Market Overview

Is Canada's Oil Pipeline Bottleneck Choking The Economy?

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Oil production is surging in Canada but producers are far from happy as their profit margin is sinking and they are striving to stay competitive with their U.S. counterparts. While upstream companies like Marathon Oil Corporation (NYSE: MRO), Hess Corporation (NYSE: HES) and others are enjoying the shale boom and rebound in prices in the United States, their Canadian counterparts like Cenovus Energy Inc. (NYSE: CVE) and others are thinking of reducing production. The primary reason behind this is the shortage of pipelines in the country. In short, pipeline construction in Canada has failed to keep pace with rising domestic oil production – the heavier sour variety churned out of the oil sands –  resulting in infrastructural bottlenecks. This has also forced producers to give away their products at a discounted rate.

Price Differences Leading to Lower Revenues

Pipeline capacity constraints mean that Canadian oil explorers are selling their products in the United States – their major market – at highly discounted prices, causing tremendous loss in revenues. In fact, the discounts have led to a huge difference between Alberta's Western Canada Select and New York-traded West Texas Intermediate oil benchmark. After adjustments made for differences in quality and shipping costs, the Fraser Institute in Canada found the difference between oil prices in the United States and Canada at $26.30 per barrel for 2018. This is expected to land a C$15.8 billion blow to the energy sector's revenues. Notably, the price difference between the two averaged at $16.54 per barrel during the 2012-17 period, which resulted in lost revenues of C$20.7 billion.

As it is, extraction from oil sands is a high-risk strategy considering the extra costs involved compared with production from conventional oil wells. Add to it limited pipeline capacity and things do not look too promising for Canada's upstream players.

Now the question is what led to this infrastructural scenario.

Environmental and Political Turmoil

Though several major pipeline projects received the green light from the review agencies in the country, their future is still uncertain due to political turmoil. Moreover, environmental protests are on the rise, thereby further derailing construction. The crusaders believe that the rapidly growing movement of oil around the country is unsafe.

For example, the C$7.4 billion Trans Mountain pipeline expansion project of Kinder Morgan, Inc. (NYSE: KMI) faced opposition from British Columbia residents and indigenous communities, who are wary of the potential impact of the project on the environment. The NDP government in British Columbia also opposed the expansion project. Currently, the Canadian government is planning to provide a financial shield to the company from the politically motivated delays.

Moreover, TransCanada Corporation (NYSE: TRP)'s $8 billion Keystone XL pipeline – expected to carry heavy crude from Alberta to refineries in the United States – is yet to get a final investment decision. The midstream company had secured 20 years commitment for 500 thousand barrels per day for the pipeline and received Alberta government's support. However, the Nebraska government sanctioned the Mainline Alternative Route for the controversial project, which is longer than the company's preferred route and has forced it to review the alternative route keeping the final decision on hold.

Related Problems

Apart from Canadian oil's massive discount relative to WTI, the pipeline shortage created another problem for the energy sector, as crude shippers increased their dependence on railway and trucks, which is costlier than pipelines as well as less safe. Carrying oil by railways and roads makes crude transportation more prone to spills, which is ironically the primary concern for environmentalists. Hence, it can be said that the pipeline shortage is causing both economic and environmental problems for Canada.

Additionally, the farmers who ship their grains via railroads are experiencing difficulties as they are left with stranded cargos and cash crunch. Rise in demand for shipping crudes by rail is pushing other cargoes off the rail. It created grain backlog due to lack of lower availability of crop cars. In short, the pipeline bottleneck is slowly squeezing Canada's two most important sectors and giving investors a hard time. It has also put the government in a tough spot.

Conclusion

Even if implementation of the pipeline policies accelerates, it will take considerable time to actually finish the projects. Until then, the economy is likely to take a blow on two fronts, energy and agriculture. In case of Trans Mountain, the government's plan to provide financial assurance, taking the burden of politically-motivated delays, will further create a hole in tax payers' fund. Hence, a sound regulatory and environmental policy framework is the need of the hour. The sooner it is devised, the better it is for the Canadian economy. Otherwise, it will become increasingly difficult for energy companies to find new routes to take the country's landlocked oil to foreign markets.

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The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

Posted-In: contributor contributorsNews Commodities Markets

 

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