Cost of cancelling Trans Mountain could be staggering
Pipeline company Kinder Morgan has stopped all non-essential spending on the Trans Mountain (TMX) pipeline expansion, citing uncertainty over the regulatory process. If the uncertainty continues, and Kinder Morgan decides to cancel the project, the economic cost could be staggering.
Canada’s crude oil price declined in recent months relative to other international benchmark prices (this is called a price discount). The recent surge in the Western Canada Select (WCS) price discount compared to West Texas Intermediate (WTI) is largely attributed to Canada’s insufficient pipeline capacity. Without sufficient pipeline capacity—a problem that will grow if the TMX expansion does not proceed—the Canadian crude oil discount is likely to remain high.
Between 2009 and 2012, the average WTI-WCS discount was only 13.4 per cent of the WTI price. However, in February 2018, the differential reached 46 per cent of the WTI, based on data from Oil Sands Magazine. This represents a striking 33-percentage point increase in the Canadian crude oil discount. This significant increase in the price differential reflects Canada’s lack of transportation capacity and restricted market access.
Despite growing oil production in recent years, Canada has been unable to build any major pipelines, resulting in significant excess production over transportation capacity. In particular, TransCanada’s Energy East and Eastern Mainline projects were cancelled due to several factors including significant regulatory hurdles. And despite receiving the necessary regulatory approvals, Canada’s remaining pipeline projects—Trans Mountain expansion, Line 3 Replacement Project, and Keystone XL—continue to face delays related to market uncertainty, environmental and regulatory concerns and political opposition.
Without adequate access to pipelines, the cheaper and safer mode of transportation, there has been a shift to more crude-by-rail. However, increased oil transport by rail is unlikely to clear the existing oil glut because oil producers now struggle to compete with farmers and grain companies for space on rail cars. As reported, rail companies recently cut back on shipping crude-by-rail to free-up more capacity for grain shipping, leaving oil products stranded.
In addition, rail companies now demand much higher rates “to move oil because they fear the business will evaporate once new export pipelines come on stream.” Specifically, rail costs to transport crude from Western Canada to the Gulf Coast may reach US$20 per barrel, which is much higher than previous estimates.
As demand for rail rises and exceeds supply, it’s not surprising to see rail companies setting higher rates for their services. The higher crude-by-rail rates mean Canadian oil producers must absorb higher costs, leading to lower prices for Canadian crude and therefore lost revenue for the economy.
In addition, if the Trans Mountain expansion is cancelled, rail companies may choose to add capacity to carry excess crude. However, increased crude-by-rail raises safety concerns as pipelines are 2.5 times safer (i.e. less likely to experience an oil spill) than rail transport.
As a result of the higher transportation cost, the current elevated discount for Canadian crude is likely to remain until more pipeline capacity comes online. Sources suggest new pipelines may come online between 2019 and 2022, but this timeline seems increasingly unrealistic given the numerous recent acts of pipeline obstructionism.
The reality is that the steep WTI-WCS price discount, and high transportation costs from crude-by-rail, reaffirms Canada’s critical need for additional pipeline capacity. In addition, building the Trans Mountain expansion will lessen our dependence on the U.S. market and alleviate transportation constraints. As such, federal and provincial policymakers should take concrete action to reduce uncertainty and get pipelines built.
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