By Robert Auers
For today’s blog, we chose a song by everyone’s favorite Canadian – Justin Bieber. By purchasing the existing Transmountain pipeline and the Transmountain expansion project last week from Kinder Morgan for C$4.5 Billion, the Canadian federal government is essentially saying that it will do everything in its power to ensure that the expansion gets built and is telling British Columbia and the other pipeline opponents to go “Love Yourself,” as Bieber did in his 2015 hit. While not entirely unexpected given the strong support Trudeau has given to the Transmountain over the past several months, this move does represent a major step in the Canadian Government’s willingness to ensure that the necessary pipeline projects to support Oil Sands production growth are built.
“I never like to admit that I was wrong”
The Transmountain nationalization certainly changes our outlook for Canadian pipeline completions going forward. We wrote about the “trilogy” of currently proposed takeaway projects (Transmountain, Line 3 replacement, and Keystone XL) from Western Canada in November here. We noted that in the short-medium term, only two of the three projects will likely be needed. At that time, we handicapped Line 3 and Keystone XL as the two most likely to be completed and noted that Transmountain may be left out for the time being. However, as we stated would be necessary, Trudeau and the Canadian Federal Government have definitely backed up their support for the Transmountain expansion by purchasing the project outright and committing federal money to the project. While ultimate completion of the project is still not assured, we would be surprised if the expansion is not completed in a relatively timely fashion. British Columbia continues to threaten lawsuits against the project and certainly will not just roll over without a fight. Still, the federal government is obviously fully behind the project at this point, and we believe they will find a way to ultimately see that the project gets built. We also note that, somewhat ironically, opinion polls shows that the majority of British Columbians actually support the Transmountain expansion. A large portion of these supporters, however, are not supporters of the NDP (the major left-leaning party in Canada and the party in power in BC, Alberta, and the Canadian Federal Government). Therefore, the BC government still feels that they are representing the majority of the people who put them in power.
Keystone XL, meanwhile, continues to face roadblocks in the courts, specifically regarding the approved alternate route through Nebraska, leaving its ultimate fate still in question. TransCanada has, however, reportedly begun clearing trees over part of the pipeline’s route and remains committed to the project. As a result, we are hesitant to simply write-off the Keystone XL project and expect that it may also see completion in the next three to five years.
“Baby, I be movin’ on”
The seeming shift toward Transmountain and (possibly) away from Keystone XL will have obvious and important potential consequences on the patterns of future Canadian crude flows. While Keystone XL would have provided another route to the Gulf Coast, where we expect growing demand for Canadian crude largely due to falling heavy crude supply from Venezuela and Mexico. Transmountain, meanwhile, represents an outlet to access not only Asian buyers, as is often discussed, but also those in California. We note California as an important potential outlet due to the fact that a large number of refineries there are already configured for the processing of high-TAN, heavy crude from the San Joaquin Valley, where crude production continues to fall. Many refiners have made up for this shortage of local heavy crude by importing barrels from Latin America, and at times, from Canada by rail. Therefore, we see California as a logical outlet for Canadian crude in this scenario and the potential for it to displace some of the Latin American barrels that are currently imported to the region. These displaced Latin American barrels may, in turn, find their way to the Gulf Coast. Further, if Transmountain is built (and Keystone XL is not), Gulf Coast refiners may be forced to look for alternative sources of heavy crude, possibly in the Middle East in addition to the potentially displaced Latin American volumes mentioned above. While current global demand for medium and heavy Middle Eastern barrels is high, we expect the competition for the barrels to decrease beginning in 2020 as a result of the new IMO regulations due to the fact that much of this crude is used as feedstock in cracking refineries in Asia in Europe. Many of these refiners will likely look for sources of lower sulfur crude beginning in 2020 to avoid the production of low sulfur bunker fuel.
Lastly, we also note that the market will likely need to see the Line 3 replacement, the Transmountain expansion and Keystone XL all completed to meet takeaway capacity demand. Further, if it becomes clear that all three projects will be completed and that surplus takeaway capacity may exist for a time, we expect this will encourage new investments in the oil sands. As a result, the completion of all three projects would not be expected to cause a significant long-term surplus of regional takeaway capacity due to the additional production growth that would likely result from increased visibility regarding future regional differentials.
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 MY Update, which is scheduled to be issued in early August, will discuss this as well and 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.