BMI View: British Columbia's official rejection of Enbridge's Northern Gateway will dampen the hopes of Canada's oil producers, which envisaged that an increase in pipeline capacity to the west coast could open up the Asian market and support Canadian crude prices. Along with the lack of progress in opening an export market to the US Gulf Coast via TransCanada's Keystone XL, Canadian crude prices will likely continue to trade at a discount in view of a lack of access to demand centres . This regulatory roadblock would not only hit the economics of oil sands projects but also affect organic growth opportunities for Canada-focused midstream companies in the short-term. Prospects for pipeline projects could improve in the longer-term, but the removal of regulatory roadblocks will heavily depend on closer inter-governmental cooperation to ensure that there is an equal distribution of the rewards and risks of allowing such pipeline links across Canada.
Enbridge 's Northern Gateway project has been dealt a devastating blow following official rejection of the midstream firm's plan to build a 525,000 barrels per day (b/d) pipeline that was to transport crude oil from Alberta to the port of Kitimat in British Columbia (BC). The BC government opposed the CAD6.5bn pipeline , due to environmental concerns about Enbridge's ability to respond to possible pipeline spills that could take place along the protected habitat areas of the pipeline's route. BC Environment Minister Terry Lake specifically stated doubts about Enbridge's proposed project route, spill response capacity and 'financial structure' to 'handle any incidents'.
BC's rejection of the pipeline follows intense indigenous and environmental lobbying against the project, particularly after Enbridge was declared culpable by US authorities for a 2010 oil spill in Michigan, US. It is now unlikely that the midstream company can make a final investment decision (FID) on Northern Gateway in 2013 as originally planned. Not only is this a disappointment for Enbridge, it is also a blow to crude oil producers in Alberta who have been hoping that the pipeline would help take oil to the west coast for export to demand -hungry Asian markets.
Stuck In The Pipeline
Canada's oil production has increased as a result of growing output from its oil sands developments, but producers are struggling to find markets for these growing volumes . A boom in US oil production has seen a sharp reduction in demand from its traditional export market. Other market alternatives are also limited by a controversial European Union (EU) ruling against the import of oil sands-derived oil , but more importantly by the lack of infrastructure within Canada to bring oil out of Alberta to domestic refineries and to Asian markets across the Pacific Ocean.
Oversupply in Alberta has resulted in a discount of Canadian crudes - particularly the heavy Western Canada Select (WCS) that most oil from oil sands projects are priced to - to the US' WTI and the European Brent benc hmark. At the time of writing, the WCS-WTI and WCS-Brent spread is US$18.38 per barrel (bbl) and US$26.68/bbl respectively - more than twice the spreads at the beginning of 2009.
|Limited Market Access Squeezes Canadian Prices|
|Spot Price Movements Of Western Canada Select, WTI & Brent, 2009-Present (US$/bbl)|
Two infrastructure projects could have help ease this glut in Alberta - Enbridge's Northern Gateway pipeline, which could open up the Asian export market, and TransCanada 's Keystone XL pipeline, which would take Canadian oil south to the US refining heartland in the Gulf Coast. Keystone XL does not look likely to be approved by the administration of US President Barack Obama anytime soon as recent oil spills in the US heighten sensitivity surrounding regulatory approval for the pipeline. BC's rejection of Northern Gateway will further dampen crude oil producers' hopes for an export market opening by 2017, the original date scheduled for Enbridge's pipeline start up.
Therefore, the discount of Canadian crudes to WTI and Brent is likely to persist in the short to medium term. We see this as a high downside risk to Canada's oil production growth, if low prices discourage FID on several oil sands developments in the pipeline. In late 2012, several Canadian companies, including Suncor, Talisman and Teck Resources, had announced plans to pare down oil sands spending on the back of weak prices and high production costs. With the prospect of better project economics increasingly unlikely, we could see more proposed projects put on the backburner until market demand and prices improve.
BC's opposition towards Northern Gateway also darkens the prospect for other proposed pipeline projects in the country. Despite the potential economic benefits of the pipeline , the government's rejection of Northern Gateway demonstrates the primacy of environmental considerations in its decision-making. Kinder Morgan 's expansion plans for TransMountain, the pipeline transporting crude from Edmonton, Alberta to BC and the state of Washington, could also be put on hold if BC raises similar objections. TransCanada's Energy East pipeline project, which would convert an existing gas pipeline into an oil line to transport crude from Alberta to refineries in the East Coast, could also face an uphill battle if BC's concerns are also raised by the authorities of Saskatchewan, Quebec City and St John, New Brunswick where the pipeline will run through.
The announcement sent Enbridge's share price sharply down to CAD44.97, though this sharp downward trend was similarly observed across major midstream firms with significant exposure in Canada - Pembina Pipelines , Inter Pipeline Fund and TransCanada . While company-specific news has seen the share prices of Pembina and Inter Pipeline recover on June 3 , continued regulatory roadblocks against pipeline projects would stifle growth opportunities for these firms in the short term.
|Share Price Movements Of Enbridge, TransCanada, Pembina Pipelines & Inter Pipeline Fund (Normalised to 100)|
The prospects for new pipeline projects and expansion within Canada could improve in the longer-term, but much of this could be dependent on inter-governmental efforts. Although the Northern Gateway had received the backing of the federal government in Ottawa and the Alberta government, one of the larger points of contention raised by BC was that the state would have to bear the bulk of the risk arising from pipeline spills. In fact, BC had asked for Enbridge to present a plan that would adequately compensate the government for this risk. Therefore, for this tension to be resolved, negotiations between various provincial governments are needed so that the economic benefits and risks of pipeline projects are evenly distributed if cross-provincial pipeline projects are to materialise.
The government of Alberta could be persuaded to more closely engage its BC counterparts in a bid to support its income, of which oil and gas receipts comprise a third of total revenues . Falling Canadian crude oil prices had hit Alberta's oil revenues, which Finance Minister Doug Horner disclosed in January 2013 would result in the province borrowing more from the markets to fund its spending. Alberta is turning to a pipeline through the Northwest Territories (NT) to solve the problem of its oil glut and despite NT's initial reception to this proposal, we warn that pipeline construction could face similar environmental and civic pressure as the Northern Gateway has in BC ( see 'Alberta-NT Pipeline: An Alternative With Similar Challenges', April 30 ). Therefore, any advance ment of pipeline projects would likely have to involve closer inter-governmental cooperation to jointly tackle public opposition against crucial pipeline links if export markets are to be opened to Canadian crude.