It seems that, once again, Canada is struggling to build crude oil pipeline export capacity fast enough to keep pace with production growth. The latest setback came with the announcement that completion of the Canadian government-owned Trans Mountain Expansion (TMX) will be delayed until the third quarter of 2023 and that the 590-Mb/d project will cost almost twice as much as previously estimated. The latest six-to-nine-month delay appears to set the Canadian oil industry on a path to exhausting its spare export capacity by later this year. And that’s not good news for producers. In today’s RBN blog, we consider this latest TMX announcement and what it might mean for pipeline constraints and heavy oil price differentials.
Canadian midstream companies have been fighting a seemingly endless battle to expand its oil pipeline export capacity at a rate that stays ahead of Canada’s rising crude production. The benefits from having sufficient pipeline capacity are clear. When there are little or no pipeline constraints, the price discounts for Western Canadian Select (WCS), the region’s benchmark heavy crude oil, stay close to the cost of transporting that crude via pipelines. And that helps to maximize economic returns to producers and to Canada. When there is insufficient capacity, the story is quite different: steeper price discounts and the loss of economic value for exported barrels.
It was just this past October that Canada was finally back in the position of having a modest amount of excess pipeline export capacity when the start-up of the Enbridge Line 3 Replacement (L3R) project created an additional 370 Mb/d of incremental capacity from Alberta to the U.S. Midwest. Indeed, after some short-term market fluctuations in October and November (dashed red oval in Figure 1), the price of WCS vs. WTI promptly narrowed back to the $12-$14/bbl range (dashed green oval) — the approximate pipeline transportation costs to the Midwest/Gulf Coast — with all current indications that at least a modest surplus of export pipeline capacity from Alberta to the U.S. remains.
Figure 1. WCS-WTI Price Differential. Source: Bloomberg
However, with Canadian oil sands output on the upswing and looking to set new production records this year, that additional capacity from L3R might be exhausted by the end of 2022, if not earlier. No problem, you might think. After all, the long-planned expansion to the Trans Mountain Pipeline (TMP) from Alberta to the coastline of neighboring British Columbia would be coming on-stream by year’s end to save the day. But it is not to be.
To get some perspective on this, let’s first review the TMP and its expansion. Spanning 715 miles (1,150 kilometers) across rugged, mountainous terrain in BC, the 300-Mb/d TMP (solid green line in Figure 2) runs from its receipt point in Edmonton, AB (with additional small receipts entering via Kamloops, BC), before reaching the 55-Mb/d Parkland Corp.-owned Burnaby refinery (blue triangle) in Burnaby, BC, or the export docks at Westridge (yellow star) about 2 miles (3 km) north of the refinery. The pipeline also transports crude oil to four refineries north of Seattle in Washington state, through the Sumas export point, via the 69-mile (111-km) Trans Mountain Puget Sound Pipeline (short hot-pink line).
Figure 2. Trans Mountain Pipeline, TMX Project, and Related Pipelines and Refineries. Source: RBN
Kinder Morgan, the previous owner of TMP and the TMX project, applied to Canada’s then National Energy Board or NEB, now the Canada Energy Regulator or CER, in December 2013 to expand the pipeline via a twinning project that would increase throughput capacity by 590 Mb/d (TMX; dashed green line) to bring total capacity to 890 Mb/d. After receiving approval from the NEB in May 2016, Kinder Morgan proceeded with the expansion, estimating that it would cost C$7.4 billion (US$5.7 billion) and be completed in December 2019.
But the project began to face increasing pushback from environmental groups and the BC provincial government. After two additional years of legal and regulatory wrangling and initial construction work, Kinder Morgan sold TMP and TMX to the Canadian federal government (and its new Trans Mountain Corp. or TMC) in May 2018 for C$4.5 billion (US$3.45 billion). After a series of additional regulatory reviews, the pipeline was approved for the second time by the CER in June 2019. In February 2020, the pipeline’s expansion timeline and cost estimates were updated, indicating completion by late 2022 at a total cost of C$12.6 billion (US$9.5 billion).
The next two years would not be kind to the pipeline and its owner, the Canadian government. The COVID pandemic in 2020 halted construction on TMX for several months, with only limited activity later in the year, further inflating the completion timeline and costs. With full work crews back in early 2021, more delays arose when serious flooding along parts of the pipeline’s route occurred in November last year, forcing a precautionary three-week shutdown of the pipeline. Although TMP and the expansion were not damaged, additional resources and funds were required for restoration work as well as for assisting other third-party repair and rescue efforts in other flooded areas.
On February 18, TMC released updated cost and timeline estimates for the expansion. After allowing for numerous delays along the route, COVID-related costs, and repair from the floods, TMX’s cost is now estimated at C$21.4 billion (US$16.8 billion) –– nearly double the government’s 2020 estimate and nearly triple Kinder Morgan’s 2017 estimate. Also, the timeline for finishing the project is now more than 3.5 years longer than originally planned: the third quarter of 2023 vs. December 2019 under Kinder Morgan’s earlier plan.
Expenditures on the pipeline to date are estimated to be in the range of C$17 billion (US$13.1 billion). That number and the updated cost estimate did not sit well with government officials. With TMC’s update on February 18, Canada’s finance minister announced that no further public funds would be forthcoming from the federal government to complete the expansion and that third-party lenders such as public debt markets and financial institutions would be engaged to fund the remainder of TMX’s construction costs. The finance minister also reiterated the government’s long-standing position that the pipeline would eventually be sold, and that Canada did not plan to be the long-term owner.
Although the delays were not a complete surprise to many in the industry, official confirmation has certainly thrown a monkey wrench into the anticipated pipeline export capacity expansion profile for Western Canada. To get some sense for how the delay in the start-up of TMX may affect pipeline export capacity, we can do a before-and-after comparison using our Western Canada pipeline egress model.
In Part 1 of We’re Here for a Good Time, we estimated that Western Canada’s total available pipeline egress capacity was 4 MMb/d (height of vertical black arrow in Figure 3) prior to the start of L3R. With that pipeline’s start-up in late 2021 (bright-green layer), total egress capacity increased by 370 Mb/d. The end result was that the region’s estimated total crude oil production (red line) was less than the Western Canadian Sedimentary Basin’s (WCSB) combined refinery demand (WCSB demand; dark-blue layer) and all other pipeline egress capacity. In other words, the capacity of available outlets for crude oil were higher than production as of late 2021, meaning that excess egress capacity was present.
Figure 3. Western Canada Crude Oil Egress Capacity Prior to TMX Announced Delay. Source: RBN
At the time of our November 2021 update — and given the oil production growth we estimated for 2022 and 2023 — we suggested that total spare egress capacity could again be close to zero by the time TMX (orange layer) came into service under its previously estimated date of late 2022/early 2023 (dashed yellow circle in Figure 3 above). As such, if there were no further delays to TMX, Western Canada might be able to narrowly escape another pipeline capacity crunch or only have a short-lived one based on the previously estimated start date for TMX.
With further clarification now in hand concerning a completion date for TMX — which we put at the end of the third quarter of 2023 (orange layer in Figure 4 below) — we believe that Western Canada will be facing a period of insufficient pipeline egress capacity relative to supply by the end of 2022 (or sooner) that will stretch for at least most of 2023 (dashed pink oval in Figure 4). In this updated outlook, we have made little change to our crude oil output estimates given that oil sands and other oil producers appear to be lining up with our optimistic assessment for production expansions this year.
Figure 4. Western Canada Crude Oil Egress Capacity Post TMX Announced Delay. Source: RBN
Given the current elevated level of global crude oil prices, narrow WCS-WTI price differentials, and very strong absolute prices for WCS, it is unlikely that Western Canada’s oil producers will ease up on production growth plans because of the increased likelihood of exhausted pipeline egress less than a year from now. The capacity to transport crude oil by rail (light blue layers at top of Figures 3 and 4), despite its higher costs ($4-$6/bbl more), remains a ready fallback position. Additional rail-loading capacity and firm transportation contracts have recently come into play, and we understand that up to 100 Mb/d of firm transportation contracts by rail could be tapped by producers if need be. Indeed, it was only two years ago that railing of Canadian crude oil exceeded 400 Mb/d — and at WCS prices that were much lower than they are currently.
With the increasing possibility of wider WCS price differentials by late 2022 or early 2023, forward WCS price differentials following the TMX announcement have not yet shown any tendency to widen for contracts dated later this year or early 2023 (green vs. blue lines in Figure 5). However, the pricing of these forward contract differentials tends to be fairly myopic and thinly traded beyond the first few months. As such, as we move through this year and surplus pipeline egress capacity is slowly exhausted, we think it likely that the forward market will need to price in the higher cost of increased railing of crude, meaning wider discounts than are currently being quoted for late this year and early next year.
Figure 5. WCS-WTI Forward Price Differentials. Source: CME
All in, this latest setback for TMX seems to be par for the course for the Canadian crude oil industry in recent years, and just adds to the many recent woes that have plagued oil export pipelines from Western Canada, including the highly publicized cancellation of TC Energy’s Keystone XL pipeline. Nevertheless, Canadian producers have shown long-term resilience and tenacity through the volatile pricing cycles of the past few years, and we think we can count on their continued perseverance.
“So Far Away” was written by Mark Knopfler and appears as the first song on Dire Straits' fifth studio album, Brothers in Arms. Released as a single in April 1985, the song went to #3 on the Billboard Adult Contemporary chart and #19 on the Billboard Hot 100 Singles chart. Personnel on the record were: Mark Knopfler (lead vocals, guitars), John Illsley (bass, backing vocals), Alan Clark (keyboards), Gus Fletcher (keyboards, backing vocals), and Omar Hakim (drums).
Brothers in Arms was recorded between October 1984 and February 1985 at AIR studio in Montserrat. Produced by Neil Dorfsman and Knopfler, the album was released in May 1985. It went to #1 on the Billboard 200 Albums chart and remained there for nine weeks. The album has been certified 9x Platinum by the Recording Industry Association of America and has sold over 30 million copies worldwide. Five singles were released from the LP, which won four Grammy Awards.
Dire Straits was a British rock band formed in London in 1977 by Mark Knopfler (lead vocals, lead guitar), David Knopfler (rhythm guitar, backing vocals), John Illsley (bass, backing vocals), and Pick Withers (drums, percussion). The band was active from 1977 to 1988, and again from 1990 to 1995. Dire Straits has released six studio albums, three live albums, three compilation albums, two EPs, and 23 singles, and has sold over 120 million records worldwide. They were inducted into the Rock and Roll Hall of Fame in 2018. Nine people passed through the band since its formation. Since disbanding Dire Straits in 1995, Mark Knopfler has gone on to a successful career as a solo artist. He continues to record and tour.
