Viewpoint: Rail a critical Canadian supply relief value

As new production and high inventories weigh on Canadian crude prices, a growing crude-by-rail trend may prevent a bad situation from getting worse.

After months of negotiation between producers and railroads, crude-by-rail exports have started to gain momentum. In a signal that railroads have made inroads to serve a growing demand, a record 193,000 b/d of crude was exported from Canada by rail during April. This was a 44pc gain from just two months earlier and executives from large producers are predicting even more in the second half of 2018.

The increase in rail activity combined with a recent upstream outage may help give rising inventories a much-needed reprieve. But with new supply on the way and a hamstrung Canadian pipeline system, bearish sentiment has also been on the rise again. For producers, the added takeaway capacity could not come soon enough.

Record restrictions on Enbridge's Mainline system persist as the market slowly works its way through a backlog that began in late 2017. Some shippers argue competitors are abusing Enbridge's nomination process, exacerbating the problem. Frequent nomination changes hinder the pipeline company's ability to flow at full rates, something Enbridge has been trying to tackle but with limited success.

Enbridge may be reluctant to propose dramatic changes to its nomination process anytime soon, so market participants should not expect added relief. Enbridge recently fended off shippers following a failed attempt to streamline the process.

Crude inventories in Alberta hit a record high of 72.4mn bl in May, topping 70mn bl for just the second time, with the first time coming in March. This is a 28pc increase over October's ending inventory, two weeks before TransCanada's 590,000 b/d Keystone pipeline temporarily went out of service amid stagnant local refining demand. Although Keystone returned to full rates and refinery turnarounds ended, production from projects like the freshly minted 194,000 b/d Fort Hills oil sands projecthave countered the recovery.

Giving a reprieve to growing stockpiles and midstream congestion was a major upstream upset in late June. Syncrude's 350,000 b/d upgrader outage on 20 June gave support to heavy crudes like Western Canadian Select (WCS) as pipeline congestion appeared to ease. The heavy sour benchmark surged by $8/bl to a $16/bl discount to the August CMA over the following three weeks. But the impact appears short-lived with prices already sinking to a $27.25/bl discount to the September CMA on 23 July, further highlighting the need for more takeaway capacity.

The need for crude-by-rail is no secret as the struggle for new pipeline capacity remains painful. But some may not realize its impact behind the scenes, allowing the incremental barrel to exit the market, preventing local stockpiles from getting worse and buying time until the next new export pipeline is built. Remaining a constant is the precarious nature of the Canadian market, and another upstream or midstream hiccup will likely cascade through prices.