Stealing People's (R)ail - Disappearing Arbitrage Opportunities For Canadian Crude-by-Rail

Crude-by-rail (CBR) has been a saving grace for many Canadian oil producers. With extremely limited pipeline takeaway capacity, rail options from Western Canada to multiple markets in the U.S. have acted as a relief valve for prices — there for producers when they need it, in the background when they don’t. In 2018, we saw a major resurgence in CBR activity from our neighbors to the north, with volumes reaching an all-time high of 330 Mb/d just this past November. But just as quickly as CBR seemed ready for takeoff, the rug got pulled out from underneath those midstream rail providers and traders who had lined up deals and railcars to take advantage of wide price spreads. When Alberta’s provincial government announced its 325-Mb/d production curtailment beginning at the start of 2019, many midstream/marketing and integrated oil companies bemoaned what it could potentially do to market opportunities. And they were spot-on. Wide price differentials for Canadian crudes to WTI disappeared quickly and eliminated most, if not all, of the economic incentive to move crude via rail, and even by pipeline. In today’s blog, we recap the recent move away from crude-by-rail by some of Canada’s largest CBR players, and discuss the risks of long-term CBR commitments in volatile times.

In our most recent Canadian crude blog, Money Changes Everything, we recapped the recent series of events that led to the Alberta government curtailing production by 325 Mb/d, or ~9% of total production, starting on January 1, 2019. Rising production and a severe lack of pipeline takeaway capacity had pushed the WCS-WTI differential to as wide as a $45/bbl average in October 2018. At one point in November, with WTI at $56.46/bbl and discounts for Canadian crude at $43/bbl, you could get a barrel of WCS for darn near the same price as a twelve-pack of Moosehead Lager (it’s real, we’ve had it). Sensing price disaster, the Alberta government stepped in and slapped on production regulations that it hoped would tighten the WCS-WTI spread, clear a glut of inventories, and improve the netback price that Canadian producers received (in turn increasing tax revenue for the province).  

What the government didn’t account for, however, were a massive price swing and the potential impact to existing takeaway. CBR volumes in Canada (blue area and left axis in Figure 1) had been rising steadily to meet demand in 2018. As the differential for WCS to WTI widened over the course of 2018 (black line and right axis), eventually gaping to more than $40/bbl in October due to Midwest refining outages, CBR volumes picked up. In order to move Canadian barrels to the Gulf Coast and the Midwest, price differentials need to be at least $15-$20/bbl. So, when the WCS-WTI spread surpassed that threshold, more and more CBR deals were suddenly in the money.

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