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Canadian Oil Prices Crash After Keystone Spill

Nick Cunningham

Prices for Canadian oil continue to sink as the Keystone Pipeline remains offline.

The pipeline sprung a leak late last month, spilling more than 9,000 barrels of oil into wetlands in North Dakota. The pipeline has been online for less than a decade, but has suffered several high-profile spills. The cleanup could also prove to be difficult.

The disasters come as the pipeline’s owner – TC Energy (formerly TransCanada) – is trying to build the Keystone XL pipeline. Reuters reports that the spill has hardened opposition to the Keystone XL pipeline in Nebraska, where TC Energy is still trying to acquire land.

Meanwhile, the outage could continue longer than initially expected. Federal regulators from the Pipeline and Hazardous Materials Safety Administration (PHMSA) said that the pipeline has to remain closed until TC Energy can determine the cause of the spill. To that end, the company needs to send a portion of the affected steel pipeline to an independent lab for testing. After that, TC Energy needs to come up with a plan for remediation.

The prospect of an extended outage of the 590,000-bpd pipeline has already pushed down prices for Western Canada Select (WCS). WCS fell below $35 per barrel by midweek even as WTI traded higher. As a result, the discount has widened from around $16 per barrel before the spill, to as much as $23 per barrel a week later.

“So far it remains unclear how long Keystone will remain shut in, but it could take up to a couple of months until flows are completely resumed,” JBC Energy said in a note on November 1. “A similar incident in November 2017 led to a blow-out of WCS differentials from $10 per barrel to $30 per barrel, but this time more crude volumes are committed to rail transportation.”

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The outage is another blow to Canada’s oil industry, which has been dealing with waning investor interest, a supply glut amid pipeline bottlenecks, and a recent election that was perceived as a setback for Alberta.

“Another squeeze in local prices, albeit temporary, will not help the operating environment in Canada, with depressed prices and constrained market access acutely affecting operator cash flow,” Standard Chartered wrote in a note. The investment bank added that the outage could also put an end to inventory builds in the U.S., due to reduced oil flowing from Canada.

A pipeline outage will exacerbate the shortage of takeaway capacity, depressing WCS prices and scrambling the Alberta’s plan for managing the localized supply glut. It could also push more oil onto rail.

Shipping oil by rail requires a WCS discount to WTI in the range of $15 to $20 per barrel in order to break even, according to Scotiabank. Because of Alberta’s mandatory production cuts, which began at the start of 2019, the differential narrowed significantly. That was good for Canadian oil producers, but it also limited oil-by-rail shipments, “and left railcars loitering in railyards with nothing to do,” Rory Johnston, a commodity economist at Scotiabank, wrote in a note on October 31.

Alberta has been gradually lifting production curbs over the course of this year, and there is a balancing act that the provincial government is trying to pull off – a slight midstream takeaway deficit results in a sizable but not overly painful discount for WCS, which pushes more oil onto rails and incentivizes investment in takeaway capacity. Keep the curbs in place for too long and WCS prices would rise too far, leading to a shortfall of investment in rail. Lift the curbs too fast and the WCS prices plunge amid a renewed glut.

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Alberta likely thought it saw light at the end of the tunnel, having gradually lifted production curbs over the course of 2019 while succeeding in draining inventories. But “we are now entering the most sensitive portion of the easing process where each subsequent production increase could push the western Canadian oil market back into egress deficit,” Johnston wrote for Scotiabank.

That was before the Keystone spill. Much of Alberta’s efforts to manage the market could go up in smoke if the pipeline is offline for an extended period of time. “The November 2017 Keystone outage resulted in an initial ~8 million barrels of backed up crude which would undo much of the inventory progress achieved by the curtailment program thus far if the ongoing Keystone outage lasts weeks rather than days,” Johnston concluded.

Oil producers in Canada are not pleased. “When something like that happens in a system that’s tight, it’s all hands on deck for what do you do to keep barrels flowing,” Rich Kruger, CEO of Imperial Oil, said during a Nov. 1 earnings call. “We've got fingers crossed that it's not something of a longer duration.”

By Nick Cunningham of Oilprice.com

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