Why price discounts for Canadian crude are here to stay

Reason #1: A massive amount of oil is flooding a stagnant market

September 01, 2012

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The difference in prices companies get for the continent’s traditional benchmark crude blend, West Texas intermediate (WTI), and that of Europe’s Brent blend has consistently been in the US$20 range (in Brent’s favor) for much of 2011 and 2012. But the differential is twice as painful for producers pumping oil out of Western Canada.

Growing supplies of crude from the United States and a lack of spare pipeline capacity has blends like Western Canadian Select (WCS) being discounted against WTI. CIBC World Markets Inc. forecasts WCS averaging US$71-$75 per barrel in 2012 and beyond. By comparison, a barrel of WTI was selling for roughly US$93 in August. Why the discrepancy? Alberta Oil explains.

1

Oily Bonanza

Oil production from U.S. reservoirs like the Bakken is forecast to grow by 600,000 barrels per year through 2016. At the same time, Canadian tight oil and oil sands production is surging. That, combined with severe export (i.e. pipeline) constraints, “makes for a massive wave of oil supply in a large but stagnant market,” CIBC says.

2

Repair Jobs

CIBC notes there are major maintenance projects planned for U.S. refineries in Petroleum Administration for Defense District (PADD) 2, where the bulk of western Canadian crude goes. CIBC counts 225,000 barrels per day coming offline for the rest of 2012 at PADD 2 refineries, exacerbating a tight supply situation and leaving Canadian producers vulnerable to steeper price discounts.

3

Slate of Hand

Refineries in PADD 2 are retooling their operations to handle more heavy crude slates from Western Canada. But U.S. refiners can still move back to refining light crude if pricing warrants it. “There is little doubt they will use this to create “crude-on-crude” competition and drive down prices for light streams, such as Western Canadian Select,” CIBC says.

4

Conduit Concerns

Building new pipelines or expanding existing ones is seen as a cure to crude price discounts. But five key export projects, which include the Keystone XL and Northern Gateway pipelines, are fraught with risk. If even one of the five projects is cancelled or is delayed long-term, CIBC says it will constrain production growth in Western Canada and dampen prices.

5

Maya Makeover

PADD 3 refiners covet WCS because it’s close to the Maya blend they run. But CIBC says Maya is currently trading at US$5-$9 below its traditional US$9 differential to Brent. “Once Canadian producers get access to the PADD 3 market, they will get the Maya price link – but unfortunately Maya will not be as high priced as it has been historically due to the big discounting of light oil in PADD 3.”

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