Oil-by-rail as ‘insurance’ has its own downside
Rising project costs and the likely approval of pipelines have companies hedging their bets
The economics of transporting oil by rail has suffered in recent months with some oil terminal projects facing cost overruns, but fears of pipeline delays will keep companies hedging their transportation bets.
Canadian oil-by-rail has benefited from the wide discounts between Canadian, U.S. and international benchmarks such as Brent over the past few years with spreads widening to as high as US$20 per barrel, but they now hover between US$5 and US$6.
“The economics aren’t as great as they used to be,” says Dale Clark, vice-president of Tundra Energy Marketing, which operates a 60,000-barrel-per-day terminal in Cromer, Man.
“That’s had a much more substantial impact on the economics of crude-by-rail than anything else.”
The idea that companies would load crude oil on a train to get better economics may be a little less right now, agrees Steven Paget, director of institutional research at FirstEnergy Capital Corp.
Canadian petroleum and petroleum product shipments are up 7.1% in the first five months of the year, less robust than the 13.7% gains made last year, according to the Association of American Railroads.
Cost overruns at Canexus Corp.’s 100,000-barrel-per-day North American Terminal Operations (NATO) in Bruderheim, Alta. are also sobering in the midst of bullish sentiment around rail.
On July 2, the company announced the appointment of new president Douglas Wonnacott nearly four months after Gary Kubera stepped down abruptly, and said its project’s costs could rise to $360-million, compared with its original estimate of $225-million.
The company loaded MEG Energy Corp.’s crude on its first unit train in December at the terminal, but shut it in June as the company worked to add 12 additional loading arms and connect the terminal to Cold Lake to serve clients such as Cenovus Energy Inc.
The company hopes to have seven unit trains up and running once it restarts in late August. A unit train can typically haul up to 120 rail cars, each holding between 560 to 660 barrels of oil.
Torq Transloading Inc. says its projects are also experiencing some cost increases, although it intends to proceed with projects such as the 168,000-bpd Kerrobert Rail Terminal in Saskatchewan.
“I don’t think that our facility will be immune to the forces of economy here in Western Canada,” said Jarrett Zielinski, president of Torq. “I am not seeing material upside, but there are definitely some items that are escalating in cost.”
Adhering to new rail safety regulations could also lead to delays in getting new car stocks, but, for the most part, companies say they can absorb the additional costs.
RBC Capital Markets estimates as much as 440,000 barrels per day of new rail capacity should begin operating this year, taking total Canadian rail capacity to one million barrels per day — more than the 830,000-bpd Keystone XL pipeline that remains the subject of U.S. State Department’s regulatory scrutiny six years after it was proposed.
“With increased uncertainty around the timing of the KXL decision, the paradigm has shifted with midstream companies and larger producers beginning to consider rail as a long-term complement to traditional transportation strategies,” RBC said in a note to clients.
TransCanada Corp. has said it may build a “rail bridge” to connect to the southern leg of the Keystone XL pipeline, while others like Cenovus Energy Inc.’s rail capacity could rise to 30,000 barrels per day.
Imperial Oil Ltd. says its joint venture with Kinder Morgan Inc. to build a 100,000 bpd to 250,000 bpd rail-loading terminal at its refinery in Strathcona County, southeast of Edmonton, is on schedule for a December 2014 launch.
“I view rail as sort of an insurance policy that you will be able to get your crude to a market,” says Tundra’s Mr. Clark. “A large producer like Imperial is building a rail-loading facility so that they don’t have their own equity production shut-in.”
Tundra signed a deal with Enbridge Energy Inc. to connect the terminal to its pipeline network in the region, and the pipeline company has an option to purchase 50% of Tundra’s rail terminal in future subject to certain terms and conditions.
“We are working toward trying to meet those conditions, but we have not met them at this point in time,” Mr. Clark said. “So the Enbridge joint venture may or may not happen, but we are doing our best to have it come to pass.”
The sector may also see some consolidation. CIBC World Markets notes that Canexus’ NATO asset could be attractive to midstream companies eager to provide a “holistic” transportation and terminal service offering, noting Enbridge, Pembina, Inter Pipeline, and TransCanada, as some possible buyers.
CIBC says these potential buyers recognize that “land is very tight in both Edmonton and Hardisty along the respective pipeline alleys and that a third hub is likely necessary to accommodate the growing diluent and solvent volumes into the oil sands, and, to a lesser extent, diluted bitumen volumes out of the oil sands.”
First Energy Capital Corp. has introduced a “pipeline risk” to its outlook, noting that it’s becoming pessimistic that TransCanada’s Keystone XL and Enbridge’s Alberta Clipper will get the sign-off from U.S. authorities. Northern Gateway also faces significant challenges despite securing federal approval. CIBC forecasts differentials between synthetic crude and Western Canada Select to rise, and expects railing capacity to pick up most of the volume that would otherwise be transported by the major pipelines.
While there are dangers of overbuilding rail capacity, the absence of a clear path for new export pipelines has left producers erring on the side of caution, Mr. Paget says. Talk of new pipelines in the Bakken basin, which has typically relied on trains, could also hurt crude-by-rail.
“You can see why people like [Canadian Pacific Railways Ltd.’s] Hunter Harrison are not getting too excited by crude-by-rail right now,” Mr. Paget says. “They are investing some, but they are not building terminals and not buying tank cars.”
Longer term, analysts expect new crude oil export pipelines will get constructed, diminishing rail options.
“Pipelines remain the cheapest transportation method for liquid hydrocarbons, “CIBC said. “As new pipeline capacity starts up, we would expect demand for crude-by-rail to fall. Based on current expectations for new pipeline in-service dates, the need for crude-by-rail in the Western Canadian Sedimentary Basin will fall in the 2018/19 time frame.”