Oil prices are surging after OPEC shocked the markets with a surprise deal to cut 1.2 million barrels per day (mbd). With WTI and Brent now back over $50 per barrel and climbing, OPEC has thrown a lifeline to a lot of high-cost oil production.

In addition to higher prices, Canada is on the verge of resolving, or at least easing, a persistent thorn in the side of oil producers. On November 29, Canadian Prime Minister Justin Trudeau gave the greenlight to two major pipelines that could allow more oil sands to flow from Alberta to international markets.

High cost production

Investment in Canada’s oil and gas sector has fallen off a cliff, plunging by $50 billion since 2014, or a 62 percent decline. In a world of increasingly scarce capital and razor thin margins, high-cost oil sands become a luxury few can afford. More than a dozen major oil sands projects were cancelled in 2015.

Even after the recent rise in oil prices, new greenfield projects are still probably a ways off.

A brand new greenfield oil sands mine requires WTI to trade at between $85 and $95 per barrel, according to IHS, a figure that assumes construction, operation, and maintenance costs, plus a 10 percent return on investment. Using steam-assisted gravity drainage (SAGD), another way of producing heavy oil and bitumen, requires at least $55 to $65 per barrel. Even after the recent rise in oil prices, new greenfield projects are still probably a ways off.

But existing oil sands operations are now safely in profitable territory. In early 2016, when benchmark prices crashed below $30 per barrel—and pushed discounted Canadian oil prices below $20 per barrel—many of Canada’s operators found themselves in a painful situation. Leaving aside the cost of construction and looking just at the cost of keeping an existing facility running, the prevailing market price for oil was too low just to keep the lights on. With operating costs of $32 per barrel for synthetic crude oil, some producers were churning out oil and losing money on every barrel produced.

The gradual tightening of the global market, which allowed WTI and Brent to rise back to the mid-$40s, has allowed oil sands companies to reduce some of the red ink on their balance sheets. The OPEC deal promises even further gains in oil prices. Goldman Sachs expects oil prices to rise to $60 per barrel in the first half of 2017, which could be high enough see a return of optimism to Calgary and Fort McMurray, one commodity that has been increasingly scarce over the past two years.

New pipelines

With those climate policies in place, the Prime Minister issued decisions on several major controversial pipeline proposals, hoping to thread a needle between environmental protection and growth of one of Canada’s largest industries.

The Canadian Prime Minister Justin Trudeau has been met with caution by Canada’s oil industry, and up until recently he has caused them some heartburn. Eager to change course from his industry-friendly predecessor, Prime Minster Trudeau has laid out a series of climate policies to reduce greenhouse gas emissions. He is seeking a national carbon price and a phase out of all coal-fired power plants by 2030. More recently he has moved to pump federal dollars into marine conservation and oil spill response.

With those climate policies in place, the Prime Minister issued decisions on several major controversial pipeline proposals, hoping to thread a needle between environmental protection and growth of one of Canada’s largest industries. On November 29, the Prime Minister approved Kinder Morgan’s Trans Mountain Expansion Project, a pipeline that will run parallel to an existing line from Alberta to the Pacific Coast in British Columbia. The $6.8 billion project will triple the system’s carrying capacity from 300,000 barrels per day to 890,000 barrels per day. Trudeau, hoping to assuage the inevitable blowback from environmental groups and First Nations, cited the 157 binding conditions addressing indigenous rights and environmental impacts that Kinder Morgan must adhere to as part of the approval. The PM also said the project will generate 15,000 jobs and provide $4.5 billion in government revenues.

The Trans Mountain expansion is expected to lead to a sharp increase in oil exports. Kinder Morgan says the volume of tankers departing Canada for Asia could rise from five per month up to 34 per month. “This is a defining moment for our project and Canada’s energy industry,” Ian Anderson, president of Kinder Morgan Canada, said in a statement.

Additionally, he also approved the Line 3 Replacement Project, another major oil pipeline. The $7.5 billion proposal will see the full replacement of 1,031 miles of pipeline that runs from Alberta to Superior, Wisconsin. Enbridge, the owner of Line 3, says that it is the largest project in the company’s history, and will nearly double the pipeline’s capacity to 760,000 barrels per day, providing a crucial outlet for Canadian oil to reach U.S. refineries.

The Canadian government granted the federal approvals for the two projects while rebuffing the industry on two other fronts.

The Canadian government granted the federal approvals for the two projects while rebuffing the industry on two other fronts. The more controversial Northern Gateway project, which would run through sensitive rainforest in British Columbia, was rejected. Also, a tanker moratorium was extended along the northern half of the coast of British Columbia, ruling out any future pipelines that would connect Alberta oil to that section of the Pacific coastline.

To top it off, Canadian oil producers unexpectedly found themselves with an ally in the White House, which could pay dividends in the years ahead. U.S. President-elect Donald Trump has promised to revive the Keystone XL pipeline, and his campaign manager and senior transition adviser Kellyanne Conway is reportedly planning a trip to Fort McMurray and will tour oil sands and will attend a private fundraiser for a conservative advocacy group. The move is a signal that the Trump administration will support greater pipeline access to the U.S., the final destination for nearly all of Canada’s oil exports.

Higher oil production?

If the two approved pipelines are constructed, they will provide Canadian drillers with much needed takeaway capacity. According to the Canadian Association of Petroleum Producers, the country’s total pipeline capacity can currently handle 4 million barrels per day. Last year, its network was nearly at capacity, moving an average of 3.981 mbd. The trade association projects that oil production will rise by an additional 850,000 barrels per day over the next five years, but that is only possible if new pipelines are constructed. Together, the two pipelines that the Prime Minister just approved could bridge that gap, adding just shy of 1 mbd in pipeline capacity.

But the approval from the federal government of two major pipelines, plus rising oil prices, as well as the potential shift on Keystone XL, means that after more than two years of contraction, Canada’s oil industry is looking ahead to brighter days.

Canada’s oil industry has been lobbying for years to get to this point. There are still formidable hurdles—environmental groups and First Nations have vowed to block construction of the Trans Mountain Expansion. But the approval from the federal government of two major pipelines, plus rising oil prices, as well as the potential shift on Keystone XL, means that after more than two years of contraction, Canada’s oil industry is looking ahead to brighter days.

ADD A COMMENT