“Canadian Railroad (Pipeline) Trilogy” – An Impending Takeaway Crunch in Western Canada?

By Robert Auers and John Auers

Gordon Lightfoot, perhaps Canada’s greatest songwriter of all time, wrote “Canadian Railroad Trilogy” to describe the building of the first Trans-Canadian railway in the 1880s.  Much as in the U.S., a trans-continental railroad marked a major milestone in Canadian development, linking the West and East Coasts of the country and allowing for rapid development of Western Canada.  Approximately 70 years later, in the 1950s, interest began to grow in the Canadian Oil Sands, which would arguably do more to shape the future of Alberta than anything since the railroad.  Originally, producers planned to use underground nuclear explosions to heat bitumen to a point where it could be produced using mostly conventional methods; however, as views on nuclear weapons shifted in the late 50s and early 60s, this Idea was scrapped in favor of simply mining the material.  Then, in 1967, Sun Oil Company began production at the first commercial-scale oil sands project, called the Great Canadian Oil Sands Project, which produced 30 MBPD of synthetic crude oil.   While growth in the oil sands fields was slow at first, it really began to take off in the 1990’s and 2000’s as higher oil prices justified the massive investments required to produce the heavy bitumen.  As production volumes exceeded regional demand, additional takeaway capacity to new markets was needed.  The completion of TransCanada’s Keystone pipeline in phases from 2010 to 2014, along with expansion of the Enbridge system has mostly kept up with production growth in recent years.  However, with new production expected to come on line in the next year, most notably SuncorTotal’s Fort Hills project, we are about to reach the limits of current pipeline infrastructure.   This will likely result in a need to turn to rail as a stopgap to allow the new crude production to reach refineries.  How long this situation persists will depend on a “trilogy” of new pipeline projects, all of which have the potential to address the current takeaway capacity constraints.  These three projects are the Enbridge Line 3 replacement, TransCanada’s Keystone XL, and Kinder Morgan’s Trans Mountain expansion. All three face notable regulatory hurdles that must be overcome before construction can begin, resulting in a significant level of uncertainty for producers, midstream operators and refiners.  We will explore these uncertainties and the critical factors which will influence what happens next in today’s blog.

“For they looked into the future and what did they see?”

The short answer to the above question is they saw continued production growth, despite low oil prices, and a potential lack of pipeline capacity.  While the rate of new project announcements has slowed and project delays and cancellations have accelerated in Western Canada since 2014’s commodity price downturn, the completion of projects already under construction will add notable volumes to supply over the next couple of years.  Smaller projects will also keep some level of growth for years to come as well.   As a result of the oil price downturn and decreased investment activity, CAPP has lowered its 2030 oil sands production forecast from over 5 MMBPD in its 2014 report to just 3.7 MMBPD in its 2017 report, released in June of this year.  This forecast, however, still predicts about 40% growth from the 2017’s likely output of about 2.6-2.7 MMBPD.  Furthermore, additional takeaway production will need to be higher than the implied production increase of ~1 MMBPD due to the fact that most new projects will produce DilBit and require additional capacity to account for the diluent required to be blended into the final product (with diluent making up as much as 1/3rd of the total DilBit volume).  With conventional Western Canadian production forecast to remain roughly flat at 800-900 MBPD, the current CAPP analysis forecasts total 2030 Western Canadian supply at 5.5 MMBPD.  Meanwhile, takeaway capacity in Western Canada is already stressed, with current takeaway capacity of just over 4 MMBPD, struggling to meet total current western Canadian supply of about 4.2 MMBPD, including diluent and conventional production.  (As part of our semiannual Crude and Refined Products Outlook, TM&C provides a separate production forecast for crude production from various regions of the world, including Western Canada.)

The most notable project slated to come on line is that of Suncor / Total’s 194 MBPD Fort Hills project, which is expected to start up next month and ramp up to full capacity over the next year.  Additionally, Canadian Natural Resources recently restarted construction at its 40 MBPD Kirby North facility and expects production to start in 2019.  Meanwhile, others players have decided to pursue smaller 10-20 MBPD incremental expansions at existing sites that will allow for continued incremental supply growth in the region.  Lastly, as oil sands projects typically require high capital investments but low operating costs and low decline rates, significant production declines, due to lower oil prices, are of little risk.  In total, we expect Western Canadian supply to grow by as much as 500 MBPD or perhaps even more, over the next 4 to 5 years, required an equal amount to new takeaway capacity.

“Bring in the workers and bring up the rails (pipes)” – Once you have regulatory approval, of course

Keystone XL

Keystone XL (KXL) has certainly received the most press of the trilogy of pipeline projects proposed to solve the takeaway crunch.  As we all know, it has also faced the toughest road through the regulatory approval process, facing significant hang-ups in both the U.S. federal government under the Obama administration and within the state of Nebraska.  Coupled with the oil price downturn and decreased Canadian production growth forecasts, these led TransCanada to all but abandon the project in late 2015.  But the surprise election of Donald Trump and his subsequent executive order approving the project, issued in March of this year, gave KXL new life.    Additionally, TransCanada officially announced last month that it has abandoned its Energy East pipeline project, lending more support to the idea that the firm has shifted its efforts to the Keystone XL project.  Major hurdles still remain however, notably commercial acceptance and approval of the proposed route through Nebraska by state authorities.   In regards to the first of these, TransCanada announced last week that they received above the minimum 500 MBPD of shipper commitments that they deemed necessary to justify construction of the 830 MBPD line, albeit with unnamed shipper conditions.    TransCanada has publicly stated that these conditions are “manageable” and is encouraged by the response.  While they have not yet officially announced that they will attempt to continue forward with the project, it seems likely that this announcement will come within the next month or two, if not sooner.   The eventual fate of Keystone XL, therefore, could rest on the state of Nebraska, which still must approve the pipeline’s route through the state.  The Nebraska Public Service Commission has just announced that they will hold a vote on their decision next Monday (November 20).  The losing side, however, will likely appeal the decision, so a final ruling may not come until next year.

Enbridge Line 3

Enbridge is trying to replace its existing Line 3 (commissioned in 1968), which runs from Edmonton, AB to Superior, WI.  In the process, Enbridge will restore the line to its original capacity of 760 MBPD, with possible expansion to 844 MBPD.  Furthermore, Enbridge has repeatedly cited safety and reliability concerns over the existing line, due to which the pipeline’s current capacity is limited to just 390 MBPD.  While the project seems relatively simple as it follows the right-of-way of the existing line for the vast majority of its length, the Minnesota Public Utilities Commission, who now effectively controls the projects fate, has yet to approve the project and is not expected to make an official decision on the project until the spring of 2018.  The Minnesota Department of Commerce recommended against the replacement, instead pushing for the existing line to be shut down in their August testimony before the Commission.  Their reasoning for this opinion was that they see limited benefit to the state of Minnesota, which they believe has sufficient access to crude oil, both light and heavy, without the line.  Furthermore, many have cited that the replaced line will follow a different path through most of Minnesota as a reason to justify rejection of the pipeline replacement.  This seems a bit ironic, however, as the new route was chosen to avoid environmentally sensitive areas, population centers and congestion along the existing right of way.

Trans Mountain Expansion

Kinder Morgan is looking to expand its Trans Mountain pipeline, which runs from Edmonton, AB to Burnaby, BC, from 300 MBPD to 890 MBPD by building a new pipeline parallel to the existing one.  This project also seems relatively simple, as there will be no new right-of-way and the existing line has been in operation since the 1950s with minimal environmental impact.  But if only it were so simple.  In 2016, the Canadian federal cabinet gave conditional approval to the pipeline and this year the National Energy Board (NEB) said all conditions had been met, and this, at least theoretically, should have settled the matter.  Yet, the Vancouver and Burnaby local governments, the British Colombian Provincial Government, and various environmental and First Nations groups vehemently oppose the project and have filed multiple lawsuits with intent to block the pipeline’s construction.  Alberta, despite being governed by the same pro-environmental party (NDP) which leads BC,  stands behind the pipeline due to its own oil-dependent economy.  Trudeau’s administration seems hesitant to firmly take a side, and would likely prefer to leave the eventual outcome to the NEB.  Still, as the situation continues to escalate, it appears that the federal government will have to step in at some point to either enforce their earlier decision and allow the expansion or rescind their decision and disallow the project.

“Let the life blood flow”­ – Heavy Crude Sourcing for Gulf Coast Refineries

While pipeline capacity from Western Canada to the Gulf Coast struggles to get built, Latin American heavy crude production (primarily from Mexico and Venezuela) continues to fall, putting pressure on the light-heavy differential at the Gulf Coast.  Most Gulf Coast refineries have significant upgrading capacities and are optimized to run substantial volumes of heavy crude and, therefore, provide a logical destination for western Canadian heavy.  Yet, a failure of the Keystone XL and/or the Line 3 replacement to get built will likely necessitate significant volumes of Crude by rail from Canada to the Gulf Coast.  While Line 3 will only run to Superior, WI, Enbridge can use other parts of its existing system to move crude from there to Patoka, IL, where it could potentially move to the Gulf Coast through a reversed Capline pipeline, which just began an open season exploring a potential reversal last month.  Keystone XL would provide transportation to Cushing, OK, potentially overwhelming takeaway capacity there (which is already stressed) until new capacity could be built from there to the Gulf Coast.  All of these developments may put pressure of the Maya-WCS differential in the interim to incentivize the necessary rail movements out of Western Canada.

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 regarding Western Canadian takeaway capacity and the impacts on heavy crude supply/demand dynamics.  TM&C does this analysis at a deeper, quantitative level in our Crude and Refined Products Outlook, where we talk much more in-depth about how the future developments in this area will affect refiners not only in the U.S., but in Asia and the rest of the world as well.   Furthermore, future supply growth may also cause pipeline capacity to be stressed in other producing basins, most notably in the Permian Basin of West Texas.  Our 2018 Crude and Refined Products Outlook,  which is scheduled to be issued in late January/early February 2018, will discuss this as well and provides 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.