Canadian oil is below $15. Depression levels of cheap.

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By Nick Cunningham

Cenovus rig

Canadian oil prices briefly plunged as low as $15 per barrel last week, after a U.S. federal judge blocked the construction of the Keystone XL pipeline.

Canada’s oil industry has lurched from pipeline crisis to pipeline crisis, with projects blocked at every turn. Just a few months ago, the Trans Mountain expansion – a proposed pipeline to be built from Alberta to the Pacific Coast – also ran into trouble and is now ultimately in doubt.

The inability to build new capacity capable of shipping higher levels of oil out of Alberta has crushed Western Canada Select (WCS), a price marker that tracks heavy oil from Canada. WCS has historically traded at a discount relative to WTI, taking into account differences in quality and the higher cost of transit, but the discount has exploded this year as Alberta’s pipelines are tapped out. In October, WCS traded at a record $50-per-barrel discount to WTI.

The ruling last week from a U.S. federal judge led to more trouble. The judge said that the U.S. State Department did not adequately consider the environmental impacts of the Keystone XL pipeline when it granted a cross-border permit for the project. The judge said that the agency needs to conduct a supplemental environmental impact before the project could move forward, adding more delays to a project that was originally proposed a decade ago.

TransCanada had hoped to begin construction next year, having secured enough buyers for the crude oil it would ship, although the company has not issued a final investment decision. The recent court ruling could add delays, although it is unclear what happens next. Chris Cox, an analyst with Raymond James, told the Wall Street Journal that construction could be delayed until 2020 at least. At that point, it could become political fodder during the 2020 presidential campaign, adding further layers of uncertainty. “Is TransCanada willing to bet $8 billion on getting another approval from Trump?” Cox told the WSJ.

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With the Trans Mountain expansion and Keystone XL both blocked for the time being, the only possible project to move forward is Enbridge’s Line 3 replacement. Enbridge is hoping to replace an aging pipeline that runs from Alberta to Minnesota and Wisconsin. The replacedpipeline, which is estimated to cost more than C$8 billion, would also double its throughput to 760,000 bpd. For now, that project appears to be on schedule and could come online in late 2019 or early 2020. That would provide both takeaway capacity and pricing relief for Canada’s oil industry.

However, Enbridge could face some other problems in Michigan. The newly elected governor Gretchen Whitmer has voiced opposition to the aging Line 5 pipeline, yet another aging pipeline that ferries oil from Alberta, through Michigan, to refineries across the border back in Canada. The current governor, Rick Snyder, reached a deal with Enbridge in early October, which would require Enbridge to encase the pipeline in a cement tunnel to prevent any leaks. Such an endeavor could cost as much as $500 million and take seven to ten years to build.

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Whitmer has suggested she would seek the closure of Line 5 before it can be replaced, a move that would put a further dent in Alberta’s takeaway capacity. Line 5 is 65 years old and carries 540,000 bpd.

Because Canada’s oil production has increased over the last few years, and pipeline companies have run into trouble in every direction, the discount for WCS has widened. But over the last week, in the wake of the Keystone XL decision, the discount blew out. WCS dropped as low as $16 per barrel in recent days. Canadian oil producers are losing around $30 million per day, according to Alberta’s finance department and the Wall Street Journal.

Now the discounts have become such a problem that some companies are actually taking the drastic step of shutting down production. Cenovus Energy reduced output because of the low prices. “Canadian companies are selling their oil to the U.S. at fire-sale prices, and it is having a significant impact,” Cenovus’ CEO Alex Pourbaix told the WSJ. Other companies are also slashing production, including Canadian Natural Resources, Devon Energy and Athabasca Oil Corp. Bloomberg estimates that together, the production curtailments could reach as high as 140,000 bpd.

As long as the discount for WCS continues to trade in excess of $40 per barrel – at a time when global oil prices are falling – then there will probably be more forthcoming announcements detailing production cuts.

By Nick Cunningham of Oilprice.com

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