As oil-by-rail shipments out of Alberta tumble, the Notley government is close to securing a deal to acquire its own fleet of rail cars.
But does this plan still make sense?
Yes, say experts, although there are millions of reasons to scrutinize the economics, before the province acquires up to 7,000 rail cars capable of transporting crude out of the province.
“Rail is needed until we get new pipelines in place and so the real question is: When are those new pipelines coming?” said Greg Stringham, who recently headed the province’s oil-by-rail committee.
“Rail becomes a real good insurance policy.”
Alberta’s energy sector has closely monitored the amount of oil being shipped out of the province by train since a pipeline bottleneck began squeezing prices for Canadian crude last year.
According to the National Energy Board, oil exports by rail jumped to a record 330,000 barrels per day (bpd) in November, more than double levels reported at the start of 2018.
With pipeline space being rationed and output swamping export capacity, oil producers faced discounts of more than US$45 a barrel for Western Canadian Select (WCS) heavy crude last November.
Amid concerns it was taking too long to significantly ramp up rail shipments, Premier Rachel Notley announced last November the province would acquire up to 7,000 rail cars to bolster take-away capacity out of Alberta by 120,000 bpd.
The premier has asked Ottawa to join the initiative, although the Trudeau government has yet to make a decision.
The province hasn’t disclosed a cost, although its business plan to the federal government suggested $350 million would be spent on fixed capital costs, one source told the Herald.
Operating costs were projected at $2.6 billion over three years, while revenue from shippers would reach about $2 billion.
The federal government would also see higher revenues of $1 million a day from the improved oil-price discount, while Alberta would see the benefit of higher royalties, investment and jobs.
The plan made sense, but circumstances have changed in recent weeks.
The Notley government began temporarily restricting oil production out of the province, beginning in January.
In short order, the price discount on Canadian heavy oil fell below $10 a barrel, undercutting the economics to move crude by train to the U.S. Midwest and Gulf Coast.
For example, Imperial Oil planned to increase its own shipments to 180,000 barrels per day in January, but has slashed it to near zero this month.
The company needs the price spread to be at least $15 to $20 a barrel to justify the additional costs of transporting its oil from Alberta by train to the U.S.
On Monday, the price discount for WCS heavy oil sat at $11 a barrel, according to Net Energy.
And while the trend is still developing, it appears industry rail shipments have fallen by more than 50 per cent in the past three weeks.
In an interview with Bloomberg News, United Conservative Party Leader Jason Kenney questioned the cost of the province’s rail strategy and whether it should proceed.
“On the rail, we are not going to honour a blank cheque. They have not told us how much they plan to spend on this,” he said last week.
“I am skeptical about risking $3 billion to do something the private sector was already doing, particularly when the economics on rail make less sense within (a) narrower price differential.”
Kenney is right to raise the questions, since taxpayers will initially foot the bill for it.
But I don’t think today’s oil-price differential changes the answer.
Officials in the premier’s office say negotiations to acquire the rail cars are ongoing and the province is “very close” to announcing a deal.
“What I can say definitely is that we will make money on whatever we spend on this and then some, so there will be net revenue,” said Cheryl Oates, spokeswoman for the premier.
For the industry and the province, the issue of buying or leasing rail cars, building pipelines and curtailing production are all inextricably linked.
On the pipeline front, Enbridge’s Line 3 replacement project is expected to begin operating later this year, adding about 375,000 bpd of additional export capacity.
Western Canadian oil production is expected to remain flat or grow modestly this year, although output could expand by more than 400,000 barrels per day in 2020, according to Kevin Birn of energy consultancy IHS Markit.
As soon as curtailment is lifted — likely at the end of this year — the need for rail will still exist, he noted.
Prices and demand for Canadian heavy oil are relatively strong in the U.S. today because of falling production coming from Venezuela.
Consultancy Wood Mackenzie projects the oil-price differential is expected to widen again into the low $20-a-barrel range in the back half of this year — supporting rail economics — and then average around $22 a barrel next year.
Based on its analysis, Mark Oberstoetter of Wood Mackenzie expects TransCanada’s Keystone XL project won’t be built and begin operating until mid-to-late 2021, while Trans Mountain is tentatively expected to be finished in 2023.
It’s the sheer unpredictability of getting pipelines built that is the most compelling reason to continue with the rail initiative.
“The problems keep happening and the pipes never come,” said Richard Masson, former CEO of the Alberta Petroleum Marketing Commission.
“It doesn’t take many months of wide differentials to pay for the cost of the (rail) investment.”
Given the uncertain nature of how long curtailment will be required and the impact on the differential, there are many issues to weigh before Alberta opens the public purse to pay for rail cars and locomotives.
But new transportation capacity will be needed. It’s an investment in the future, protection against yet another pipeline setback.
Right now, Alberta’s rail plan might not be perfect, but it is the best mid-term option the province has until new pipelines are finally completed.
Chris Varcoe is a Calgary Herald columnist.
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