Prices for heavy crude in Canada have fallen to $36.66 per barrel, once again coming under pressure because of limits on pipeline capacity.
Western Canada Select (WCS) typically trades at a discount relative to WTI, due to quality differences and because of the long-distance it needs to travel. But the discount tends to increase – or, put another way, the price of WCS tends to drop – when oil producers run into pipeline bottlenecks. In severe cases, such as late 2018, there is a “blowout” in the price differential between WCS and WTI, which can be interpreted as a kind of glut of oil trapped in Alberta.
Last year, Alberta put mandatory cuts into place to rescue WCS prices, which had dropped as low as $13 per barrel in late 2018, which meant that it was trading roughly $50 per barrel below WTI. The cuts the provincial government put into place helped to rescue WCS prices almost immediately.
Fast-forward to early 2020 and WCS is once again trading at much lower levels compared to the U.S. benchmark.
“Canadian crude failed to participate in the relatively constant price increase since October, remaining largely below $40 per barrel,” JBC Energy said in a note on Friday. WCS prices have been trading at a discount relative to WTI of about $23 per barrel so far in 2020, which is a larger discount than was seen even after the Keystone pipeline leaked a few months ago.
WCS is now trading at its widest discount since December 2018, the month just before Alberta’s mandatory production cuts went into effect.
“The suppressed prices are coming on the back of strengthened supply, in particular of heavy crude amid upgrader maintenance,” JBC added. Oil sands production was up 80,000 bpd in November, compared to the same month a year earlier.
“Furthermore, Albertan stock levels jumped to 74 million barrels in November, within grasp of the all-time highs seen in 2018 and earlier last year,” JBC Energy said. The surge in inventories is also the result of the Keystone pipeline leak, which kept the pipeline offline for a period of time and resulted in Canadian oil exports falling by 500,000 bpd in November.
Alberta has been gradually lifting the mandatory production cuts that were put into place a year ago, but as the cuts are phased out and production ramps up, the industry finds itself facing the age-old problem of inadequate pipeline capacity. As a result, WCS prices could remain under pressure.
In fact, there is a risk of another price “blowout,” according to a report by Credit Suisse. If the WCS discount exceeds $25 per barrel, “Alberta government might be forced to step back in and raise the volumes on mandated cuts to control a bloating inventory situation,” Credit Suisse said.
The wider differential will likely push more oil onto rail. Oil-by-rail shipments surged in 2018 on the larger discount but fell in early 2019 after Alberta’s production cuts went into effect. Since then, oil-by-rail shipments have increased, as the province has sought to increase rail capacity at a time when it was also unwinding the production cuts.
In December, oil-by-rail shipments shot up to 500,000 bpd, a record high, according to Tudor, Pickering, Holt & Co. If Canadian oil can reach the U.S. Gulf Coast, it can fetch a decent price due to the global tightness in the heavy oil market, which is the result of sanctions on Venezuela and declines in Mexico’s heavy oil, among other factors. “It’s pretty telling in terms of how much these Gulf Coast refiners want to pay for these barrels,” Matt Murphy, analyst at Tudor Pickering, told Reuters.
Rail shipments make sense when WCS trades at least $15-per-barrel below WTI. With WCS currently trading at around $23 per barrel, and no new pipeline capacity coming online anytime soon, rail shipments could continue to climb.