Canadian oil trapped by tight line capacity

The fact that Canada needs new markets for its crude exports is nothing new. Nor is the story about China wanting to get its hands on some of these exports, considering the $15 billion CNOOC recently threw at Nexen for its valuable Canadian acreage.

But the lines that take Canadian crude to the US are now full, according to RBN’s Sandy Fielden in a blog post last week, and that means Canada is dangerously close to running out of markets for its crude.

“The pipelines transporting Western Canadian crude oil to US markets are full to overflowing,” Fielden said. “Space on the main lines is being rationed.

Fielden cites Enbridge imposing apportionment, or a reduction of total shippable volume allowed, on three of its main lines that go from Western Canada to the US: the 796,000 b/d Line 4, which runs from Edmonton to Superior, Wisconsin; the 450,000 b/d Line 67, which runs from Hardisty to Superior; and the 609,000 b/d Line 6A between Superior and Griffith, Indiana. The scope of the apportionment, based on Platts reporting, is enormous: Enbridge has limited January spot crude oil nominations on its 231,000  b/d Ozark line by 96.4% and is limiting January nominations by 80.9% on its 190,000 b/d Spearhead line. Much of these steep reductions, according to market observers, is a result of heavy overnomination driven by a shippers’ need to create a historical record of demand, for future priority, and the development of a secondary market of actually trading the space that was granted. So it becomes a vicious circle.

Still, that’s not the entire reason for the cutbacks; output is rising.

During the last few years, before, during and after the Keystone XL debate the hypothetical was always that one day Canada was going to need to act. Canada would either need increased takeaway capacity to the US, or one way or another get another line over the Rockies and through First Nations’ land for export to Asia.

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So, has the day of reckoning finally come to Canadian producers? If you measure this by the discount of Western Canadian Select to WTI the answer should certainly be yes.

Between June and October 2012, WCS prices ex-Cushing and ex-Hardisty were more or less moving in lock step, with the typical ex-Hardisty discount averaging just under $6/b, which is understandable considering the distance to market at Cushing. However the two prices have begun to diverge since late-October. And though they seem to again be moving in lock step, the ex-Hardisty discount has since averaged just over $21/b.

The differentials tell a similar story. Since late-October the gap between ex-Hardisty and ex-Cushing differentials to front-month WTI (WTI CMA) has blown out.

So as things stand now, WCS priced in Canada fetches a much smaller price than it does at Cushing, if you can even get it there. And without more pipeline capacity, producers face some tough choices ahead.

“First, pipeline expansion projects have been delayed (eg Keystone XL) by political opposition and second Canadian crude is facing increased competition for pipeline capacity from rising US domestic production,” Fielden explains. “That production — particularly in North Dakota — is increasingly taking up pipeline capacity that would otherwise have been available for Canadian crude.”

If a pipeline fails and the crude it carries is still in high demand by refineries that cannot replace it, prices typically rise. But when there is no market for a crude, for whatever reason, prices tank.

“The market reacted by increasing the discount (i.e., decreasing the price) traders paid for the heavy Western Canadian Select (WCS) crude versus the NYMEX benchmark West Texas Intermediate (WTI),” Fielden said.

And Canadian pipeline issues aside, the boom in US crude production is likely to last for at least a few more fiscal quarters. Unfortunately for many Canadian oil producers, the same cannot be said for the duration they can go on producing with such slim differentials.

However, Sterne Agee energy equity analyst Grant Fox councils caution. “I think patience is a virtue,” he said, regarding Canadian exports. “With President Obama’s second term commencing I don’t believe his administration is as

politically constrained with the Keystone XL expansion as in its first term. Committing *excessive* capital to West Coast pipelines could prove foolhardy if Gulf Coast capacity improves as expected. The USGC is the natural and easiest market for Western Canadian crude and would make [British Columbia/Washington crude flows] challenged on price.”

Fox also said that the WCS diffs have moved lower since the beginning of January, more because WTI moved higher, which is primarily due to the Seaway reversal. “This is likely short-term and should resolve itself,” Fox said.

Meanwhile, Canadian E&P’s had a weak 2Q12 with relatively “good” pricing, said Fox. “This has created a budgetary domino effect where expected revenues to be apportioned towards operations were diminished, leading to faltering E&P activity in Canada at the end of the year.”

Fox says it is still “too soon to tell whether Canadian activity will rebound but indications from drilling rig counts point to strength in the near-term.”  This, suggests Fox, could put even further pressure on differentials simply in terms of the growth in supply.

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