Faced with a crisis moving oil out of the country, the provincial government in Alberta is stepping in to purchase trains in order to ease the midstream bottleneck.
Western Canada Select (WCS), the benchmark for heavy oil in Alberta, continues to trade below $15 per barrel, or roughly $40-per-barrel lower than WTI. That is a hefty discount, although slightly narrower than the $50 per barrel discount WCS traded for a few weeks ago.
“It’s worth more in the ground than it is to produce it right now,” Athabasca Oil Corp. CEO Rob Broen said in an interview Wednesday with BNN Bloomberg Television. “These differentials are so extreme.”
The problem for Alberta – and for Canada – is that after a decade of trying, the region is still no closer to building a major oil pipeline to move product to either the United States or to the Pacific Ocean. As pipelines have filled up, the discount has exploded.
Now, the government in Alberta is in talks to purchase enough rail cars to move 120,000 bpd out of the province. Alberta’s Premier Rachel Notley said the deal could be concluded within a few weeks and could cost C$350 million (US$263 million). The provincial government said that the additional rail capacity could narrow the WCS discount by $4 per barrel.
Alberta, as a hopelessly oil-dependent petrostate, is flailing about, looking for a solution to the pipeline bottleneck. Last month, oil sands producers asked the Premier to mandate industry-wide production cuts. Notley’s challenger in next year’s election for premier is now trumpeting his support for mandatory production cuts.
It’s an odd evolution for Notley, who ended decades of rule by the Progressive Conservatives, and as a New Democrat, is decidedly to the left of the longstanding industry-friendly PCs. She even introduced a carbon tax after she took office and moved to shut down coal plants.
But “leftist” in Alberta, if she can be called that, is not the same as leftists everywhere else. After all, the carbon tax was conjured up in order to smooth the path for new pipelines – the logic being that a carbon tax and other incentives to boost renewable energy would buy the “social license” to operate, and might convince the US government to greenlight Keystone XL.
The green initiatives have done little to advance a new pipeline, even though the Trump administration gave the go-ahead to TransCanada’s long-delayed project. So Notley is now dispensing with the green trade-off and is now using every power at her disposal to support the oil industry, including state-led intervention to buy railcars. She has also aggressively campaigned for pipelines in every direction – she championed the Trans Mountain expansion pipeline that would run west, the Keystone XL pipeline that would run south, and the now-defunct Energy East pipeline that would have run to the east.
Canada’s federal government stepped in to nationalize the Trans Mountain expansion earlier this year, even though its construction remains an open question. Alberta is now looking to buy trains to move oil out of the province. Canada – at both the provincial and federal level – is at the mercy of, and now an active owner in, the oil industry.
Still, the rail cars will take time to procure and bring into operation. According to Reuters, the first 15,000 bpd of rail capacity would not come online until December 2019, and won’t reach the full 120,000 bpd until the following summer – August 2020. Still, there are no other options. If Keystone XL or the Trans Mountain Expansion are ever constructed, those projects will come online well after 2020.
However, the one salvation could be Enbridge’s Line 3 replacement, which is expected to come online late next year or early 2020. “The good news is there is light at the end of the proverbial pipeline,” analysts at Scotiabank wrote in a note on November 21, referring to Enbridge’s Line 3 replacement, which would provide an outlet for 370,000 bpd. “The bad news is that Line 3 is still at least a year away. Between now and next winter the Western Canadian oil market is at the mercy of rail schedulers and their attempts to mobilize more locomotives, tank cars, and trained crews—an effort that has thus far proved insufficient to clear the market.”
Alberta estimates the province is currently over-producing by about 250,000 bpd. The capacity addition from the Line 3 replacement is expected to add more than that amount, and since it is scheduled to come online before the rail cars, the whole business of the government buying into rail seems odd. But Notley is unbowed. “Line 3 only clears the market for three months before we find ourselves back in this situation again,” Notley told Maclean’s.
Meanwhile, the addition of $4 per barrel to the price of WCS from new rail capacity is also a relatively small payoff. “Don’t mistake me — this is not the long-term answer,” Notley said on Wednesday. “It absolutely is not. New pipelines are the long-term answer.”
To reiterate, though, pipelines are not a near-term answer. In the meantime, the WCS discount of around $40 per barrel is probably too much to bear for many oil producers. Some are already voluntarily cutting back. Scotiabank says that a hypothetical 4 percent mandatory production cut (140,000 bpd) could narrow the discount from $40 per barrel to to something like $20 per barrel. That sounds more effective than a provincial-led purchase of rail capacity that will take 18 months to go into effect.