ENBRIDGE DEBACLE STEAMS U.S. REFINERS
Change in shipping contract rules cause cancellations and chaos with producers
Add Midwest refiners to the growing list of U.S. industries upset with Canada.
Their ire has sprung, not from tariffs, but Enbridge Inc.’s attempt to create more space on its main oil pipeline network on June 1, only to reverse the decision on June 4 under pressure from both U.S. and Canadian players.
The decisions, one after the other, infuriated refineries in the U.S. Midwest as they set off a wave of contract cancellations, led to chaos in the Canadian oil trading market and has strained ties of Canadian producers with their limited set of customers, the U.S. refiners.
In a bid to squeeze out “air barrels,” an industry term when shippers buy more space from a pipeline company than they need, Enbridge decided to use historical averages to apportion contracts. That upset U.S. refiners, many which buy their oil only once it’s already in the pipeline system and therefore don’t have a history of shipping on the line. The result was they were allocated zero space under the new rules.
In addition, some Canadian oil producers — motivated by a big, short-term swing in heavy oil prices — cancelled contracts to supply the refineries with oil when the rules changed, adding to the refiners’ panic.
Heavy oil prices gyrated on Enbridge’s rule change — the heavy oil benchmark Western Canada Select dropped over $10 per barrel on the news, and then surged $12 per barrel to close the gap when the rules were cancelled one business day into the trading session. The worst of the price swing is over, but the market remains volatile, with analysts expecting a lasting fallout from the cancellation of the contracts, which has forced some U.S. refineries to scramble to find alternative oil supplies at the cost of millions of dollars. Of the unintended consequences, the cancelled contracts and related costs caused the most acrimony between U.S. refineries and Canadian producers.
A source at a U.S. refining company with direct knowledge of the situation said it received a contract cancellation from a longtime Canadian oil supplier on June 1, which caused the refiner to move quickly to backstop the cancellations with other oil barrels. Its competitors faced similar issues. The industry source, who requested anonymity because the information is commercially sensitive, said the refinery has ended its relationship with the Canadian producer that cancelled the contract.
CITGO, a U.S.-based subsidiary of Venezuela’s state-owned PDVSA, scrambled to re-contract all of the volumes at its 135,000-barrels-per-day Chicago-area refinery. The company declined to comment.
Sources at two Canadian oil producers confirmed there had been cancellations in the market. Since oil trading is a closely held corporate secret in the oilpatch, they spoke only on condition of anonymity.
Given that the Canadian oil market is not as liquid as the U.S. or global market, refineries had difficulty in finding the appropriate blend of oil at short notice, and some refineries ended up buying less-than-ideal blends just to ensure they had enough supply. “It would make absolutely no sense for a Canadian producer to bite the hand that feeds them,” said Jen Rowland, senior analyst with St. Louis-based Edward Jones. “Where else are they going to go? It’s not like they have an option.”
Canadian producers who cancelled contracts after the sharp fall in WCS prices likely got a shortterm boost — given how Western Canada Select oil prices jumped after Enbridge reversed its decision — but could suffer from strained relationships in the future with U.S. refiners.
The vast majority of Canadian oil is shipped to the U.S. Midwest due to delays on new pipelines such as TransCanada Corp.’s Keystone XL to the U.S. Gulf Coast and the federal government’s Trans Mountain expansion to the West Coast.
Canadian oil companies, in turn, directed their anger at Enbridge for the rapid shift in rules and blasted the Calgary-based pipeline giant for insufficient consultation before the new rules came into effect. BP Plc., which produces oil in Canada and refines it in Indiana, complained directly to the National Energy Board.
“The hasty implementation, lack of sufficient prior notice, and abrupt reversal of the supply verification procedure by Enbridge, all in the span of eleven days, is an unreasonable exercise of discretion,” BP vice-president, global oil Jennifer Geggie said in a June 6 letter to the NEB, which also said cancelling the rules in the middle of a trading session was “unreasonable.”
Enbridge defended that it was trying to solve a problem, but acknowledged the proposed system had “unintended consequences.” Analysts believe those consequences will make Enbridge reluctant to try again to find a solution.
The problem is that some oil producers and oil traders are “gaming the system,” said Rowland.
“Not all companies, but some clearly jack-up to the extent that they can, the amount of barrels they nominate (to ship on Enbridge’s pipeline system),” she said. “So if you need 100, ask for 125, and hopefully you’ll get 100.” Shippers typically ask Enbridge for more pipeline space than they need every month, so the company’s Canadian Mainline pipeline system — the largest crude oil export system in the country — is not full despite the fact that more oil is being produced than can fit in the pipes.
In a June 11 letter to the NEB, Enbridge acknowledged its attempt to fix the problem — verifying how many oil barrels each company had historically shipped on the network versus how many air barrels they requested, then cancelling the process — had several unintended consequences. “Behaviours by a number of market participants — such as diverting historical supply to other markets, dramatically increasing/decreasing prices offered for the purchase/sale of crude, and rumoured contract cancellations — were causing significant unforeseen and unforeseeable financial harm for many of Enbridge’s customers,” the company said. The letter also explained why the company cancelled the verification process in the middle of a period of heavy trading activity. “Enbridge recognized the cancellation of the procedure a full ( business) day into the June trading period was not ideal for shippers, but Enbridge could not move forward with the procedure’s implementation in good faith knowing the concerns shippers had expressed,” the letter said. Given Enbridge’s influence over Canadian oil exports, a handful of industry players, refiners and producers are also upset that they were given eight days notice before the new rules went into place. Enbridge hosted a meeting of about 200 industry participants on May 29 — two days before its new rules went into effect — at Calgary’s Metropolitan Conference Centre to discuss the new procedures. At the meeting, Enbridge also angered its shippers when it said it would not be fielding questions. The company told attendees to follow up with the company individually, a move one person who attended the meeting said was short-sighted given the enormity of the changes.
“We have been engaged with our customers to improve the nomination process and will continue to work directly with them on this issue,” Enbridge spokesperson Michael Barnes said in an email. He did not address why shippers and refiners were not given the opportunity to ask questions and provide more feedback before the meeting.
Oil producers and refiners are still hopeful that Enbridge can resolve the air barrels problem, which forced the company to ration space on its pipelines. “I don’t know why there’s never been a move to a capacity auction,” said Martin King, director, institutional research with GMP FirstEnergy on Calgary, describing a system in which the total amount of air barrels on the network from one month would be put up for auction the next month.
“If you’ve got so much left over every month then put it on the market,” he said, adding that such a system would allow spot customers to make use of the unused space in the line and boost Canadian crude oil deliveries.
For now though, King expects any changes to fix the problem will be a long way off, given the complaints to the NEB. “I’ve got to think they ’re licking their wounds over that,” he said.
In its NEB letter, Enbridge detailed why it’s difficult to come to an agreement with producers and refiners on how to improve the system.
The pipeline giant said it has “explored a range of options” with its customers over the past two years to address the problem but that these methods “have failed.” “Other potential solutions have not garnered significant shipper support because, ultimately, apportionment is a zero sum game: every time a shipper gains a barrel through the process, another shipper loses a barrel,” the letter stated. “Accordingly, any proposed methodology to curb air barrels results in a lack of consensus from shippers.”
The hasty implementation (and Enbridge’s) abrupt reversal ... is an unreasonable exercise of discretion.