Midstream Infrastructure Still The Missing Link

BMI View: The recent announcement that India is considering signing a long-term oil supply contract with Canada is a positive signal. However, given several above-ground problems - including the 2012 change to the investment law and insufficient midstream infrastructure - we remain sceptical that it presages a substantial acceleration in liquids growth. Rather, we maintain our forecast that after 2.9% year-on-year average crude, NGL and other liquids growth, we will see more tempered average expansion of 1.9% y-o-y between 2014 and 2023.

Although Asian interest in Canada's heavy oil sands could drive substantial growth in the North American country's liquids production, a number of above-ground concerns encourage us to maintain a more cautious outlook. Most recently, this issue has been highlighted by Indian Oil Minister M Veerappa Moily, who indicated interest in a long-term oil supply contract with Canada at the 2014 Petrotech Conference - likely as an attempt to diversify India's oil resources to protect against the potential for unstable supplies from the Middle East. This follows from a decision last November wherein state-owned Indian Oil Corp joined private refiners Reliance Industries and Essar Oil in importing oil from the North American country. However, while the uptick in demand is positive sign, we caution that without sufficient midstream infrastructure to move the country's heavy oil sands to the coast, we retain a more tempered outlook on Canadian liquids production.

Asian Investment Could Buoy Growth…Or Not?

Feeding The Dragon
Crude Oil Imports To China By Region, 2009 To Year-To-Date ('000b/d)

Midstream Infrastructure Still The Missing Link

BMI View: The recent announcement that India is considering signing a long-term oil supply contract with Canada is a positive signal. However, given several above-ground problems - including the 2012 change to the investment law and insufficient midstream infrastructure - we remain sceptical that it presages a substantial acceleration in liquids growth. Rather, we maintain our forecast that after 2.9% year-on-year average crude, NGL and other liquids growth, we will see more tempered average expansion of 1.9% y-o-y between 2014 and 2023.

Although Asian interest in Canada's heavy oil sands could drive substantial growth in the North American country's liquids production, a number of above-ground concerns encourage us to maintain a more cautious outlook. Most recently, this issue has been highlighted by Indian Oil Minister M Veerappa Moily, who indicated interest in a long-term oil supply contract with Canada at the 2014 Petrotech Conference - likely as an attempt to diversify India's oil resources to protect against the potential for unstable supplies from the Middle East. This follows from a decision last November wherein state-owned Indian Oil Corp joined private refiners Reliance Industries and Essar Oil in importing oil from the North American country. However, while the uptick in demand is positive sign, we caution that without sufficient midstream infrastructure to move the country's heavy oil sands to the coast, we retain a more tempered outlook on Canadian liquids production.

Asian Investment Could Buoy Growth…Or Not?

Across Asia we have seen a rapid uptick of investment into hydrocarbon-rich regions, driven by rising domestic demand and a desire by many of these countries to diversify their resource bases. Indeed, we have previously noted a scramble amongst the major Asian players for access to Sub-Saharan Africa ( see 'Asian Money Complements Hydrocarbon Riches', August 72013), and even moves into Latin America ( see 'Petrobras-PetroChina Deal Sees Both Companies Moving Toward Goals', November 19, 2013). While Canada should be a major contender for Asian investment, in recent quarters it has begun to look increasingly left out of the buying spree.

Feeding The Dragon
Crude Oil Imports To China By Region, 2009 To Year-To-Date ('000b/d)

With proven oil reserves of 173.1bn bbls, largely because of the country's massive Alberta-based oil sands, the country sits behind only Venezuela and Saudi Arabia in terms of the size of its reserves. However, whereas previously Canada's oil sands had received considerable foreign interest, we have noted a considerable slowdown in investment in the past year. Indeed, while in 2012, total investment in oil sands totalled US$30bn according to Platts, it plummeted to around US$1bn in 2013. This is highly problematic given that the government has estimated that as much as CAD650bn (US$598bn) will be needed over the next decade to ensure the development of Canada's natural resources, much of which will have to come from abroad.

Highly Prospective
Proven Oil Sands Reserves, bn bbl

Above-Ground Issues Still A Concern

We attribute the pullback in investment to two factors, which together underpin our forecast that after a 2.9% year-on-year expansion over the past decade, we will see slower average growth of 1.9% over the coming 10 years:

First, a 2012 tightening of investment rules - whereby foreign companies were restricted from majority ownership of Canadian oil sands producers barring 'exceptional circumstances' - has slowed foreign inflows. The policy change came in the wake of a flood of investment from Asian oil companies, most notably the US$15.1bn takeover of Calgary-based Nexen by China National Offshore Oil Corporation (CNC) in 2012. The single-largest foreign acquisition by a Chinese oil company that year - the deal between CNC and Nexen was fraught with controversy as it was perceived by some as a foreign takeover of strategic Canadian assets.

At the time we had highlighted that the more stringent rules could weigh significantly on investment in Canada's prospective oil and gas resources, potentially slowing the rate at which prospective resources are developed and monetised - a view we believe has played out ( see 'CNC-Nexen: A Pyrrhic Victory', December 11, 2012). Moreover, while Alberta's Minister of Energy Ken Hughes has taken aggressive steps to woo foreign investment, including an October 2013 trip to Asia - we are uncertain this will be sufficient in the absence of a policy change at the federal level.

About To Crash
Alberta - Hydrocarbon Investment, CADbn

Second, we believe infrastructure bottlenecks are likely to persist, potentially creating less attractive project economics for oil sand development. At present, we calculate the pipeline takeaway capacity from Alberta at around 3.67mn b/d, including Enbridge's Mainline (2.5mn b/d), Kinder Morgan's Trans Mountain (300,000 b/d), TransCanada's Keystone (591,000 b/d) and Spectra's Express-Platte (280,000b/d).

While this is only modestly below the Canadian Association of Petroleum Producers (CAPP)' 3.71mn b/d production estimates for Alberta, we note that the actual takeaway deficiency is likely larger than these numbers suggest. This is due to physical constrains at terminals on the system, as well as competition for pipeline capacity. For example, according to CAPP, US production is also carried on Enbridge's Mainline, reducing available takeaway capacity from western Canada.

Indeed, in recent quarters, this infrastructure deficit has been reflected by an increasingly stark divergence between the price at which Western Canada Select (WCS) and WTI trade. Some of this is likely due to the differences in crude grades - WCS is much heavier and more sour crude than WTI. However, we believe that the sharp increase in the spread between the two is also a reflection of the fact that while midstream infrastructure has improved noticeably from Cushing, allowing WTI to begin to trade at a less substantial discount to international prices, Canadian oil pipeline capacity is still insufficient. This has seen companies forced into a greater reliance on more expensive crude-by-rail or trucks, depressing the price of the crude. Indeed, even Mexico's Maya crude- with a relatively similar assay to WCS - is currently selling at a considerable premium.

Trading At A Discount
WTI, WCS & Maya Crude Blends, US$/bbl

Moreover, the situation seems unlikely to be resolved quickly. While a substantial number of pipelines have been proposed - potentially bringing capacity up to 7.07mn b/d 2017, they are facing stiff opposition from both environmental advocacy groups as well as the First Nations. Further, even if the pipeline capacity is brought online, questions remain over whether port capacity will be sufficient to handle the exports.

Rapid Ramp-Up In Takeaway Capacity?
Pipelines Planned For Western Canada, '000b/d

This is not to say the situation is completely bleak. In recent months, we have seen a series of high profile derailments of trains carrying crude across North America, which could begin to slowly soften public opinion toward pipelines. Moreover, Enbridge's Northern Gateway pipeline - meant to run from Alberta to Kitimat on the Pacific Coast - received conditional approval from the National Energy Board. That said, we stress that while these incidents suggest that additional pipeline capacity will begin to come online eventually, the process is likely to be relatively prolonged. Indeed, in regards to the Northern Gateway project, we caution that Prime Minister Stephen Harper has indicated that the final approval of the project is in no way a foregone conclusion, and even if it is approved, we believe advocacy groups may attempt legal challenges. This encourages us to maintain a more tempered view of Canada's liquids growth potential.

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