PETROANALYSIS || ARTICLE
Canada oil sands: Discount level reinforces OPEC strategy
Canadian crude production is close to 4.5 million barrels per day (BD), thanks to the success of the development of oil sands. 64% of total production, 2,700,000 BD corresponds to oil processed by the exploitation of these oil sands. Total crude oil production in Canada is 4,200,000 BD, of which 3.3 million BD is exported.
While conventional crude production has stagnated in this country, total crude production tends to be increasingly based on the exploitation of oil sands located in the province of Alberta.
This production dominated by oil sands corresponds to Canada’s oil reserves, which are mostly bitumens.
Canadian oil and natural gas sales are mainly restricted to the Canadian and US markets. Those destined for the United States are between 60% and 65% of total sales and 97% of exports. This total dependence on the US market brings immense vulnerability. This neighboring market is mainly served through oil pipelines and marginally by rail. The main final destination for this type of crude – represented by the upgraded acidic crude that comes from the exploitation of the bitumen – are the refineries located near the Gulf of Mexico that work with acidic and heavy crudes similar to those of Venezuela and Mexico.
Given that there has been a mismatch between the growing Canadian production and the lack of oil pipelines, due to a shortfall in their construction in the United States, Canadian crude is sold at a discount to West Texas Intermediate. This discount reached a historical level in November 2018.
An important reason for this crisis that affected Canadian oil was the temporary shutdown due to maintenance in September of the Whitting refinery in Indiana. This was extended in 2013 to process the type of crude oil that comes out of Alberta. It has a refining capacity of 430,000 bd and is the main buyer of Canadian crude.
The discount of Western Canadian Select (WCS), a benchmark for diluted crude oil that comes from exploiting bitumen, stood on average in November at USD 45.66, a record level equivalent to USD 56.69 for the WTI and USD 11.03 for the WCS. The previous historical mark of this discount was observed in December 2013 when it stood at USD 38.94. This discount for 2018 registered an average annual historical ceiling at USD 26.31.
Canadian crude is sold at a discount to WTI due to a problem of excess supply caused by insufficient transport capacity by pipeline that allows its timely arrival to its main buyer. The other route for transportation is by rail, which, besides being insufficient, is expensive and risky.
The transport of Canadian crude oil by rail, for example, from Edmonton to its destination to refineries on the Gulf Coast, involves selling the crude at a usual discount of USD15 to USD 20 per barrel. In 2017, exports of Canadian crude by rail did not reach 150,000 barrels per day, but in December 2018 they reached 281,000 BD.
This situation has tended to worsen as Canadian production continues to grow and local supply of surpluses accumulates. It is worth mentioning that the possibility of moving this Canadian production to other markets such as those in Asia via the Pacific or trading it on the west coast of the United States also has the problem of lack of pipelines or transportation capacity.
The expansion of the Trans Mountain pipeline, which supplies the west coast of Canada and starts from the province of Alberta, has a capacity of 300,000 barrels per day, and there are plans to expand it to 890,000. However, its construction has been questioned for reasons of environmental impact and violation of the rights of the indigenous peoples who inhabit lands where the route of the pipeline would go. It has a length of 1,150 km. and is a transport route from Edmonton, Alberta, to the Westbridge Marine Terminal in Burnaby, BC. The oil is stored in the Westbridge Terminal and then pumped to oil tankers who transport the oil to refineries in other markets outside of Canada.
Also, there is a problem of logistics and cost to direct this excess supply of crude oil to the Canadian refineries located on the east coast of this country that mainly source foreign oil. Refineries located in the Atlantic have access to external oil, which generally has a price closer to Brent. The oil from Alberta would be attractive at a big discount for the refineries, even if it arrives by rail as there is no oil pipeline to connect them, one is planned, the Energy East, but it has not been built.
Such discount must be very broad to be attractive, given the distance of 4,500 km between Edmonton, Alberta and the 320,000 bbl / Irving Oil refinery in Saint John, New Brunswick, the largest refinery in Canada and the largest importer of crude oil. As New Brunswick is 1,000 km farther than the Gulf Coast, the displacement of 100% of Canadian foreign imports with Alberta crude is unlikely to occur.
In the sense that the bottleneck generated by the pipelines is difficult to resolve – since the construction permits for the Keystone XL, an extension of the current Keystone system, for example, in US territory, has been questioned by non-governmental organizations that defend the right of the indigenous peoples over the land through which the pipeline would pass, and also bearing in mind criticisms of the degree of environmental contamination that the production of crude from bitumen implies, and which would be stimulated by this pipeline.
The current pipeline system known as Keystone has a length of approximately 3,360 kilometers, while the proposed expansion of Keystone XL is estimated at more than 1,760 kilometers. It is estimated that Keystone XL can transport more than 800,000 barrels of oil per day, which increases the capacity of the Keystone system to 1.1 million barrels per day.
Likewise, the construction of the Canadian oil pipeline, which is in discord, is also rejected by sectors of the Democratic Party that defend clean energy and American regional state factors that oppose a particular path.
In Canada, the crisis was accentuated in November when the discount at which crude oil was sold reached record historical levels. This caused the industry to shake and presented the authorities of that country with measures that were unthinkable and in contradiction with the philosophy of market freedom which dominates the main parties that take turns in governing at central and provincial levels. It should be noted that the equilibrium price to exploit the tar sands is around USD 30, so the huge discount endangered the cash flow of the companies that exploit them.
For this reason, the government of Alberta approved a three-month temporary cut in production of 325,000 barrels per day from January 2019 and then from 95,000 BD until December 2019, in order to reduce the oversupply that had been weakening prices. The provincial government also began a discussion of measures that would favor greater transportation by railroad of Canadian crude.
The construction of a refinery has also been discussed. This would allow processing – on Canadian soil – the surplus oil that now and in the future may derive from the expansion plans of the exploitation of oil sands, and would have difficulties in being sold to United States due to the impossibility of the construction of the oil pipeline that is needed for its sale to this country.
It should be noted that not all oil companies in Canada are in favor of the cut, since they estimate that what has caused the crisis now is the lack of foresight and that the lack of refining capacity ended up prioritizing the sale of crude oil that led to an excess supply and pressures for the construction of pipelines that are now being questioned and prevented from being built.
Likewise, it has been questioned whether the Canadian industry should invest in oil upgraders in Canadian territory that eliminate sulfur content and prevent the export of diluted bitumen to the United States. In 2017, only 43% of the bitumen produced was upgraded in Canada and 57% was exported to the United States to be upgraded. They argue that while there is no attempt to upgrade the bitumen in Canada there will be the problem of the lack of capacity of the pipelines, both the expansion of existing ones and new ones as their critics increase due to environmental reasons.
For the time being, the 8.7% cut in Canadian production from January 1, 2019 helped the discount between WCS and WTI to be reduced to its lowest level in a decade, falling below 7USD, then climbing up to USD 50 in November 2018. It is not unreasonable to think that this production cut by the authorities of the province of Alberta, coinciding with the plan of cuts of 1.2 million barrels approved by OPEC and its allies from January, has reinforced the global recovery that has been observed in the price of oil. Even though Canada did not agree such a measure with OPEC, it undoubtedly reveals that OPEC’s action aimed at stabilizing the price through the reduction of supply was correct.