Western Canada's benchmark heavy crude differential has tightened since early April, but observers say this could widen back out to reflect the cost of moving crude by rail and as heavy crude production increases.
WCS has been assessed at a $15-$18/b discount to the NYMEX light sweet crude futures calendar-month average (WTI CMA) since April 3, S&P Global Platts data shows. That is in from a discount of $30.55/b in early February, when WCS was depressed by a lack of pipeline takeaway capacity following an unplanned Keystone Pipeline outage in November. Price swings going forward are likely to hinge on whether producers and rail companies are able to sign contracts for dedicated crude unit trains, traders and analysts say.
"We expect volatility between unit train and pipeline economics," said Kevin Birn, a senior analyst with IHS Markit. "It's going to be very hard to predict pricing until it makes a definite switch."
Birn said it was likely a WCS differential based on the cost of shipping by unit train will likely take hold over the course of this quarter, which would imply a discount to the WTI CMA of around $17-$19/b. Cenovus Energy CEO Alex Pourbaix made a similar prediction on an earnings call late last month, saying that once rail volumes ramp up he expects the WCS differential to "persist in the high teens to get rail down to the Gulf Coast."
While price discounts tend to narrow as producers start moving more crude by rail to reduce a backlog, shipping by dedicated crude trains is still more expensive than using pipelines. The all-in cost of moving barrels by unit train from Alberta to the US Gulf Coast -- including loading, unloading, tariffs, fuel and car rental -- is currently estimated at $12.50/b by S&P Global Platts Analytics, with a higher rate for unexpected spot cargoes.
The cost of shipping crude from Hardisty, Alberta, to Houston via Cushing, Oklahoma, is around $11/b, according to current pipeline tariffs.
The last time Canadian rail companies committed to running dedicated crude trains was in 2014, when crude-by-rail exports out of Canada for the year averaged 161,014 b/d per month, according to Canada's National Energy Board. That compares with average monthly crude-by-rail exports of 131,883 b/d in 2017.
The WCS discount to WTI averaged $16.55/b in December 2014, tightening from $27.56/b in December 2013. WCS at Hardisty was last assessed Wednesday at WTI CMA minus $15.55/b.
A Canadian crude trader based in Calgary said differentials are starting to reflect spot rail customers dropping out of the market and more agreements for longer-term contracts.
"They are quite serious for sure," the trader said of the rail companies. "It's the term they come up that spooks the producers who don't want to commit on a long term basis."
RAILROADS OPTIMISTIC
Producers are optimistic that increased rail exports will save the day.
"As production grows in Alberta we obviously are going to need rail to balance production and takeaway," Cenovus' Pourbaix said on the company's first-quarter earnings call in April. "I'm really confident as we move into second half of this year and first half of 2019 we are going to see very material volumes of oil moving by rail."
Canada's two major rail carriers -- Canadian National Railway and Canadian Pacific Railway -- have also appeared optimistic in public statements.
Jean-Jacques Ruest, interim CEO and president of Canadian National, said during a first-quarter earnings call last month the company had begun signing contracts to start in the second quarter with the intention of ramping up into the third and fourth quarters, and into 2019. He declined to say how much capacity the company was willing to deploy for crude-by-rail after it halted crude-by-rail business in the previous six months to focus on a backlog of other commodities.
Canadian National in December said it had bought 200 new locomotives from GE Transportation to be delivered over the next three years and in April said it would buy 350 boxcars as part of a $3.2 billion capital program for 2018. That capital program includes building new track, and the company has already added about 400 conductors this year and continues to hire, it said.
The country's other large rail carrier, Canadian Pacific Railway, expects to move more crude by rail starting in the third quarter, John Brooks, CP's chief marketing officer, said on an earnings call in April. CP moved 17,000 car loads of crude in the first quarter. A rail car can typically transport 560 to 600 barrels depending on the grade.
"We remain committed to growing [the volumes] under a disciplined approach and are in talks with various groups of shippers and terminal operators," Brooks said. A "very small part" of CP's existing crude-by-rail contracts now are for a year, and the rest of the contracts are for a maximum of two years, he said.
However, as a precursor to putting 100 more locomotives on tracks to haul the tank cars, the railroad is seeking three-year deals, Brooks said.
Still, the potential for a strike from Canadian Pacific rail workers is also simmering after a vote was postponed last month, Birn said, potentially dimming the rail outlook.
MORE HEAVY CRUDE
To be sure, there are other factors driving heavy Canadian crude prices besides the prospect for increased unit trains.
Matt Murphy, an analyst with energy focused investment bank Tudor, Pickering, Holt & Co., said one reason differentials rose so sharply for April delivery was that Enbridge began temporarily shipping heavy crude on light dedicated pipelines as turnarounds curbed light production.
"There are more barrels moving on pipe than expected," Murphy said. "The market is less tight today than expected."
Murphy said that the WCS differential is likely to drift back down toward WTI CMA minus $20/b this month, and could be below that level at the end of the year. He said that, at a minimum, the differential will weaken over May as light barrels come into the system from turnarounds, curtailing the ability to ship heavy grades on light lines.
Another bearish factor for WCS is the potential for increased production, most notably from Suncor's Fort Hills project. Suncor said Wednesday it is ramping up production at its 194,000 b/d Fort Hills oil sands project earlier than expected, with capacity reached before the end-2018 schedule. However, Suncor said on an earnings call Wednesday it has existing pipeline access to accommodate all the output from its existing oil sands assets.
