By Dan Cronin and John Auers
A good case can be made that Canadian rock legends Rush best summed up the pipeline situation in Western Canada with their hit song, “Time Stand Still.” It is no secret that a pipeline is the most efficient and environmentally friendly way to transport crude oil and it is also no secret that the existing pipeline system out of the Western Canadian oil sands is at capacity and new pipelines are needed to clear the market. To satisfy this need, three major pipeline projects are being developed to help meet this need: (1) the Enbridge Line 3 Replacement Project (Line 3); (2) the TransCanada Keystone XL Pipeline (KXL); and (3) the Canadian Federal Government’s (formerly Kinder Morgan’s) Trans Mountain Pipeline Expansion Project (TMX). All three projects have faced significant delays and unfortunately, as a result of recent events, in terms of gaining meaningful incremental pipeline capacity out of Western Canada, it seems that – Time Stand(s) Still.
“A Little Bit Longer” – Line 3 Replacement Start-Up Delayed Again
Of the three projects, Enbridge’s Line 3 Replacement Project was always the one which was the most likely to be completed first and after the Minnesota State Public Utilities Commission (PUC) granted approval last summer, a start-up was expected before the end of this year. However, on March 1, Enbridge announced a significant delay in that schedule after receiving a permitting timeline from the state of Minnesota. This new schedule says that all the necessary State permits for the construction of Line 3 will not be certified until November of this year and then the required Federal permits will be finalized ~30 – 60 days thereafter. Based on this timeline, the in-service date for Line 3 does not come until the second half of 2020, a delay of about one year from what was previously anticipated. It should be noted that even this schedule is not a certainty (is anything when it comes to Canadian pipelines?) as significant opposition still exists, with Minnesota’s Governor, Tim Walz, recently announcing that his Administration will continue to pursue an appeal of the PUC approval of the Line 3 Replacement.
The Line 3 Replacement Project will bring on an incremental 370 KBPD of capacity that, when available, will most likely be utilized immediately. With a delay in the Line 3 in-service date, heavy producers in Western Canada now find themselves in a position where they should directionally face a wider light/heavy differential – a differential that blew out to beyond $50/bbl in October 2018. A wider light/heavy differential makes rail projects more economic so one would expect producers to look to rail to export incremental barrels out of Western Canada; however, this may not necessarily be the case. The Government of Alberta has tools at its disposal to make or break rail economics on a whim. The Government of Alberta can directly impact the light/heavy differential through mandated production cuts, and it can also directly impact rail economics through its recent entry into the rail game with a $C3.7 billion investment. To increase the uncertainty even further, a Provincial Election in Alberta is looming this spring, and the United Conservative Party (the official opposition), while in favour of mandated production cuts, continues to signal that all rail deals executed by the existing Government (New Democratic Party) will be terminated if it were to come to power.
It is difficult to predict how the Provincial Government will act going forward as it is in a position where it has an incentive for both a wide and a narrow light/heavy differential. If the light/heavy differential widens, the Provincial Government will receive less royalty revenue; however, the wider light/heavy differential allows for a better return on the Provincial Government’s rail investment. If the Provincial Government decides to intervene in the market with mandated production cuts (as it already has) to narrow the light/heavy differential, royalty revenue would increase; however, the economics for its rail initiative would suffer. It is already a very difficult task to accurately forecast Canadian light/heavy differentials – layer in potential government intervention into the market in addition to a potential change in government through a spring election, this task becomes even more difficult if not impossible.
The figure below depicts Canadian crude oil exports by rail. As you can see, the high-water mark was reached in December 2018 (the most recent data available from the National Energy Board). It will be interesting to monitor the volume of railed barrels in the future and see how many of those railed barrels will be attributed to the Provincial Government.
“Before I Start Off Again” – Should I (Canadian Producers/Project Developers) Invest in Rail?
Will Line 3 be in service in the second half of 2020? This is a difficult question to answer; however, even when/if Line 3 eventually does come into service, it is still expected that another pipeline project (TMX or KXL) will be required in order to have the necessary pipeline capacity to clear the market. Unfortunately, if most recent history is to repeat itself, one should plan for further delays in these pipeline projects – the question is: What is that plan?
In a free market scenario, a producer would most likely look to alternative methods to export crude out of Western Canada and that would be rail; however, we do not find ourselves in a free market today with respect to the crude oil industry in Alberta. A rail investment by a producer today will face two major uncertainties. The first uncertainty a producer will face is the ability to forecast their own production volumes as the Provincial Government has the power to mandate production cuts across the board thereby making it difficult to forecast how much rail capacity a producer needs. The second uncertainty a producer will face is competition from the Provincial Government to market their railed barrels – competition against an institution that faces few if any economic drivers. So, with this in mind, who of you out there is ready to backstop a rail facility? How long should the term be? How many barrels are you going to commit? As you can see, things get very complicated when trying to develop a plan against further pipeline delays under the current investment environment in Alberta.
With pipelines at capacity and with the tremendous difficulty in bringing on new pipelines, we need to find a way to utilize pipeline space more effectively. One way of maximizing pipeline space is through Partially Upgraded Bitumen (PUB). As already mentioned in our PUB blog series, processing bitumen into a PUB has the ability to reduce or even eliminate the need for diluent. Not only will the industry gain capacity through this initiative, but pipelines that currently import diluent into Western Canada (Enbridge Southern Lights and Kinder Morgan Cochin) could potentially be utilized for crude oil exports. While PUB will take time to develop and is not an immediate solution – should history continue to repeat itself with pipelines continuing to be delayed, an investment in PUB does potentially represent an opportunity for those players bold enough to pursue it.
Unfortunately, we were not surprised by the delay in the Line 3 Replacement Project – despite how much sense it makes. Here we have a project that would replace an old pipeline thereby reducing the potential for future leaks/spills, one which would also reduce greenhouse gas emissions by transporting crude via pipeline instead of rail, while at the same time reducing costs which ultimately flow to consumers. It is hard to conceive the rationale for delaying such a project; however, we are talking about politics here and good sense seems to be a forbidden criteria in that realm. In the end, the pipeline has been delayed and this, unfortunately, seems to be the status-quo for all pipeline projects connected to the Canadian oil sands – Time Stand(s) Still.
TM&C continuously monitors all factors that impact crude supply and logistics out of Western Canada and its impact on crude disposition and pricing. We include our independent analyses of these impacts in our semiannual Crude and Refined Products Outlook, the most recent issue of which we released in late February. For more information on our Outlook, any of our other products or our consulting capabilities, please call us at 214-754-0898 or email us at firstname.lastname@example.org and email@example.com