How much crude should Western Canadian producers ship via railways?
Subscribers to Solomon's retainer service recently received the February 2018 Topic Report, Canadian Oil Forecast to 2025, providing them with a forecast for Canadian oil production to 2025, including production from the Alberta oil sands and East Coast Newfoundland. From just the oil sands, Solomon is forecasting that an incremental 350 thousand barrels per day (350k bbl/d) will come online between 2017 and 2020. The new Topic Report also highlights the requirements for long-term pipeline solutions to achieve both new growth and brownfield expansions for oil sands capacity via a more sustainable WCS (Western Canada Select) oil price spread. Both the Transmountain expansion and Keystone XL projects are working to provide long-term solutions; however, in the near term there are three quick wins for WCS pricing:
- The Keystone pipeline, which is currently operating at reduced pressure/capacity due to a US Pipeline and Hazardous Materials Safety Administration (PHMSA) mandate. Solomon is forecasting an additional 50k bbl/d of Keystone flows in the third quarter of 2018 as pipeline pressure is restored.
- Enbridge Line 3, which is expected to be placed in service in November 2019, providing an incremental 370k bbl/d of egress capacity.
- Utilization of the rail terminal loading capacity of 1.2 million barrels per day (1.2M bbl/d) in Western Canada for the shipment of crude by rail.
The chart below shows that rail exports have averaged 110k bbl/d since 2012. Solomon expects crude-by-rail exports to increase 245%, to 270k bbl/d, in 2018 as producers wait for incremental pipeline capacity to balance the market. However, railways are benchmarked versus peers on operating ratio (measure of operating expenses as a percentage of revenue), which is negatively impacted by having incremental locomotive capital and crews available on an interruptible basis. As a result, Canadian railway companies have been indicating that they require term agreements with take-or-pay conditions to mobilize engines from storage and hire crew members to operate and ship incremental crude. Solomon believes signing up for 270k bbl/d of rail contracts by Canadian producers in 2018 would provide price uplift via closer WCS differentials for the approximately 3.7M bbl/d of remaining production in Western Canada.