US independent refiners expected discounts on Canadian heavy crude to persist for years as today's transportation constraints linger until sour demand falters in 2020.
Still-growing Alberta crude production has outstripped pipeline capacity out of the province and left local crude storage swollen. Producers and US importers anticipated that rail tariffs roughly 37pc higher than pipeline costs would force heavy crude priced at the storage and export hub in Hardisty, Alberta, to accept lower prices for the next two years.
That would leave Canadian producers struggling to squeeze production through a window of higher demand before marine fuel regulations in 2020 under the international Marpol treaty make high-sulfur crudes less attractive.
"With Marpol coming, it just gets exacerbated," PBF Energy chief executive Tom Nimbley said in a quarterly earnings call.
Western Canadian Select (WCS) at Hardisty averaged $25.74/bl in the first quarter, its deepest discount to Nymex WTI at Cushing since 2013. The discount has averaged $25.29/bl so far this quarter after recovering to an average $18.02/bl in the second quarter.
The Canadian upstream industry expected some relief on the supply glut as 79,000 b/d of new refining capacity starts up at the Sturgeon refinery in Alberta. That facility, co-owned by Canadian Natural Resources (CNRL), planned to begin processing bitumen by the end of this quarter — a slight slip in the schedule from the end of July.
Prices remained higher at the US Gulf coast, where falling deliveries of Venezuelan and Mexican heavy crude have left open a window of demand for alternative supplies. But Enbridge, TransCanada and now Canadian government pipeline expansions must still clear regulatory and construction hurdles to reach markets. The 1.8mn b/d of pipeline expansion planned to enter service in early 2020 would easily accommodate production increases scheduled by Canadian producers. The two largest projects — TransCanada's Keystone XL and the Trans Mountain expansion to Canada's west coast — face legal challenges that could cause schedules to continue to slip.
Pipeline expansion uncertainty helped to limit rail response, producers said. Operators have sought longer shipping commitments than producers want to take, Canadian Natural Resources (CNRL) president Tim McKay said during a quarterly earnings call. A three-year commitment would lock in the costliest path to customers well after pipeline capacity becomes available.
"If you look ahead and say Enbridge will be on stream in [the fourth quarter] and the differentials will tighten, you will be out of the money very shortly," McKay said.
MEG Energy, a heavy Canadian producer with no downstream operations, said WCS discounts would reach "the low $20s" into 2020.
US refiners expected the constraints to offer a sustained profit boost for those who can reliably retrieve the feedstock. Phillips 66, which through joint ventures and direct purchases led the US in Canadian heavy imports at roughly 475,000 b/d last year, said in July it had reached maximum throughputs of the crude. The company runs 80pc of the imports in its sprawling US refining system and sells the remainder. Phillips 66 reported a $392mn midcontinent refining profit for the second quarter, its highest in the region since 2013, when WCS discounts to WTI averaged 11pc narrower.
PBF Energy increased rates through its Delaware City, Delaware, rail facility to above 60,000 b/d last September. The pipeline constraint would support expected high import levels to the Atlantic coast and PBF's Louisiana and California refineries for up to two years, Nimbley said this month.
"We believe this puts us in a favorable position to source a difficult crude to run, but a profitable crude for us," Nimbley said.
And US refiners expect the sour crude market to become even more competitive next year. Under the terms of the international Marpol treaty in 2020 marine vessels must lower emissions to levels consistent with the use of 0.5pc sulfur fuel, compared to the 3.5pc sulfur fuel used today. The change will eliminate for less complex refiners an outlet for more sulfurous byproducts generated by heavy, sour crudes.
Suncor was sanguine in its quarterly earnings call, expecting its US and Canadian refineries to share the benefits of higher margins from increased lower-sulfur diesel demand.
"We are largely agnostic because we can mitigate that through the integrated model," Suncor chief executive Steven Williams said.
US refiners expected the change to either drive down demand for sour crude or to create another competitive stream of coker feedstock as the less complex refiners seek a new home for their production.
US midcontinent refiners would see less direct competition for their capacity, as pipelines connecting waterborne supplies from the coasts have largely reversed over the past decade. But incremental Canadian barrels to US coastal refiners would face new competitive pressure.
"The big play will be to allow us to actually increase the amount of heavier, higher-sulfur crude we expect to be obviously threatened or negatively impacted, from a price standpoint, in a post-Marpol world," Nimbley said.
