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From Pipe Dreams to Reality?

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By Peter G Hall *
Vice-President and Chief Economist Export Development Canada

Contrary to recent high-profile predictions, North America is awash in crude oil. Surprising many, the International Energy Agency announced last fall that the US would become the world’s largest oil producer by 2017 and could come close to energy independence by 2035. While high prices usually give rise to surges like this, America's production U-turn has happened at blinding speed. What are the implications of this sea change in production for Canada?

Chalk up the change to progress and pricing. Hydraulic fracturing technology (fracking) was developed over a number of years, but exploitation of shale and tight oil production was not feasible at 1990s prices. Technical refinement and sharply higher prices changed that. Oil from these formations will help to bring US crude oil output to over 7 MMbpd in 2012 – the highest level since 1992 and not too far from doubling the 4 MMbpd low-point in 2008.

The long-term impacts are profound for Canada. Close to all of our oil exports are US-bound, and they made up 20% of total Canadian goods exports in 2012. The American production bonanza is creating a perfect storm of logistical bottlenecks both in Canada and the US. At the same time, Canada has seen impressive increases in production, compounding oil export capacity constraints.

This is an expensive bind. For starters, pipe capacity and congested US refineries have forced Canadian producers to sell Western Canadian Select (WCS) crude at a huge discount. Recently, WCS has fetched $22 less than a barrel of West Texas Intermediate (WTI) crude, and $40/bbl less than Brent crude. Price differentials have cost Canadian producers an estimated $16 billion yearly. EDC Economics anticipates that this spread will remain more or less constant this year and next.

Will capacity and production remain out of whack? The Canadian Energy Research Institute (CERI) notes that current pipeline infrastructure will likely be insufficient to transport oil sands production by 2015 when total volumes from Western Canada reach close to 3.4 MMbpd. There are at least four responses that are planned or underway. Rail cars are being signed up by the hundreds to transport crude, in all directions. Producers are also looking at reversing and repurposing pipelines to send Alberta crude to refineries in the East. In the West, the options are expansion of Kinder Morgan’s Trans Mountain pipeline or building Enbridge’s Northern Gateway pipeline facilitating shipments to Asia. And to the South, there's the contentious Keystone XL pipeline, the most rapid and likely pipeline solution with a projected in-service date of 2015.

Assuming capacity increases for oil exports, the current discount on Western Canadian Select should steadily decline to more normal levels. Pipeline repurposing and rail capability should meet new production requirements over the short term. Beyond 2015, the discount should decrease further as pipeline capacity expands. It's a good thing, because crude oil exports have recently contributed as much as 20% of Canada’s annual GDP growth, and it is and will be a huge source of investment. Canada's energy exports are slated to increase by 8% and 6% in 2013 and 2014, respectively.

The bottom line? Supply constraints are currently costing Canadian oil producers dearly. But the losses are shifting the eyes of industry leaders toward more lucrative export markets, and in time, we can expect to see much more Canadian crude moving east and west. In the mean time, US consumers are likely to enjoy better prices at the pump. This won't last, but it may be a bit of very timely stimulus for a US economy that is quickly gaining momentum.


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