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Sailing Stormy Waters – The Gulf Coast Market for Canadian Heavy Crude

Western Canadian heavy crude producers are getting desperate to find markets for oil sands production expected to increase by 1 MMb/d over the next 3 years. Few Canadian refineries can process these heavy bitumen crudes and domestic Canadian conventional crude production exceeds local refining capacity. Of all the current market alternatives, the US Gulf Coast is the most logical. Transporting heavy crude to that market continues to be constrained by a lack of infrastructure. Oversupply into the Midwest market and continued uncertainty about infrastructure have created a volatile price environment. Today we begin a two-part analysis of the Gulf Coast market for heavy Canadian crude.

The number of refining markets with capacity to process increasing Canadian heavy crude production is strictly limited. Heavy crudes need to be processed by refineries equipped to handle the extremely heavy hydrocarbons they contain. Such refineries upgrade the high yields of residual fuel oil from heavy crude into lighter products by running them through coker units (see Complex Refining 101 – Part 2 Upgrading). Complex refineries like these are prohibitively expensive to build from scratch. It does not make sense to build them in Western Canada where there is no ready market for refined products. Canadian heavy crude production is therefore largely destined for export to markets that have heavy refining capacity. [Note that about 0.5 MMb/d of Canadian heavy oil sands crude is upgraded to synthetic light crude at the point of production. This crude can be refined more easily than heavy crudes and it is therefore an option for Canadian producers to upgrade more heavy crude. The recent shelving of the Suncor Voyageur upgrader project suggests that the economics of this approach are not currently viable.]

The closest export market to Western Canada is the US Midwest but that market is already saturated with heavy crude. Canadian National Energy Board (NEB) data shows that in the final quarter of 2012, more than 550 Mb/d of heavy bitumen crude was exported to the PADD 2 Midwest region of the US. That is more heavy crude than Midwest refineries can process at the moment. Inventories of crude at the Cushing, OK Midwest trading hub are at record levels right now and prices are being discounted. The Midwest over supply situation may ease up in the second half of 2013 when the massive 400 Mb/d BP Whiting refinery near Chicago comes back online with new heavy crude processing capability. However Canadian bitumen production continues to increase.  As noted above,  another 1 MMb/d is expected in the next 3 years.  So regardless of the BP Whiting refinery boost, Canadian producers need to find other destination markets for their heavy crude outside the Midwest.

Last week in our ongoing series covering crude by rail we discussed the transport of Western Canadian heavy crude bitumen to the US Gulf Coast (see Crude Loves Rock’n’Rail – Heat It! Bitumen Economic Part 1). The Gulf Coast is the largest market in the world for heavy crude refining. In fact the Gulf Coast region has about 2.38 MMb/d of refining capacity configured to process heavy crude grades, primarily from Mexico and Venezuela (see Production Stampede – Where Will Canadian Oil Production Go?). The big challenge for Canadian producers right now is figuring out how to transport their heavy crude to US Gulf Coast refineries. NEB data shows that only 90 Mb/d of Canadian heavy crude made it to the Gulf Coast during the final quarter of 2012. New pipelines expected online that would deliver Canadian oil all the way to the Gulf Coast market have been delayed (e.g. Keystone XL) for political and environmental reasons. The expected relief afforded by completion of the second phase of the 400 Mb/d Seaway pipeline from Cushing to Houston in January of this year (2013) did not materialize because of congestion at the Houston end of that pipeline. This week the situation took a turn for the worse when the ExxonMobil Pegasus pipeline that previously delivered up to 96 Mb/d of Canadian crude from Patoka, IL to Nederland, TX was closed because of a leak in Arkansas.


Aside from the Gulf Coast about the only other choice for Canadian producers is to export their crude to Asia from the West Coast of Canada. That choice also requires pipeline infrastructure to be built – over mountainous terrain. Although plans are in place to expand existing and build new West Coast pipelines, they are the subject of significant opposition and will not be in service before 2017 at the earliest (see West Coast Pipe Dreams – Canadian Crude Oil Double Jeopardy). For the moment at least – the Gulf Coast is the only market choice. And unless you are lucky enough to find space on the Seaway pipeline, shipping heavy crude to the Gulf Coast is currently only possible by rail (now that the Pegasus pipeline is shut). As we learned last week – moving heavy crude by rail from Alberta to the Gulf Coast can cost upwards of $30/Bbl (see Crude Loves Rock’n’Rail – Heat It! Bitumen Economic Part 1).

Let’s not forget another factor that comes into play when transporting Canadian heavy crudes - the need to blend them with lighter diluent components to flow through pipelines (see Fifty Shades of Eh? Part 1 and Part 2). Bitumen crudes can be transported without diluent in rail cars but it requires special equipment to load and unload the railcars and specially equipped steam coil rail tank cars to heat the bitumen on arrival. Whether by pipeline or rail additional transportation costs for heavy crude have to be taken into account.

Even though transport costs to the Gulf Coast are higher, Canadian producers that find transportation routes are at least getting access to a market that has plenty of refining capacity to process their crudes. That means Gulf Coast refiners will pay higher prices than Canadian producers have been getting in the Midwest where the oversupply situation has led to big discounts for crude priced in that market against the benchmark West Texas Intermediate (WTI) crude versus the Gulf Coast.  At the Gulf Coast, Canadian heavy crude would compete with similar grades such as Mexican Maya that are priced relative to international benchmarks and not subject to the big inland discounts that domestic US crudes such as WTI have suffered.  

At the moment however, most Canadian producers have to settle for prices set in Alberta based on a substantial discount to WTI. Prices for pipeline specification diluent blended bitumen (dilbit) in Alberta are set against the benchmark Western Canadian Select (WCS) blend crude. Four production companies - Cenovus, Suncor, Canadian Natural Resources and Talisman, created WCS in an effort to produce a crude blend with consistent qualities that would be more attractive to refiners than an ever-changing recipe of bitumen crudes from different producers in the Canadian heavy oil sands. [Maintaining consistent crude blending quality is a common challenge for producers and refiners – we covered similar issues with the North Sea Brent market recently – see Crazy Little Crude Called Brent – The Art of Quality Maintenance]. WCS is made with up to 19 different Canadian heavy conventional and bitumen crude oils blended together with sweet synthetic and condensate diluents.

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