Canadian Oil Sands: A Look Back and a Look Ahead

By Dan Cronin and John Auers

In today’s blog, we introduce TM&C’s newest consultant, Dan Cronin, who establishes our first on-the-ground presence in Calgary.  Dan, who is a Canadian native and has spent almost two decades working in a variety of assignments in the Western Canadian oil industry, brings a uniquely “North of the Border” perspective to our team.   He actually started his career in Calgary on the consulting side of the business with Purvin & Gertz, before moving over to work at two large integrated oi and gas companies (Petro Canada/Suncor and Cenovus Energy).  Most recently, he spent several years in the midstream sector at Enbridge Pipelines, in a variety of assignments, primarily focused on business development.    Things have come full circle for Dan as we are excited to bring him back into the consulting world to help us better serve the needs of our Canadian clients.   As Dan begins this work, we thought it appropriate to allow him to provide some of his personal reflections on how the Western Canadian oil industry has changed since his start back in 2002 and his views on what to look for in the coming months and years.

A Look Back – Growth Followed by Challenges

Just as the global oil environment has changed dramatically over the past 17 years, so too has the landscape in Western Canada.   The most obvious development has been the significant growth in production as billions of dollars have been spent to turn the vast regional oil sands reserves into commercially viable crude oil.   Most of these barrels have come to market as heavy crude and this has had a cascading effect on U.S. refineries, particularly in PADD II.  These plants, most notably BP Whiting, WRB Refining Wood River, and Marathon Petroleum Detroit, have invested in significant downstream upgrading facilities to allow them to economically process heavy Canadian barrels.  A further cascading effect that occurred as supply increased was a continued push into the crude slates of refineries not only in the mid-west but also in the mid-continent and eventually PADD III.  Since 2002, Canada has become (by far) the largest source of U.S. crude imports, approaching 4 million BPD in recent months.  While refineries in PADD II still process the majority of these barrels, PADDs IV and III have also become important destinations, and rail has even allowed the East and West Coasts to access barrels from Western Canada. (see Fig 1 below).

The biggest surprise to me during my career; however, hasn’t been the significant increase in supply; it hasn’t been the billions of dollars of investment by PADD II refiners to run Canadian heavy crude, and it hasn’t been the penetration of Canadian crude deeper into the U.S. crude market – the biggest surprise to me has been the lens in which the oil sector is viewed; more specifically, the negative light in which the Canadian oil sands is portrayed by some groups and even policymakers.   Early on in my career, I held the view as most did, that as Western Canadian supply increased, rational decisions would be made and the necessary infrastructure would be built to transport crude to market in the most efficient manner possible (i.e., pipelines) – I was wrong.  Unfortunately, the negative view of the oil sands has become entrenched in some circles, and the industry is now having to deal with the consequences.

I would argue that a negative perception of the oil sands began to crystalize in July of 2006 when an oil sands dump truck was the main attraction for an Alberta exhibit at the National Mall in Washington, D.C. (could you imagine doing this today?).  Up until that point, the oil sands generally flew under the radar and the oil sands were sort of an “out of sight out of mind” matter; however, since that July event this has no longer been the case.  Attention had been brought to the Western Canadian oil industry and opposition was beginning to form on many fronts to stop the “tar sands.”  A playbook then soon evolved and those in opposition realized that the most effective way to slow down and even ultimately stop oil sands development was to thwart the buildout of the infrastructure necessary to bring it to refining markets.  Unfortunately, Canadian producers are now facing the consequences of this 10+ year battle that has resulted in inadequate pipeline takeaway capacity and the reliance on rail (ironically with a higher CO2 footprint versus a pipeline) to transport the marginal barrel out of the basin.

I have personally felt the impact of this battle against the oil sands when working on a pipeline project a few years ago. The project was already commercially completed and my role was to help secure regulatory approval for the pipeline.  I felt the project was relatively innocuous as a new pipeline wasn’t being constructed, the regulatory approval was simply for a pipeline reversal; and as a result, I wasn’t expecting significant opposition to the project.  Unfortunately, I was wrong and the protests against this particular project were staggering.  Protests continued to grow until it reached such a level that the final day of public hearings were cancelled by the overseeing government agency due to security reasons.  Earlier on in my career, I don’t think I would have believed such a story; today, very little surprises me in this regard.

Recent Developments and a Look Ahead – Government Intervention Takes Center Stage

What has surprised me in the current environment has been the level of intervention at both the Federal and Provincial levels here in Canada.  At the Federal level, the left leaning Liberal government under the leadership of Prime Minister Justin Trudeau purchased the existing TransMountain Pipeline from Kinder Morgan for $C4.5 Billion – a topic we covered in a previous blog (June 12, 2018 blog).  The announcement to purchase the pipeline was made at the end of May; however, on August 30, a Federal Court of Appeal overturned the pipeline’s construction permits.  The court ruled that the federal government did not consult with affected First Nations and that the report issued by the National Energy Board was flawed as it ignored the issue of tanker traffic.  New reviews will need to take place which will impact cost and schedule.

More recently, in response to the exceptionally high Canadian crude discount, the left leaning Alberta Provincial government of the New Democratic Party (NDP) has further  intervened in the oil industry with two announcements of their own. On November 28, Alberta Premier Rachel Notley announced that the government was only weeks away from finalizing the purchase of a fleet of rail cars to help transport crude to market and in turn help narrow the Canadian crude discount.  The plan is to secure enough rail cars to transport 120 KBPD out of Alberta.  It is anticipated by the government that the first rail cars will start transporting crude in December 2019 at ~15 KBPD with the ultimate capacity of 120 KBPD being reached in August 2020.  Of note, this isn’t the first time that the Alberta government has secured takeaway capacity; in January 2018 the Alberta government committed 50 KBPD to the Keystone XL pipeline.

On December 2, Premier Notley came forward with another announcement to assist the oil industry in Alberta.  Armed with the statistic that pipeline constraints were costing the country over $C80 million/day, Premier Notley announced that production would be reduced by 325 KBPD starting January 1, 2019, and the curtailments would terminate December 31, 2019.   This announcement quickly moved markets as the WCS discount to WTI snapped back in from over $US 40 to less than $US 20.  In addition to a narrower light/heavy differential, stocks of many Canadian producers also traded higher – notably Cenovus Energy Inc. and Canadian Natural Resources Ltd., both of whom supported the curtailment; however, not all Canadian players were supportive of the move – specifically, highly integrated oil companies that have benefited from cheaper feedstock at their refineries and those companies that anticipated the pipeline situation and invested the necessary capital to mitigate this risk accordingly.

While most were surprised by the Federal government’s purchase of the TransMountain pipeline, it is difficult to see the Federal government intervening on such a large scale a second time; however, the current Alberta Provincial government, facing a spring election, may have a few more announcements in store.  On December 11, perhaps bolstered by the immediate success of its announcement to reduce production, the Alberta government indicated that it is looking to incentivize the construction of a new refinery or refinery expansion in the province.   This is not the first time the government has been involved in efforts to help build new refining capacity in the Province, and the challenges involved in such an effort can be very well illustrated by that previous example, the North West Redwater Sturgeon Refinery (NWRSR).  The NWRSR commenced operations in December 2017 but has yet to meet nameplate capacity and the cost of the project has ballooned from the original estimate of $C4 billion in 2008 to the most recent estimate of $C9.7 billion.  High costs of refinery construction in Alberta is not the only challenge either – just as with the heavy crude itself, any refined product would also have to find markets outside of the region, begging the question whether the takeaway situation is really any better with more in-region refining capacity.

“May you live in interesting times” is a famous quote and my time in the Western Canadian oil industry has been very interesting.  I started my career at a time when the oil sands were essentially a nonissue to a time now where the oil sands have been effectively demonized. It is this demonization that has caused the current challenges faced by Western Canadian producers and has subsequently pushed governments to act.  It is debatable how far governments should intervene into any economy and to what extent – it will be interesting to see if governments (especially at the Provincial level) continue to intervene and the impact they will have.

Due to the time and space limitations of a weekly blog, we have included only a high-level discussion today on the very wide-ranging and critical developments taking place in the Western Canadian oil patch.  TM&C will address these developments, particularly the takeaway capacity issues and the impacts on heavy crude supply/demand dynamics in a deeper, quantitative level in our 2019 Crude and Refined Products Outlook.   This report, which is scheduled to be released in early February, will provide a comprehensive and detailed forecast of supply, demand, and prices for all crudes and products on a regional and global basis through 2030.  Market, policy, demographic and technology developments are all considered in our analysis and forecasts.  For more details about this or other TM&C publications, please visit our website or give us a call at 214-754-0898.

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