QEC 14.01.2019 kl 16:20 691

"The Canadian Oil Differentials Will Remain Normal In 2019, Could Narrow Further In 2020"

The Canadian oil differentials hit extreme levels in Q4 2018, but we have experienced a rapid shrinkage in the Canadian oil differentials over the last weeks.

We see a scenario where we could move to a surplus of egress capacity in Canada in late 2019.

Therefore, we believe that the Canadian oil differentials will remain normal in 2019 while narrowing further in 2020 is not out of question.

A government change in the 2019 Federal Election in Canada will be an additional tailwind, which has not yet been priced in the current valuations of the Canadian energy names.

The fund managers who left the Canadian energy sector in 2017 and 2018 must change their investment strategy and initiate a long position on selected Canadian energy names now.

This idea was discussed in more depth with members of my private investing community, Value Investor's Stock Club. Get started today »

When it comes to oil supply and demand, every disastrous scenario was extracted into infinity in Q4 2018 and the energy investors were pricing Armageddon that would last forever. This highly speculative and frivolous approach along with tax loss selling, margin selling, negative sentiment, Trump's Iran waivers and the U.S.-China trade war created the perfect storm that mercilessly hit the oil markets in the last quarter of 2018.

As a result, WTI had an epic fall plunging from $76 to $42 within less than three months, while WTI/WCS and WTI/Edmonton mixed sweet spreads hit extreme levels reaching C$50+ and C$30+ respectively.

All the energy investors got caught off guard by this historic price crash. However, it was not all doom and gloom. We explained in our article a couple of months ago why this was a temporary hit and a "darkest before dawn" situation that created a unique buying opportunity:

As such, we anticipate that WCS and Edmonton mixed sweet will gradually rise from their current prices of C$28/bbl and C$50/bbl respectively in the coming months thanks to strong demand from PADD II and PADD III refiners upon completion of the seasonal maintenance, the start-up of Alberta's Sturgeon Refinery and crude-by-rail shipments. Therefore, we expect WTI/WCS and WTI/Edmonton mixed sweet differentials to narrow and normalize below C$30/bbl and below C$15/bbl respectively over the midterm.

WCS and Edmonton mixed sweet recovered exceeding C$50 and C$60 respectively last week, while the Canadian oil differentials have narrowed significantly over the last days.

Specifically, the WTI/WCS and WTI/Edmonton mixed sweet spreads returned to normalcy and dropped below C$15 and C$10, respectively, a couple of days ago. Barring unforeseen events, we are confident that the Canadian oil differentials will remain at these levels in 2019, while they could even surprise us and narrow further in 2020 thanks to the reasons below.

Key Developments in 2019
The pipelines that transport crude oil from Canada to the U.S. markets are: Keystone Pipeline (from Hardisty, Alberta to the U.S. Midwest and U.S. Gulf Coast), Trans Mountain Pipeline (from Edmonton, Alberta to Vancouver, B.C., Washington State, and offshore markets), Express Pipeline (from Hardisty, Alberta to Casper, Wyoming), Enbridge Mainline (from Edmonton, Alberta to the U.S. Midwest and Sarnia, Ontario), the Milk River Pipeline and the Rangeland/Aurora Pipeline.

On that front, Canada's National Energy Board (NEB) released a new report a few days ago giving us a good idea about the imbalance between supply and pipeline capacity to move crude oil from Canada to the U.S. markets.

Specifically, the available for export oil supply from the WCSB was 4.153 million bbls/d but only an estimated 3.788 million bbls/d flowed in pipelines, while the available takeaway capacity on existing pipeline systems is currently estimated at 3.95 million bbls/d.

Therefore, WCSB's oil supply currently is estimated at 365,000 bbls/d above the amount of oil flowing daily in existing pipelines and this figure could drop to 203,000 bbls/d, if the system uses all the available takeaway capacity of 3.95 million bbls/d.

This excess oil supply is either held in storage, where available, or exported from the WCSB by other modes of transportation, such as rail and truck. Actually, it's mainly exported by rail and therefore, crude-by-rail exports hit a series of record highs in 2018 reaching 327,229 bbls/d in October 2018, nearly 2.4 times higher than a year ago.

That said, these key developments will move the needle and will change the demand side for the better in 2019:

1) As linked above, crude-by-rail shipments slightly exceeded 300,000 bbls/d in late 2018 and it's expected to further increase in 2019 reaching 400,000 bbls/d, as shown here and Athabasca's (OTCPK:ATHOF) presentation here. In other words, there is at least another 80,000 bbls/d of additional crude-by-rail volumes to take place in 2019. These additional volumes of 80,000 bbls/d will be mainly coming from Cenovus Energy (NYSE:CVE) and MEG Energy (OTCPK:MEGEF) that have signed long term deals to move their bitumen through rail, based on their latest news here and here.

2) Alberta recently announced negotiations for the purchase of rail cars to transport 120,000 bbls/d of crude oil to higher priced markets. Alberta expects the first 15,000 bbls/d of that capacity to start in December 2019, increasing to 120,000 bbls/d by August 2020.

3) After some operational delays due to equipment failures, the Sturgeon refinery with 80,000 bbls/d of diluted bitumen capacity will be fully online in Q1 2019.

4) Enbridge's Line 3 will be in service in the second half of 2019. ENB's Line 3 has initial capacity of 760,000 bbbls/d and will transport light, medium and heavy crude. This represents a return to the original design capacity of the Line 3 pipeline from its current capacity of 390,000 bbls/d and as a result, the additional pipeline capacity that will be enabled by this project is 370,000 bbls/d.

5) Based on the latest news, Enbridge's (NYSE:ENB) optimization is ongoing. Specifically, the company has embarked on a de-bottlenecking project designed to boost the capacity of the system by between 50,000 bbls/d and 100,000 bbls/dby the middle of 2019, as illustrated below:

Source: ENB's presentation

Doing the math is easy; we are looking at approximately 600,000 bbls/d of additional egress capacity for Canadian crude by the end of 2019.

Let's check now the latest key developments on the supply side:

1) Alberta recently announced production curtailments to better align output with pipeline space and protect its royalty stream in 2019. Under the curtailment, the production of raw crude oil and bitumen will be reduced by 325,000 bbls/d this January to address the storage glut. The curtailment will be reviewed monthly. After excess storage is reduced, the curtailment will decline to an estimated average of 95,000 bbls/d until 31 December 2019 when the mandated reduction is scheduled to end.

2) The new oil sands projects that are coming online in 2019 are Devon Energy's (NYSE:DVN) Jackfish Expansion and Cenovus Energy's (CVE) Christina Lake Phase G. They will only bring 70,000 bbls/d of additional supply in the second half of 2019.

To sum it up, the excess oil supply is currently estimated 365,000 bbls/d, which will take a hit due to Alberta's cuts of 325,000 bbls/d. Meanwhile, the new oil supply of 70,000 bbls/d in H2 2019 will be more than offset by about 600,000 bbls/d of additional egress capacity coming online by year end.

After all, this isn't rocket science. Barring unforeseen events, simple math indicates that:

Canada will not have an egress problem in 2019.
The Canadian oil differentials will remain normal in 2019 and can even surprise us to the upside in the second half of 2019.

Key Developments in 2020

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