FRASER RESEARCH BULLETIN FROM THE CENTRE FOR NATURAL RESOURCE STUDIES May 2018 The Cost of Pipeline Constraints in Canada by Elmira Aliakbari and Ashley Stedman MAIN CONCLUSIONS Despite the steady growth in crude oil From 2013 to 2017, after accounting for available for export, new pipeline proj- quality differences and transportation ects in Canada continue to face delays costs, the depressed price for Canadian related to environmental and regula- heavy crude oil has resulted in CA$20.7 tory impediments as well as political billion in foregone revenues for the Ca- opposition. nadian energy industry. This significant loss is equivalent to almost 1 percent of Canada’s lack of adequate pipeline ca- Canada’s national GDP. pacity has imposed a number of costly constraints on the nation’s energy sec- In 2018, the average price differen- tor including an overdependence on tial (based on the first quarter) was the US market and reliance on more US$26.30 per barrel. If the price differ- costly modes of energy transportation. ential remains at the current level, we These and other factors have resulted estimate that Canada’s pipeline con- in depressed prices for Canadian heavy straints will reduce revenues for Cana- crude (Western Canada Select) relative dian energy firms by roughly CA$15.8 to US crude (West Texas Intermediate) billion in 2018, which is approximately and other international benchmarks. 0.7 percent of Canada’s national GDP. Between 2009 and 2012, the average Insufficient pipeline capacity has re- price differential between Western sulted in substantial lost revenue for Canada Select (WCS) and West Texas the energy industry and thus imposed Intermediate (WTI) was about 13 per- significant costs on the economy as a cent of the WTI price. In 2018 (based on whole, and will continue to do so. This the first quarter data), the price differ- reaffirms Canada’s critical need for ad- ential surged to 42 percent of the WTI ditional pipeline capacity. price. fraserinstitute.org FRASER RESEARCH BULLETIN 1 The Cost of Pipeline Constraints in Canada Introduction Despite the strong economic case for pipelines, new pipeline projects in Canada continue to Canada’s energy industry is a major contribu- face delays related to environmental and regu- tor to Canada’s economy and provides eco- latory impediments as well as political oppo- nomic benefits to all Canadians. However, that sition. Ultimately, Canada’s lack of adequate contribution could be larger still: Canadian oil pipeline capacity has resulted in depressed producers have been facing depressed pric- prices for Canadian heavy crude and lost rev- es for their crude oil relative to other inter- enue for oil producers and thus the Canadian national benchmark prices, resulting in fore- economy as a whole. gone revenue for the Canadian energy industry. The price differential between Canadian heavy This bulletin will explain the reasons behind the crude (Western Canada Select or WCS) and US steep WTI-WCS price differential and will sub- crude (West Texas Intermediate or WTI) has sequently demonstrate Canada’s critical need widened substantially in recent months due to for new pipeline projects. We will examine the insufficient transportation infrastructure and extent to which Canada’s heavy crude is be- pipeline bottlenecks, which has dramatically ing discounted relative to other benchmark oil lowered the market price of Canadian crude oil prices and how the price differential for Cana- relative to other comparable oil prices. dian crude has grown in recent months. Finally, we will estimate the revenue lost between 2013 Western Canada’s oil exports have been rising and 2017 due to depressed prices from Cana- steadily since 2013. Despite the steady growth dian heavy oil exports, as well as the foregone in crude oil available for export, construction revenue for the energy sector associated with of pipelines to transport crude oil has been lag- insufficient pipeline capacity in 2018. ging, as many major pipeline projects have been delayed or cancelled. Insufficient pipeline ca- pacity is driving increased shipments by rail- Reasons behind the Canadian crude oil way—a more expensive (and slightly less safe) discount and the case for pipelines mode of transportation—leading to higher costs Canadian oil producers command substantially for Canadian producers.1 The issue of inad- lower prices for their crude oil relative to other equate transportion capacity has also resulted international benchmark prices. Some part of in rising crude oil inventories, putting Canadi- the differential between the Western Canadi- an oil into storage rather than into the market. an Select (WCS) price, Canada’s primary heavy crude benchmark, and the West Texas Interme- 1 According to the National Energy Board, “rail diate (WTI) benchmark price is natural and can costs are roughly double or triple the pipeline tolls” be attributed to two factors: quality differences (NEB, 2014). Meanwhile, studies show using pipe- and transportation costs. line and rail transportation of oil and gas are both quite safe; however, pipelines continue to result in In terms of quality differences, WCS crude oil fewer accidents and fewer releases of product, when is heavier than WTI crude (an API of 20.5 de- considering the amount of product transported by grees versus 34.3 degrees) and it contains 3.5 pipeline. Based on data from 2004 to 2015, pipelines percent sulphur by weight compared to WTI’s were 2.5 times less likely than rail to result in a re- lease of product when transporting a million barrels 0.9 percent (BNN News, 2013). Being heavier of oil (Green and Jackson, 2017). and more viscous, WCS is more costly to trans- fraserinstitute.org FRASER RESEARCH BULLETIN 2 The Cost of Pipeline Constraints in Canada port by pipeline (as it requires more energy to While there is and will always be a natural dif- move a given distance). Further, the heavier the ferential between the WCS and WTI prices be- crude oil, and the greater the sulphur content, cause of quality differences and transportation the lower its value to a typical refiner as it will costs, Canada’s insufficient transportation in- require more complex methods to produce fuels frastructure and pipeline bottlenecks have dra- like gasoline. For these reasons, oil refiners gen- matically increased the differential beyond its erally expect to pay less for heavy WCS crude oil natural level in recent years.2 compared to light, low-sulphur WTI crude oil. Western Canadian oil exports have been rising The second component of the natural differen- steadily in recent years (figure 1). According to tial between WCS and WTI is associated with the National Energy Board’s analysis, Canada the cost to transport oil from Western Canada had 3.95 million barrels per day of oil available to US refining hubs. WCS is priced at Hardisty, for export in 2017, compared to 2.95 barrels per Alberta and WTI crude oil at Cushing, Oklaho- day in 2013, an increase of 35 percent. Despite ma. If it were not for the quality differences and the steady growth in crude oil available for ex- the impact that this has on refinery demand for port, construction of pipelines to ship oil out of competing crudes, the difference between the the region has been lagging (as shown in figure price of WTI and WCS would boil down to just 1) as major pipeline projects have been delayed the transportation cost between Hardisty and or cancelled. These include Enbridge’s Cushing. According to the Canadian Associa- tion of Petroleum Producers, the 2017 tolls to 2 The tight takeaway capacity has penalized both ship heavy oil from Hardisty to Cushing are be- Canadian heavy and light crude oil in US markets. tween US$5.45 and $6.85 per barrel, depending However, Canadian heavy crude oil (WCS) suffers more on which pipeline system is used. than light, sweet crudes due to quality differences. Figure 1: Canadian oil pipeline capacity and exports, 2013–2018 4.0 Oil available for export 3.5 3.0 2.5 2.0 Enbridge Mainline 1.5 Million per day barrels 1.0 Express Trans Mountain 0.5 Keystone Rangeland/ Milk River 0.0 2013 2014 2015 2016 2017 2018 Source: NEB, 2016. fraserinstitute.org FRASER RESEARCH BULLETIN 3 The Cost of Pipeline Constraints in Canada Northern Gateway Pipeline and TransCanada’s Canadian crude oil exports by rail were more Energy East and Eastern Mainline projects, than twelve times greater than in January 2012 which have been cancelled due to a number of (NEB, 2017). Of course, those Canadian oil pro- factors including significant regulatory hur- ducers that have resorted to shipping by rail have dles, political opposition, and changing market had to absorb the higher transportation costs. conditions. The Keystone XL pipeline proposal The more that oil producers have to depend on faced significant delays in the US as this proj- rail because of insufficient pipeline capacity, the ect was initially rejected by the Obama admin- greater the average WCS transportation cost and istration in November 2015 and finally got ap- the spread between WCS and WTI prices. proved by the Trump administration in March The inadequate transport capacity dilemma 2017. Despite receiving many of the necessary is also reflected in rising crude oil inventories regulatory approvals, Canada’s remaining pipe- in Alberta in recent years. Many oil producers line projects—the Trans Mountain Expansion have been forced to put excess production into and the Line 3 Replacement Project—along with storage tanks until sufficient capacity is avail- Keystone XL—continue to face delays related to able. Specifically, based on data provided by the environmental and regulatory concerns, politi- Alberta Energy Regulator, crude oil inventories cal opposition, and market uncertainty (Scotia- increased by 47 percent between January 2013 bank, 2018).