Canadian pipelines to nowhere
Lack of midstream takeaway capacity had been a growing concern for years, but Covid-19 has reversed the danger
Western Canadian oil producers have suffered from a shortage of export capacity from the region for much of the past decade, in part due to the environmental movement and its allies— strongly opposed to Alberta’s oil sands industry—slowing the pace of pipeline development.
The Covid-19 pandemic has turned this problem on its head. Regional production of c.1.2mn bl/d has been shut in due to lower prices following a collapse in demand for refined products, particularly gasoline and jet fuel—leading to a significant surplus of takeaway capacity from the region.
The short-term surplus should dissipate over the next year or so as North American and global oil demand rebounds. But it is likely to become an issue again by 2023 for a different reason—a lack of growth in Western Canadian oil production just as an array of small-scale and big-ticket crude pipeline projects come online.
It appears there is about 700,000bl/d of surplus oil pipeline capacity out of Western Canada, based on comments by midstream firm Enbridge’s CEO Al Monaco during the company’s first quarter earnings call. Some spare capacity could remain at the end of this year as the rebound in oil consumption will likely remain incomplete into 2021.
700,000bl/d – Current pipeline surplus
Crude-by-rail volumes will be curtailed “first and fast” because of their higher transportation cost, says Monaco, while some shut-in production previously supplied the Western Canadian refinery market. The region exported almost 400,000bl/d by rail in the first quarter, according to the Canada Energy Regulator (CER), and this figure has the potential to fall to c.100,000bl/d—the amount Canadian producer Imperial Oil normally rails to affiliated ExxonMobil refineries in the US. Demand losses within Western Canada likely account for another 200,000bl/d, for a sub-total of 500,000bl/d.
This number appears to make sense, as Enbridge expects volumes shipped on its Canadian Mainline system, which accounts for roughly three-quarters of Western Canada’s inter-regional capacity, to decline by 400,000-600,000bl/d in the second quarter. In April, the Mainline shipped an average of 2.45mn bl/d, about 400,000bl/d lower than in the first quarter.
New Brunswick-based Irving Oil, owner of the 320,000bl/d Saint John refinery—the largest in Canada and situated just over the border from Maine in Canada’s far southeast—has moved fast to take advantage of this surplus capacity and potentially source significantly more oil from Western Canada. In mid-April, Irving made an application to the Canadian Transportation Agency (CTA) for a one-year waiver to the 1992 Coasting Trade Act, a Canadian version of the US’ Jones Act, to hire a low-cost foreign, mid-size tanker to transport Western Canadian oil from the Westridge Marine Terminal in Burnaby, British Columbia, to the Saint John refinery by way of the Panama Canal, as well as an application to do the same from a terminal in either Louisiana or Texas.
Irving was granted a one-year waiver by the CTA at the end of April to transport Western Canadian oil from the Westridge facility but awaits approval to do the same from the US Gulf Coast. Canadian oil presently represents about a fifth of the Saint John refinery’s crude slate, most of which comes from offshore Newfoundland and Labrador by domestic tankers, while a “small amount” comes from Western Canada by rail.
Enbridge has also made an application to the CER. It is looking to switch its Mainline crude pipeline network from a 100pc common carrier system relying on monthly nominations to one with 90pc capacity on long-term fixed-volume contracts—primarily due to concern about a lack of Western Canadian supply growth in the coming years meaning less use of its network as other options become available.
Capital spending by Western Canadian oil producers has been depressed since the middle of the last decade but has fallen off a cliff with the historic collapse in global oil consumption due to nationwide lockdowns.
Capital spending by Western Canadian oil producers has been depressed since the middle of last decade
And Enbridge is concerned it will have underutilised capacity in the future as new crude pipelines come online, especially the federal government’s 590,000bl/d Trans Mountain Expansion (TMX) and Calgary-based TC Energy’s 830,000bl/d Keystone XL (KXL) pipeline (see Table 1), as these are to be exclusively contract carriers. The next potential Western Canadian crude pipeline surplus will be much longer-lasting than the current glut and could be significantly larger, depending on the fate of KXL.
The three major projects to expand crude pipeline capacity from Western Canada—TMX, KXL, and Enbridge’s 370,000bl/d Line 3 Replacement—have all seen significant forward momentum this year, despite some continuing regulatory and legal headwinds. In early February, the Minnesota Public Utilities Commission voted to re-approve the Line 3 pipeline across the state and Canada’s Federal Court of Appeal dismissed the last remaining legal challenge to TMX. Construction of TMX in British Columbia, the epicentre of resistance, began at the start of June.
In addition, at the end of March, Alberta Premier Jason Kenney backstopped the KXL project with C$7.5bn of his province’s money—consisting of a C$1.5bn equity investment and a C$6bn loan guarantee—to ensure a positive FID and allow construction to begin in April.
There is little doubt that KXL’s backer, Canadian midstreamer TC Energy, would have postponed its FID until after the US presidential election in November if the Alberta government had not de-risked it. KXL has long been a political football in the US—with President Barack Obama cancelling it with an executive order in November 2015 and President Donald Trump resurrecting it in January 2017. In mid-May, Joe Biden, the presumptive nominee for the Democratic Party for this year’s presidential election, vowed to again kill KXL if he were to enter the White House.
There are also several lower-risk smaller-scale projects to expand existing pipeline capacity from Western Canada, totalling another 320,000bl/d. Combined with the Line 3 Replacement and TMX, this should add almost 1.3mn bl/d of additional pipeline by December 2022. Including the more politically precarious KXL project, Western Canada could add over 2.1mn bl/d of capacity by June 2023.
On 2 June, the Canadian Association of Petroleum Producers (Capp) announced it had deferred release of its long-term Canadian oil production forecast—the industry standard—due to global uncertainty associated with the coronavirus pandemic. That leaves Capp’s June 2019 production outlook, with relatively optimistic capital spending assumptions, as the basis for comparison to estimate potential surplus crude pipeline capacity exiting Western Canada in the future.
1.4mn bl/d – Projected surplus by 2023
Based on Capp’s June 2019 outlook and assuming 140,000bl/d of crude-by-rail is backed out—roughly 240,000bl/d of Western Canadian crude was exported by rail in 2018—there would be 570,000bl/d of surplus pipeline capacity at the beginning of 2023. Assuming KXL is cancelled yet again by a US president, a surplus would remain until the year 2030 based on Capp’s production forecast.
If KXL is completed, there would be almost 1.4mn bl/d of surplus crude pipeline capacity exiting Western Canada by the second half of 2023, and a surplus would remain through to 2035—the end-year of Capp’s outlook.
But capital spending by Canada’s oil and gas producers—most of which occurs in Western Canada—was C$34bn in 2019, almost a tenth less than originally forecast by Capp and a far cry from the record spend of C$81bn in 2014. On 9 June, Capp slashed its estimate for 2020 capital spending to C$23bn compared with a forecast of C$37bn in January.
On the basis that, once Capp re-forecasts, its production numbers will be significantly lower on the back of this capital crunch, it seems safe to assume Canada will experience far greater surplus crude pipeline capacity than the figures above. Indeed, a Biden victory and a swift death knell for KXL might, with the exception of TC Energy, suit most parties.