Keystone seen failing to sop up Canada oil glut

Even if U.S. President Barack Obama approves the Keystone XL pipeline, Canadian crude oil probably will remain the cheapest in the world, hampering expansion of the country’s largest export industry.

Canadian oil prices are forecast to fall compared with world benchmarks because production from oil sands, fields of sand coated with heavy oil beneath about 90,000 square kilometers (34,749 square miles) of boreal forest in northern Alberta, is estimated to more than double to 3.8 million barrels a day by 2022. Keystone, the 1,179-mile link from Alberta to Nebraska first proposed in 2008 and delayed in part by environmental activists, would only briefly relieve the glut.

“Keystone will help alleviate the lack of pipeline infrastructure but only temporarily,” David Bouckhout, a senior commodity strategist at TD Securities in Calgary, the securities unit of Canada’s second-largest bank, said in a telephone interview. “Growth of supply on both sides of the border, Bakken and Canadian supply, will outpace what Keystone’s capacity will provide in likely two to three years.”

The prospect of prices staying below other types of crude oil risks undermining investment in the Alberta oil sands, the world’s third-largest reserves and the U.S.’s biggest source of imports. Companies from Exxon Mobil Corp. (XOM) to Canadian Natural Resources Ltd. (CNQ) lost a combined C$2.5 billion ($2.45 billion) in revenue last year on lower prices, according to Houston-based PPHB Securities LP. Oil-sands investment fell 10 percent last year to $20.4 billion, Alberta’s Energy Resources Conservation Board said.

Supply Glut

Canada refined about 1 million barrels a day of its crude output last year, leaving 2.3 million to be exported. Domestic demand will grow by 346,000 barrels a day by 2020 if Canadian regulators approve pipelines to the country’s eastern provinces, while production will grow by 1.6 million over the same period, according to a June 5 forecast by the Canadian Association of Petroleum Producers. That means at least 1.3 million barrels of extra production will need to move out of the country by then.

The four existing routes from Alberta to the U.S. West and Midwest have a combined capacity of 3.7 million barrels a day, more than the 3.2 million barrels a day Canada produced last year, of which 55 percent was from the oil sands. Some of the lines carry extra supplies from North Dakota, which pumped 663,000 barrels a day in 2012, Energy Information Administration data show.

Additional Supply

In addition, about 799,000 barrels a day of North Dakota and Canadian output is due to come online in 2013 and 2014, according to CAPP and the U.S. Energy Information Administration, sopping up almost all of the 830,000-barrel-a-day capacity that Keystone would add if it starts up as proposed in 2015.

“Once we get Keystone in place, that will not be the answer,” Greg Stringham, CAPP’s vice president of oil sands and markets, said in a June 5 interview from Calgary. “It may hold us off for a couple of years, but it’s clearly not going to be the long-term answer.”

Western Canadian Select, or WCS, swaps for 2019 were priced at $61.74 a barrel, or $19.94 below similarly-dated West Texas Intermediate, the U.S. benchmark grade, at 2:30 p.m. today, according to the Bloomberg Fair Value Index. Mars Blend, a medium-density, high-sulfur crude produced in the U.S. Gulf of Mexico, was at $83.55 a barrel. Dubai crude, the benchmark Asian grade, was valued at $86.42.

Output Growth

Total Canadian production is forecast to grow more than 50 percent to 4.9 million barrels a day by 2020, while U.S. output expands 37 percent to 11.1 million barrels, the International Energy Agency said in its World Energy Outlook in November. Canadian output jumped 38 percent over the past 10 years, according to the National Energy Board, the federal energy regulator.

Canada’s export capacity will have to double to more than 8 million barrels a day by 2030 should production expand at the rate predicted by CAPP. Even if all the current pipeline projects are approved, additional capacity of more than 1 million barrels a day will be needed from 2025.

“That’s really just 13 years from now, and in pipeline years that’s not a long time,” Stringham said.

The $5.3 billion project, connecting Hardisty, Alberta, with Steele City, Nebraska, was rejected by Obama in early 2012 because it was to be laid across the environmentally protected Sand Hills Grassland and Ogallala Aquifer areas. The president expects to make a decision on the re-routed line, now to run about 100 miles to the east of the Sand Hills, sometime this year, North Dakota Senator John Hoeven, a Republican, said after meeting the president in March.

Environmental Concerns

Environmental groups say the line shouldn’t be built because of the risk of spills and because it would increase pollution by encouraging development of the oil sands, from which is extracted bitumen, a thick, tar-like form of oil that flows like cold molasses at room temperature.

Emissions from the production and use of the sands are 8 percent to 37 percent higher than from oil, according to the Calgary-based Pembina Institute, a non-profit environmental research and advocacy group.

TransCanada Corp. (TRP), the builder of the line, aims to complete a $2.3 billion southern pipeline between Cushing, Oklahoma, and Nederland, Texas later this year that would take oil delivered on Keystone XL to refineries on the Gulf Coast.

Lacking Capacity

“We are out of pipeline capacity right now,” Peter Howard, chief executive officer of the Canadian Energy Research Institute, a non-profit energy economics and environment research group in Calgary, said yesterday by telephone. If Keystone is delayed further, “the political fallout from that is going to sour the relationship between Canada and the U.S. for sure.”

Canada is increasingly reliant on revenue from oil. Energy products were the country’s fastest-growing export over the past 20 years, rising to 23.2 percent of all shipments, from 9 percent in 1993, data from Statistics Canada show.

WCS dipped to a record discount of $42.50 a barrel to WTI in December as pipelines reached capacity. The grade recovered this month as maintenance at oil-sands upgraders reduced production and as BP Plc (BP/) prepared to start the largest crude unit at the Whiting, Indiana, refinery, after converting it to process mostly heavy Canadian oil. August WCS was $17.25 below WTI at 3:59 p.m. New York time today. It has traded at an average $22.29 a barrel discount from 2012, compared with $13.69 in the previous three years, according to data compiled by Bloomberg.

Hurting Revenue

Alberta’s government said it will run a deficit in the coming fiscal year as it collects C$6 billion less revenue than it expected, forcing cuts in services and the use of reserves from a provincial wealth fund. Steve Laut, president of Calgary-based Canadian Natural Resources Ltd., cited the price decline as a reason for a drop in first-quarter cash flow on a May 3 conference call.

“The resulting uptick in heavy and upgraded light oil supply is overwhelming local refining demand and pipeline takeaway capacity,” analysts at Goldman Sachs Group Inc. led by Arjun Murti in New York said in a note to clients June 2. WCS will average $27 less than WTI next year and $41 a barrel cheaper in 2015 if Keystone is delayed or the bottleneck worsens, the analysts said.

A decision blocking Keystone would reduce spending on oil-sands projects by about $9.4 billion between 2014 and 2017, Dan MacDonald, an RBC Capital Markets analyst, wrote in a note to clients May 27.

Overwhelm Demand

North America’s growing supply of shale and oil-sands crude will overwhelm demand unless it’s exported, according to Jackie Forrest, the senior director of global oil research in Calgary at IHS CERA, an energy markets research firm based in Englewood, Colorado. The U.S. will be able to consume as much as 5 million barrels of its neighbor’s crude, she said.

“Sometime between 2020 and 2030, the Canadian oil sands will need other markets than the U.S.,” Forrest said. “Even then the vast majority of supply can fit into the U.S. market, because the refineries on the Gulf Coast and potentially California are so well fitted to process that heavy crude.”

Additional routes are under consideration. TransCanada is studying the conversion of a line from gas to oil that would transport as much as 1 million barrels a day of light oil to refineries in eastern Canada. Enbridge Inc. (ENB)’s Northern Gateway line would bring as much as 525,000 barrels a day of heavy oil to Kitimat, British Columbia, for overseas shipment as soon as 2017. Kinder Morgan Energy Partners LP (KMP) plans to almost triple the size of its Trans Mountain pipeline from near Edmonton, Alberta, to Vancouver to 890,000 barrels a day, by 2017.

“Even with Keystone XL there has to be some other method of getting oil out of Canada” if Keystone is rejected, Michael Formuziewich, who helps manage C$2.2 billion at Leon Frazer and Associates Inc. in Toronto, said in a June 4 phone interview.