Canadian oil production continues to rise and pipeline capacity remains constricted, pushing 200,000 barrels of oil a day onto the railways.
"In the past several years, we have seen big increases in supplies of oil from the United States and Canada," said Afolabi Ogunnaike, a senior research analyst in refining and oil product markets for Wood Mackenzie. "Most of the supply is from parts of the country far removed from refining demand centres. That has led to price discounts."
The discounts are the lower prices Canadian producers receive for oil purchased by refineries in the southern U.S. The differential is between the price of Western Canada Select (WCS) and West Texas Intermediate (WTI), the North American benchmark.
Oil transportation bottlenecks can cause oil differentials to rise. The differential, dubbed the "bitumen bubble" by former Alberta premier Alison Redford a few years ago, can potentially reduce the earnings of energy companies and the royalties collected by provincial governments.
Currently, the differential between WCS and WTI is narrow, at about $7 a barrel compared to $20 last summer.
Groups battle pipelines
Wood Mackenzie expects $100 billion in value is at stake over the next 15 years based on how much the differential will grow, multiplied by the anticipated oil production of Western Canada. Wood Mac expects oilsands growth to reach four million barrels a day by the mid 2020s, up from 3.7 million barrels a day now, a fairly conservative growth estimate. It assumes the worst case scenario, that no new pipelines will be constructed.
That is precisely what some environmental groups are pushing for. Without any new pipelines, future growth of the oil sector would be impacted. The strategy of many environmental groups is to indirectly constrict oilsands production, by opposing pipelines, whether they be conversions, expansions, or new builds. The analysis by Wood Mackenzie puts a number on what is at stake for the energy sector if that opposition is entirely successful.
More than $40 billion worth of pipeline projects are proposed in North America, although many are stalled, including TransCanada's Keystone XL and Enbridge's Northern Gateway. While a few projects such as Northern Gateway try to export Alberta oil through the West Coast, most pipelines aim to move crude south to refineries on the Gulf Coast.
That's the mission of Keystone XL, although Wood Mackenzie does not expect that pipeline to be constructed before 2020. Instead, the firm points to other projects that have a better chance of being constructed and operational in the next five years such as Enbridge's Alberta Clipper and Line 3 replacement. Both projects involve expanding current pipelines.
"We see heavy Canadian crude making inroads into the Gulf Coast refining market," said Ogunnaike. "Of course this is predicated on a set of pipeline assumptions."
Canadian heavy oil to Gulf Coast
Ogunnaike expects heavy oil from Canada to increasingly replace supply from other countries such as Mexico and Venezuela. Mexican production continues to decline, while increasingly Venezuela is sending heavy oil to Asia, in part to pay back debt.
In 2011, Canada was supplying five per cent of the heavy oil refined in the Gulf Coast. That could rise to 50 per cent by 2025. Gulf Coast refineries are set up to process heavy oil, rather than lighter oil like the output from U.S. shale fields.
While Wood Mackenzie does not expect Keystone XL to be constructed in the next five years, the firm does not dismiss the project altogether. Keystone still makes economic sense to transport Canadian crude to the Gulf Coast compared to alternatives such as TransCanada's Energy East project or shipping crude by rail. With so much production possible from Western Canada, the oil industry could use both of TransCanada's proposed projects.
"Energy East is a more expensive path than Keystone XL to the Gulf Coast, but there still is a need for additional capacity," Ogunnaike said.
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