The Fuse

Pipeline Delays Continue to Dog Canada’s Oil Industry

by Nick Cunningham | September 04, 2019

In August, the provincial government in Alberta extended mandatory production cuts through the end of 2020 as a result of persistent delays in the construction of long-distance pipelines. The midstream bottleneck continues to hamper the ability of the province and industry to move oil to market.

Pipelines delayed…again
The United Conservative Party won control of the provincial government in Alberta earlier this year, ousting the New Democratic Party. The government may have changed, but the policy approach is more or less the same. The previous government implemented mandatory production cuts from oil companies operating in Alberta in an effort to shrink a supply surplus that resulted from midstream bottlenecks. The cuts, which began at 325,000 barrels per day (b/d) in January 2019, succeeded in that effort, leading to a dramatic increase in the price of Western Canadian Select (WCS).

The new government has carried the policy forward, gradually easing the curtailments in small monthly increments this year. The cuts appeared on track to expire at the end of 2019, but the government says that ongoing pipeline delays necessitate another year of market management.

Major cross-continental pipelines have been repeatedly delayed

It’s a familiar tale for Alberta. Major cross-continental pipelines have been repeatedly delayed by a combination of reasons, including permitting delays, legal setbacks and stiff resistance from environmental groups and First Nations. There are three major pipelines that could yet reach completion, but each face their own set of obstacles, even as they inch forward.

The infamous Keystone XL pipeline has spent the better part of a decade in legal limbo. TC Energy (formerly TransCanada) recently scored a major victory with a Nebraska Supreme Court decision in its favor. It is closer than ever to moving forward, but ongoing litigation and local resistance still present hurdles to its construction.

The Trans Mountain Expansion project has quickly become as controversial and divisive as Keystone XL in a much shorter period of time. Facing protracted delays, legal uncertainties and fierce opposition from First Nations in the pipeline’s path, Kinder Morgan moved to scrap the project altogether in 2018, but managed to pressure the federal government into purchasing the project. The Trans Mountain Expansion was effectively nationalized at great public expense last year, as the government of Prime Minister Justin Trudeau was desperate to keep the project alive. The pipeline would nearly triple the existing line’s throughput if it reaches completion.

In August, the state-owned Trans-Mountain Corporation announced plans to restart construction work and says that the pipeline is on track to come online in mid-2022, barring other delays. But delays are certainly a possibility.

Finally, the Line 3 replacement was thought to be a done deal, but it too faces uncertainty. Replacing a decades-old pipeline seemed to be an easier lift than constructing a new pipeline from scratch, but the replacement has suffered permitting delays and unfavorable court decisions in Minnesota. Instead of coming online by the end of this year as originally planned, the pipeline is slated to reach completion at the end of next year. But again, environmental and indigenous groups have vowed to oppose its construction.

Rail a stop-gap
The pipeline bottlenecks has put a greater emphasis on shipping oil via rail. In June, Canada shipped 286,701 barrels of oil per day (b/d) by rail, which was significantly higher than in prior months but still down from a high of more than 350,000 (b/d) in December 2018.

Alberta’s mandatory production cuts have arguably been too successful

Alberta’s mandatory production cuts have arguably been too successful, pushing WCS close enough to WTI to make shipping oil by rail a tricky proposition. It may seem odd that higher WCS prices are a bad thing, but because of steeper costs, WCS needs to trade at a large enough discount to justify the effort. WCS traded at a discount to WTI that exceeded $50 per barrel late last year due to a worsening glut. The mandatory production cuts implemented by Alberta at the start of this year rapidly narrowed that discount in a matter of weeks. More recently, the discount has traded at about $11 to $12 per barrel more recently. But WCS needs to be at least $15-per-barrel below WTI in order for rail to really make sense.

Paradoxically, progress on stalled pipeline projects can present challenges to the oil industry because it makes it more difficult to ship oil by rail if the market bids WCS prices higher. “Canada’s oil patch…experienced some rare good pipeline-related news and curtailment has kept Canadian crude differentials tighter than rail economics require,” Rory Johnston, commodity economist at Scotiabank, wrote in a note on August 30, referring to positive developments for Keystone XL and Trans Mountain Expansion. “The flurry of pipeline headlines is great news for the future but distracts from the present, where production curtailments have kept markets tight and WCS prices too high, in our view, given the need for further rail investments.”

Johnston argues that rail will need to take on 500,000 to 600,000 b/d in order for Alberta to have the ability to completely rid itself of the mandatory production curtailments. But for that to occur, WCS prices will need to fall further relative to WTI in order for rail shipments to make sense.

Ultimately, shipping oil by rail is a sort of last ditch effort for Canada’s oil industry to move oil to market. Without new pipelines, production growth will be stunted. The industry has three major pipelines in the works, but each have faced delays and their completion is not yet assured.

 

 

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