You Ain't Seen Nothing Yet - Court Ruling on TMX Extends Need for Canadian Crude-by-Rail

The late-August decision by Canada’s Federal Court of Appeal to overturn the Canadian government’s approval of the Trans Mountain Expansion Project will delay the project’s completion to at least 2021 or 2022. And — who knows? — the unanimous ruling may ultimately lead to TMX’s undoing, despite the Canadian government’s acquisition of the existing Trans Mountain Pipeline and the expansion project and its commitment to get TMX built. As producers in the Western Canadian Sedimentary Basin (WCSB) know all too well, TMX’s 590 Mb/d of incremental pipeline capacity would help to resolve ever-worsening pipeline takeaway constraints out of the Alberta oil sands and other production areas in the WCSB. These constraints are having a major economic impact every day — as evidenced by price differentials wide enough to run a locomotive through. Speaking of trains, crude-by-rail exports out of Western Canada reached a record 205 Mb/d in June, an 86% increase from the same month last year, and with WCSB production rising as new oil sands capacity comes online and with only limited relief likely on the pipeline capacity front from the Enbridge Line 3 Replacement Project in late 2019, many producers will need to depend on rail shipments of crude well into the 2020s. Today, we discuss the recent court ruling and what it means for Western Canadian producers, price spreads and the future of crude-by-rail.

We didn’t expect to revisit the related issues of Western Canadian differentials and crude-by-rail so soon - we provided an update just a few weeks ago, in Revival. But the Federal Court of Appeal’s’ 3-0 ruling on August 30 was a major blow to the TMX project, which producers have been hoping would increase pipeline takeaway capacity out of the WCSB and allow them to significantly expand sales to markets in the Pacific Rim.

Before we review the court’s decision and its implications, we’ll take a quick look at the latest data on (1) the price spread between Western Canadian Select (WCS; a heavy, sour blend) and West Texas Intermediate (WTI) and (2) the volume of crude being exported by rail from Canada to the U.S. As we said a few months back in our Western Canadian Drill Down Report (The Shape I’m In), the differential between WCS and WTI is a key indicator of the severity of pipeline constraints. WCS naturally sells at some discount to WTI because it requires more complex refining than light, sweet crudes like WTI, Magellan East Houston (MEH) and Louisiana Light Sweet (LLS) and therefore is less valuable to most refineries. Also, it costs several dollars per barrel to transport crude by pipeline from Western Canada to Cushing, the Gulf Coast and other far-away refining centers. But when the WCS-WTI spread blows out past $15/bbl ­— to $20, $25 or even $30/bbl — as it has in the past few months, it indicates that takeaway pipelines out of the WCSB are running full or nearly full, and that the extra costs associated with transporting crude by rail are being factored into the WCS price.

Through 2012-14, WCSB producers suffered from pipeline takeaway constraints and wide WCS-WTI differentials (orange line in Figure 1) — spreads that spurred the development of new crude-by-rail capacity and a rise in crude-by-rail volumes (blue line; data available through June 2018). New pipeline capacity added mid-decade reduced the need for railed shipments of crude out of Western Canada and shrunk the WCS-WTI differential to a more reasonable and typical $10 to $15/bbl in 2015, 2016 and most of 2017.

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