Experience RS

Realizations, Not Operations, Holding Back Oil Sands

Long gone are the days of $100 oil where oil sands production grew by 15% per year. Since the oil collapse in late 2014, production growth has slowed by two-thirds. Tightened budgets and increased efficiencies have held operators afloat. New technologies such as natural gas injection, solvent extraction, autonomous-haul trucks and in-pit processing provide hope for continued improvement. These advancements may not be enough, however, unless the oil sands can address the heavy discount of bitumen to lighter forms of crude.

Not all oil is the same, which is why the Canadian heavy oil benchmark, Western Canadian Select (WCS), has historically traded at a discount to the medium crude bench, West Texas Intermediate (WTI). WCS has qualities that are generally less desirable for refineries, resulting in a quality price differential. Some of the key attributes that define a better-quality crude oil include higher vapor pressure, lower viscosity, lower sulphur content and lower density (Figure 1). Raw bitumen is further discounted from WCS as it must be mixed with costly diluent to be transported. Some oil sands projects have dedicated upgraders that improve the quality of their sales streams, but these require large capital investments and have challenging economics.

Figure 1 | Qualities of Canadian Crude Oils, 2017

Figure 1 | Qualities of Canadian Crude Oils, 2017

Although the quality discount poses a challenge for oil sands producers, some refineries take advantage of the opportunity to purchase discounted feed. These refineries are specially geared to take heavier crude blends, which require more advance refining techniques. This opportunity can only be seized, however, if the refinery secures an adequate supply of heavy oil.

As production from Venezuela continues to shrink in the wake of political and social turmoil, heavy oil differentials at Gulf Coast refineries have tightened and even traded at a premium to light sweet crude. Despite increasing Canadian heavy oil production during this time, transportation bottlenecks prevent oil sands operators from replacing heavy oil supply at the Gulf Coast and realizing higher prices. Most oil sands crude is sold at Hardisty, Alberta, where it has traded at a steep discount (Figure 2). Operators such as MEG, CVE and IMO have turned to shipping crude by rail to the Gulf Coast until pipeline constraints are resolved.  

Figure 2 | WTI–WCS Differentials

Figure 2 | WTI–WCS Differentials

The long-term outlook of the differential is critical when investing in oil sands. In our recent report on SAGD projects, we model every long-term $1 change in the WTI-WCS differential results in a ~$1.50 change in breakeven price. Future pipeline projects such as ENB’s Line 3, TRP’s Keystone XL and the newly government-owned TransMountain Expansion are expected to come into operation starting in 2020+. These pipelines should boost the economics of new oil sands projects by alleviating transport constraints. If oil prices remain strong during that time, growth in the oil sands may return to pre-2015 levels.

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