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How Long Will Canadian Oil Sand Producers Be Disconnected From World Prices?

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OIL REFINERY
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Oil sand producers in Alberta can't but help notice the nearly $20 per barrel spread between landlocked West Texas Intermediate and global prices such as Brent Crude.

Even the U.S. Department of Energy is charging world oil prices (Light Louisiana Sweet -- whose price mimics Brent) for the 30 million barrels it is releasing from its strategic reserves.

So why can't America's leading foreign supplier get top prices as well?

As the price spread between West Texas and Brent continues to widen into uncharted territory, Canadian producers must be wondering why they are benchmarking the price of their oil exports to the huge price discount in the U.S. marketplace.

The reason for the spread is two fold. The divergence between U.S. and global oil prices mimics the divergence between U.S. and world oil demand. U.S. oil demand is shrinking while world oil demand is booming.

Second, brimming storage tanks in Cushing Oklahoma where West Texas Intermediate is priced, are disconnected from global oil markets. The oil stored in Cushing is landlocked and it has no way of getting to world oil markets despite the price incentives for it to move.

And with more oil coming from Canadian oil sands, as well as shale oil from the Bakkan formation in the Dakotas, inventories at Cushing are getting even more bloated. Until, of course, those price differentials ultimately compel Canadian oil to find another path to flow.

Just like water doesn't flow uphill, oil can't be expected to flow in ways that defy price gravity. Basic economics says Canadian oil will ultimately flow to where it gets its greatest return. And that isn't to already near full storage tanks in Cushing.

Pipeline access to the Gulf coast could connect oil sand producers with world prices but only if U.S. regulators give their approval. So far, approval for Transcanada Pipeline Ltd.'s proposed Keystone XL pipeline that could take oil sand product to Gulf coast refineries has been held up. Its future now rests with the U.S. State Department but given the widespread environmental opposition in the U.S., getting approval for the project is no slam dunk.

But not all paths to world oil prices run through the U.S. Enbridge, one of Transcanada's chief rivals, has already proposed building a pipeline from the oil sands to Kitimat, B.C, which is geographically the closest point for trans-shipment to markets in China and Japan. And with the Arctic Ocean becoming increasingly ice free, a pipeline to Churchill, Manitoba on Hudson's Bay could be another route to world oil prices.

While the location of future pipelines is up for grabs, one thing is certain: Today's price differential is more than sufficient to evoke a supply response. If oil sand product can't get to the Gulf of Mexico and fetch world prices, Canadian oil sand producers and their pipeline partners will need to have a big rethink about which markets they want to serve.

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