Go Your Own Way – The Canadian Rail Versus Pipeline Bitumen Challenge

New pipeline capacity from Cushing to the US Gulf Coast, expected online at the end of 2013 and early in 2014, will ease the congestion that has stranded a lot of Western Canadian crude in the Midwest. There will subsequently be more opportunity for Canadian oil sands crude to reach Gulf Coast refineries by pipeline. Yet at the same time Canadian bitumen producers, rail terminal operators and railroad companies are jointly developing unit train loading terminals in Alberta - including one announced yesterday by Kyera Corp and Kinder Morgan Energy Partners. These terminals plan to load Canadian crude for delivery to the Gulf by rail. Today we ask how rail can compete with pipelines on this route.

We have previously described growing Western Canadian heavy crude “bitumen” production and the challenges of getting it to market (see Heat it!  Bitumen Economics Part 1).  Bitumen production from oil sands is expected to increase from about 1.8 MMbd/ in 2012 to 3.6 MMbd/d in 2020 (source: Canadian Association of Petroleum Producers – CAPP). Oil sands crude is thick like treacle and difficult to move by pipeline because it doesn’t flow well. Yet the largest market for this heavy crude is over 2 thousand miles away from the production areas at US Gulf Coast refineries configured to process similar grades from Mexico and Venezuela (see Production Stampede – Where Will Canadian Oil Production Go?). Travelling that kind of distance is most efficiently accomplished by pipeline. But to get heavy crude moving in a pipeline it has to be diluted with roughly 30 percent natural gasoline or condensate diluent to make “dilbit” crude. Diluent adds to the cost of pipeline transportation because it has to be hauled to the bitumen production site and  does not have the yield characteristics that heavy crude refiners need.

We have also looked at the economics of bitumen transportation and whether it is cheaper to move it by rail – where the diluent requirement can be reduced to nil – or by pipeline where a 30 percent diluent addition adds cost and volume to the logistics (see Heat it! Bitumen Economics Part 2). The jury is still out on that question – it depends who you talk to – and exactly where and how they need to ship bitumen and how much diluent is added. One thing is certain – the complete economics of using rail to move Canadian bitumen have not been fully tested yet because shipments so far have been in small manifest batches of a handful of rail tank cars rather than more efficient 100 car “unit” trains. Yet by the end of this year the first unit train loading facility will be operating in Edmonton, AB. And the investors behind that project and several others like it to follow next year clearly believe that rail shipments can compete with  pipeline capacity to deliver Canadian heavy crude to the Gulf Coast.

In this series we’ll take a deeper look at Western Canadian heavy crude-by-rail options in light of increased investment in infrastructure this year by producers, refiners and railroads. Those investments were already underway when the tragic accident at Lac Megantic occurred earlier this month (July 2013) so although there will certainly be increased regulation of the rail industry as a result, the impact will not likely be immediate.

Ultimately two key questions determine the fate of Canadian heavy crude shipments by rail. First - is rail capacity needed to supplant a shortfall in available pipeline capacity now or in the future and second - can the cost of bitumen by rail transport compete against pipeline delivery when both options are available to producers? We will address each of those questions in this episode and then in future episodes in this series, look at specific plans being made to bring more rail loading capacity online in Western Canada and to build more unloading facilities at the Gulf Coast.

Starting with the question of crude takeaway capacity out of Western Canada…. Current crude production in the region is about 3.4 MMb/d with 0.6 MMb/d - mostly light crude and upgraded bitumen - consumed by local refineries – leaving 2.8 MMb/d that could use pipeline capacity out of the region (source: Bentek – July 2013). Existing pipelines have available space for about 3.1 MMb/d meaning that on paper there is no need for additional capacity (i.e. rail) at the moment. However, the current takeaway capacity of the existing pipelines is constrained by limits on their downstream deliveries to refineries. Right now three major pipeline systems out of Canada deliver crude into the US Midwest, providing more than adequate supplies to refiners in that region. The trouble is that transport beyond the Midwest – from Cushing, OK to the Gulf Coast where there is unfulfilled demand for Canadian heavy crude – is constrained. So even though there is additional pipeline space available out of Canada, much of the crude shipped that way that is surplus to Midwest refinery requirements ends up stockpiled at Cushing waiting for limited capacity to the Gulf Coast. It is also the case that the largest pipeline system out of Canada – the 2.5 MMb/d capacity Enbridge Lakehead system shares space with Bakken crude from North Dakota and shippers often have to accept prorated allocations of space.   

Planned expansions to the pipeline systems out of Western Canada, starting next year and ongoing through 2018, will increase capacity to the Midwest by as much as 1.8 MMb/d and to the West Coast of Canada by 1.1 MMb/d. The first of these expansions will be Phase 1 of the Enbridge Alberta Clipper Project due to open in Q3 of 2014 that will increase capacity into the Midwest by 120 Mb/d. But for the moment, these expansions are not as important to Canadian heavy crude producers as the expansion of takeaway capacity between Cushing, OK and the Gulf Coast, expected online at the end of 2013 and start of 2014 (450 Mb/d Seaway expansion and 700 Mb/d Keystone XL). These expansions to the Gulf Coast make it possible for significant volumes of Western Canadian crude to reach Gulf Coast refineries directly by pipeline.

The coming availability of so much pipeline capacity led us to note a lack of fervor on the part of Canadian producers for full-scale rail transport infrastructure last time we looked at this issue (see Heat it! Bitumen Economics Part 2). We suspected that with plenty of pipeline solutions in the works, Canadian producers felt no urgency to invest in rail long-term. Especially because bitumen is more complicated to move by rail as a result of the various diluent options that need to be accommodated, or if moving ‘raw’ bitumen, the need for  insulated rail tank cars and special heating equipment at the destination terminal.

So why are Canadian producers and railroad companies just now building out larger crude by rail loading terminals in Alberta and at Gulf Coast destinations? The rail infrastructure developed in Alberta during 2012  – a number of smaller manifest loading terminals – has helped to bridge the pipeline capacity gap this year (as much as 100 Mb/d) but does not appear to be needed going forward except to feed smaller demand from US East and West Coast refineries. Once the big pipelines reach the Gulf Coast the need for large-scale rail movements into that region should be redundant (see Canadian Heavy Crude After the Pipelines).

Which brings us to the second question that we asked earlier - could the cost of bitumen by rail transport compete against pipeline delivery if and when both options are available to producers? After all, it is one thing to use rail transport in the absence of adequate pipelines, when there are big price discounts between stranded crudes in production basins and coastal refining centers. Quite another to use rail transport if it is more expensive than pipelines and price spreads between production centers and coastal markets are not artificially inflated by pipeline constraints.