President Biden’s decision to ax the controversial Keystone XL pipeline, which had been approved by his predecessor, is a tremendous blow for Canada’s energy sector and particularly its oil sands industry. For years, the U.S.’s oil-rich northern neighbor, which has the world’s third-largest proven oil reserves of 168 billion barrels, has for some time lacked sufficient takeaway capacity for the crude oil produced. That lack of transportation capacity is weighing heavily on prices for Canadian crude oil grades which sees the crucial heavy oil benchmark blend Western Canadian Select (WCS) trading at an almost $14 discount to West Texas Intermediate. Such a substantial discount is weighing on the profitability of Canadian heavy oil producers in a difficult operating environment where crude oil prices are caught in a prolonged slump. Even after the latest rally, sparked by Saudi Arabia’s surprise one million barrel per day production cut, WTI is selling at around $53 per barrel. The Keystone XL pipeline was an essential piece of industry infrastructure that would boost Canada’s pipeline transportation capacity and connect Canada’s economically vital oil sands to crucial U.S. energy markets.
Lack of adequate access to U.S. refining markets, notably in the mid-west where many refineries are configured to process heavy and extra-heavy crude oil, could cripple Canada’s oil sands industry. The U.S. is the main consumer of Canadian crude oil importing, according to Natural Resources Canada, importing 79% of all petroleum produced by Canada during 2019. The U.S. consumes 98% of Canada’s crude oil exports, further underscoring the importance of Canadian energy companies being able to cost effectively transport crude oil to refineries south of the border. The long-standing lack of takeaway capacity saw the volume of crude oil placed in storage surge causing WCS prices to plunge. A chronic lack of pipeline capacity coupled with growing bitumen production caused the WTI WCS price differential to soar toward the end of 2018 to over $43 per barrel.
Source: Government of Alberta. That meant not only was WCS selling for less than $6 per barrel while WTI was trading at $43.50 a barrel but many oil sands companies were pumping bitumen at a loss. This development demonstrated how significantly the chronic lack of pipeline capacity was impacting Canadian crude oil blend prices and Alberta’s economically crucial oil sands industry. The crisis was that severe Alberta’s provincial government was forced to introduce mandatory production limits which commenced in January 2019 and ended in November 2020.
Alberta’s government and oil sands industry expected the Keystone XL pipeline to bolster pipeline capacity alleviating the need for production limits and reduce the WCS price differential. Biden’s revocation of the key cross-border presidential permit, granted by Trump, has essentially sounded the death knell for the Keystone XL pipeline and the considerable relief its commissioning would give Canada’s battered oil sands industry. In the wake of that presidential decision, the WCS price differential has widened placing pressure on the profitability of already struggling oil sands producers. It will also trigger a sharp uptick in the demand for the rail transportation of Canadian bitumen exports. For November 2020, the volume of Canadian crude oil exports by rail had soared 86.5% month over month to 173,095 barrels daily. This was also four and half times greater than July when crude oil exports by rail hit a multiyear low of 38,867 barrels daily. November’s number was still significantly lower than a year earlier when 302,345 barrels of crude oil daily was exported by rail. The significant decrease in crude by rail export volumes during 2020 can be attributed to significantly lower heavy oil production and reduced demand from U.S. refiners because of sharply weaker oil prices as well as lower fuel consumption because of the COVID-19 pandemic. By May 2020 Canadian oil production had fallen to a multi-year low of 3.96 million barrels daily, 13% lower than a year earlier as operators slashed capital spending, shuttered uneconomic wells, and deferred or canceled development activities in response to the pandemic and oil price collapse. Even after oil prices firmed and Canadian energy companies ramped-up operations during the second half of 2020 Canada’s annual oil output was well below 2019. December 2020 production of 4.74 million barrels daily was 9.5% lower than a year earlier and annual oil output averaged 4.38 million barrels daily which was 6.6% lower than 2019.
The lack of pipeline capacity along with Canadian oil sands operators boost spending and production because firmer oil prices will eventually trigger further pricing pressures for WCS, causing the differential to WTI to widen. That does not bode well for the profitability of Canadian oil sands companies. While large oil sands operators such as Suncor, Cenovus, and Canadian Natural Resources have low cash operating costs of around $32, $20, and $19 per barrel respectively, industry-wide breakeven prices are far higher. Alberta’s government pegged the breakeven price for new oil sands projects at $55 to $75 per barrel WTI, compared to $46 to $52 a barrel for U.S. shale oil, which is significantly higher than the current WTI price of $53 per barrel. This means despite Suncor, Cenovus’, and Canadian Natural Resource’s existing oil sands operations being cash flow positive in the current environment, there is little if any incentive to develop new projects. That will deprive Canada’s and particularly Alberta’s economy of much-needed investment, impacting growth with crude oil responsible for around 8.5% and 16% of GDP respectively.
The axing of the Keystone XL pipeline has the potential to spark a repeat of what occurred during 2018 where rising oil sands production, a lack of takeaway capacity, and nearly full Canadian oil storage caused WCS prices to collapse. The situation will worsen as Canadian oil production grows in response to higher oil prices. A lack of pipeline capacity coupled with crude by rail being unable to fill the gap, and being more costly, will force the additional oil produced into storage. As storage volumes grow and move closer to capacity it will weigh on WCS pricing causing the price differential with WTI to widen, impacting the profitability of oil sands producers. While Biden’s decision aligns with the environmental, climate, and political outlook it will have an immense negative impact on Canada’s oil patch. The death of the Keystone XL pipeline effectively caps the growth of Canada’s oil industry and will weigh heavily on the prospects of Alberta’s vast economically important oil sands. For these reasons, it is a disappointing development for Canada and the country’s oil industry.
By Matthew Smith for Oilprice.com
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Matthew Smith is Oilprice.com’s Latin-America correspondent. Matthew is a veteran investor and investment management professional. He obtained a Master of Law degree and is currently located…
Published at Sat, 30 Jan 2021 22:00:00 +0000-What Will The Death Of Keystone XL Mean For Canada?