When Propane and Exports Collide, Part 2 - Price Crash Could Upend Western Canada's Propane Export Outlook

The collapse in crude oil prices has sent shock waves throughout the global energy industry and Canada has been no exception. Sorting through all the impacts will take time, but what’s clear is that any earlier optimism surrounding supply growth in Canada has evaporated, including for propane supply to feed the new propane export terminals on British Columbia’s coastline. Edmonton propane prices fell 58% since the start of March to as low as 10.25 cents per gallon in U.S. dollars on March 23 — the lowest level since April 2016 — and settled yesterday at 13.13 cents per gallon, according to data from our friends at OPIS. A dampened supply outlook means future export expansion plans also are being reconsidered. Today, we explore what the sharp decline in propane prices could mean for the region’s supplies and future propane exports, including from Pembina Pipeline’s nearly completed export terminal in Prince Rupert, BC.

The past few weeks have seen many an energy outlook completely overturned. The effects of the huge downturn in crude oil prices have rapidly forced a large majority of producers in the U.S. and Canada to drastically reduce their spending plans for at least the first half of this year, and likely for all of 2020. Our examination of Canadian producers, both large and small, reveals more than C$6 billion ($4.1 billion) of capital spending reductions announced in just the past three weeks, with some producers still to release information on their capex plans. These spending reductions equate to a more than 30% cut versus previously announced capex plans for this year before prices came crashing down. The impacts may soon be seen in the number of drilled and completed crude oil and liquids-rich gas wells across Western Canada, although it may take some time for the supply impacts to be more fully realized. (See Déjà Vu for reasons as to why supply impacts can take time to materialize.) The capital spending cuts have not been confined to just producers, but also have quickly surfaced in the form of capital reductions by major Canadian energy infrastructure companies such as Pembina Pipelines, Inter Pipeline and Keyera Corp.

To get some sense for what all these cuts might mean for Western Canada’s propane supply, we have to first assess where supplies are to date. In Part 1 of this series, we noted that propane supplies in the Western Canadian Sedimentary Basin (WCSB) materially rose at the beginning of 2016, as producers began to more aggressively focus on drilling liquids-rich wells in unconventional plays such as the Montney and the Duvernay. This led to a nearly 40% increase in propane production between the start of 2016 and the end of 2019, and, ultimately, an oversupply of propane and other NGLs, prompting the development of propane export terminals off the BC coast. AltaGas and Vopak’s Ridley Island Propane Export Terminal (RIPET) just outside of Prince Rupert, BC, was completed and began exporting propane in May 2019 (see Harbor Lights). Then, as we covered in Part 1, Pembina Pipelines in May 2017 undertook development of a propane export terminal for the Prince Rupert area; that project is now targeting completion and export operations early in the second half of this year.

Propane is generated from four sources in the WCSB. Fractionation plants, which separate “raw mix” or y-grade NGLs into propane and other so-called “purity products,” currently account for more than 80% of all the propane production (blue area in the left graph in Figure 1), followed by, in decreasing order, gas plant fractionation (red area), refineries (green area), and what are called off-gases from oil sands operations (purple area). The volumes from the last two categories are much smaller, while fractionation and gas plants combined accounted for more than 90% of propane supply as of the end of 2019.

We should point out that the share attributable to fractionation plants has grown from a relatively stable 55% to 65% in the 2010-16 period, to more than 80% by the end of 2019 (black line in left graph). That ramp-up reflects the increasing focus in 2017-19 on liquids-rich drilling in the Montney and related plays, which has resulted in sharply higher supplies that make the piping of NGLs to larger, centralized fractionation plants cost-effective. When NGL production in the plays was much lower, NGLs were processed in the field and trucked to other locations — an inherently smaller-scale and more costly means of dealing with y-grade and producing propane and other purity products.

WCSB Propane Supply by Source and Province

Figure 1. WCSB Propane Supply by Source and Province. Sources: Alberta Energy Regulator, Canada Energy Regulator, BC Oil and Gas Commission, Statistics Canada (Click to Enlarge)

The vast majority of propane production in the WCSB comes from hydrocarbon-rich Alberta (blue area in the right graph in Figure 1), which accounted for an average of more than 80% of the basin’s supply in 2019. Impressive as that may be, that’s down from closer to 90% in the mid-2010s, as the volume of propane being produced in BC’s part of the Montney (red area) has increased in the past five to six years.

Only a few months ago, we would have said BC’s share of propane supplies was sure to keep rising as additional Montney development took place there. But a lot has changed in recent weeks with the huge collapse in crude oil and liquids prices during March, which has cast serious doubt on any substantial growth prospects for propane supply over the next few years. What at the start of 2020 seemed like assured expansion and growth in propane supplies and related infrastructure, including pipelines and export terminals, is now entirely under question at current prices.

As we noted above, significant capex reductions by producers has been accompanied by a reduction in spending commitments by energy infrastructure companies on related pipeline and terminal projects to transport and handle crude oil and liquids. For example:

  • After sanctioning a 15-Mb/d expansion to its Prince Rupert propane export terminal in mid-December 2019, Pembina announced on March 18, 2020, that this expansion will be indefinitely deferred. This will leave the export capacity of the terminal at its original 25 Mb/d, with completion and start-up still targeted for early in the second half of this year.
  • As part of the same capital reduction announcement on March 18, Pembina also deferred expansions to its Peace Pipeline system (phases VII to IX), a portion of which would have been dedicated to transporting upwards of 100 Mb/d of NGLs, including propane. (We previously discussed these expansion plans in our Pipes of Peace blog back in May 2019.)
  • Although not directly related to our discussion here, Pembina further added as part of its March 18 announcement that it would defer some of the spending it had planned for a propane dehydrogenation/polypropylene (PDH-PP) plant that is being jointly developed with Canada Kuwait Petrochemical Corp. and currently under construction outside its Redwater complex northeast of Edmonton, AB. The project was previously scheduled for completion in the second half of 2023; Pembina did not elaborate last week on whether this completion date has changed due to the spending deferral. (See Living in the Plastic Age for details on that project.)
  • On March 16, 2020, Keyera announced that it will still be proceeding with a new condensate (natural gasoline) and mixed NGLs (y-grade) twin pipeline system in west-central Alberta, dubbed KAPS (being jointly developed by Keyera and SemCAMS Midstream; see (In) Your Back Yard), but that it would be closely monitoring market developments and be ready to cancel or defer spending if warranted. With the bulk of capital spending on KAPS set for late this year and 2021, and start-up in the first half of 2022, this project could still be deferred or cancelled by Keyera should market conditions remain weak for the balance of this year. The exact capacity of the KAPS system has not been announced, but is rumored to be in the vicinity of 100 Mb/d; a deferral or cancellation would clearly be another blow for the pipeline transportation of propane in the next few years.

As we said, the situation with Canadian producers and infrastructure companies remains very uncertain in the current market environment, but the spending reductions that have been announced will at some point begin to impact the growth profile of most hydrocarbons in the WCSB, as well the ability to transport and export those hydrocarbons if oil and liquids prices are sustained at recent low levels for an extended period of time. So, what do all of these announcements mean for our expected supply profile for Western Canadian propane, one that, just a few weeks ago, seemed more certain to grow steadily over the next few years?

Our long-term propane supply outlook had previously been predicated on producers remaining active in the drilling of unconventional liquids-rich wells, as well as the development of various pipelines by infrastructure players, some of which we just mentioned above, in transporting those liquids to market. With reductions in investments in both drilling and pipeline infrastructure, we have moderated this supply outlook.

Our original outlook envisioned an increase from an average of 274 Mb/d of propane supply in 2019 to an average of 332 Mb/d in 2025, a gain of 58 Mb/d, or about 21% (red line in Figure 2, Original Supply Outlook). Most of this growth was focused in Alberta, given that much of the Montney lies within the province’s borders and also that much of the liquids pipeline infrastructure being developed to deal with the growing supply was planned for Alberta. With the cutbacks that have been announced in recent weeks, we are now looking at a slow decrease in propane supplies in 2020 on the order of 8 Mb/d versus our original outlook, followed by a flattening and recovering trend later in 2021, with growth resurfacing in 2022 (green line in Figure 2, Reduced Supply Outlook). This brings the net gain in propane supplies in our Reduced Supply Outlook between 2019 and 2025 to 20 Mb/d (274 Mb/d to 294 Mb/d), or 38 Mb/d less than our prior outlook. This is based on the view that there will be some stabilization and improvement in crude oil and liquids prices toward the end of this year, followed by additional price improvement into 2021. That gradual rebound in prices — if it happens — would encourage producers to return to the field to again focus on liquids-rich gas wells in the Montney and surrounding plays.

Western Canada Propane Supply Outlook

Figure 2. Western Canada Propane Supply Outlook. Sources: Alberta Energy Regulator, Canada Energy Regulator, B.C. Oil and Gas Commission, Statistics Canada and RBN (Click to Enlarge)

Much is still uncertain about the near-term outcome for oil and liquids prices, and things could get worse before they get better. Moreover, additional spending cuts could be announced by Canadian producers, or cuts already announced could be deepened, depending on the severity and duration of the oil price collapse. However, given that some spending has already taken place and that it will take time for the full impacts of the announced spending cuts to be felt in the field, it could be many months before we begin to see any supply impacts emerging in the data. In a more extreme example, for instance, we may actually see very little impact on Canada’s oil sands output from the oil price crash, given the long-lived and large fixed cost nature of these operations; meaning that oil prices are less of a determinant on variable production costs and decisions to reduce supply, as long as the producing asset is generating cash flow to cover some or all of those variable costs (see Tortoise and the Hare).

As for Canada’s overseas propane exports, we think these will largely be unaffected in the near and medium term. We believe there is still enough of an overhang of propane supply in Western Canada to continue feeding the AltaGas/Vopak RIPET terminal (40 Mb/d of capacity, with upgrade plans to go to 50 Mb/d by the end of this year) and Pembina’s soon-to-be-completed Prince Rupert export terminal (25 Mb/d capacity). As such, propane exports out of the region could be in the 65-to-75-Mb/d range by late 2020 (red bars in Figure 3), depending on what happens with the upgrade plans at RIPET. With the indefinite deferral of Pembina’s Prince Rupert 15-Mb/d expansion, it now seems likely that propane exports from Canada’s West Coast will be capped at between 65 and 75 Mb/d until at least the middle of this decade, rather than closer to 90 Mb/d as we suggested in Part 1.

Canadian Overseas Exports of Propane

Figure 3. Canadian Overseas Exports of Propane. Sources: Canada Energy Regulator and RBN (Click to Enlarge)

A lot is up in the air, including the degree to which primarily Asian buyers of propane from these export terminals may or may not adjust their purchase plans in the future, given the real potential for a global recession this year. That’s in addition to the possibility that they will be inundated by large volumes of incremental propane supplies from Saudi Arabia, with its plan to open the spigots on its oil wells at the start of April. The resulting deluge of Saudi propane may reduce the demand for Canada’s propane exports. Monitoring all of these developments will make for some interesting blog fodder in the future.

"When Love & Hate Collide" was written by Joe Elliott and Rick Savage of Def Leppard. Originally recorded in 1990 as a demo for possible inclusion on the group’s Adrenalize album, the finalized version appears as the ninth cut on the band's 1995 greatest hits album, Vault: Def Leppard Greatest Hits (1980-1995). The demo of the song contains the final recorded guitar solo of original guitarist Steve Clark, who died in 1991. When released as a single in October 1995, "When Love & Hate Collide" went to #58 on the Billboard Hot 100 Singles chart, #29 on the Mainstream Top 40 and #39 on the Adult Top 40 charts. The song was produced by Def Leppard and Pete Woodroffe. Personnel on the record were: Joe Elliott (lead and backing vocals), Steve Clark (guitars, backing vocals), Phil Collen (guitars, backing vocals), Vivian Campbell (guitars, backing vocals), Rick Savage (bass, backing vocals), Rick Allen (drums, backing vocals), Stevie Vann (backing vocals), Randy Kerber (piano) and Michael Kamen (string arrangements). 

Vault: Def Leppard Greatest Hits (1980-1995) was the first greatest hits album by the band. Produced by Mutt Lange, Mike Shipley, Pete Woodroffe and Def Leppard, the LP was released in October 1995. "When Love & Hate Collide" was the only newly recorded song on the album, even though the band had originally made a demo of it in 1990. Vault went to #15 on the Billboard Top 200 Albums chart, and has been certified 5X Platinum by the Recording Industry Association of America. 

Def Leppard is an English rock band formed in Sheffield, England, in 1977. Since 1991, the band has consisted of Joe Elliott, Rick Savage, Rick Allen, Phil Collen and Vivian Campbell. Former band members were Tony Kenning (1977-79), Pete Willis (1977-82) and Steve Clark (1978-91). Def Leppard has sold more than 100 million records worldwide. The band has released 11 studio albums, two live albums, four compilation albums, two EPs and 60 singles. They have won two American Music Awards and are members of the Rock and Roll Hall of Fame. Def Leppard still records and tours to this day, and will be on tour from May through October of this year.