Rule Change Cuts Demand for Canadian Oil

As if pipeline bottlenecks were not enough, Canadian heavy oil producers are facing a new barrier to marketing their crude.

New rules limiting the amount of sulphur allowed in shipping fuel is expected to cut demand for both high-sulphur fuel oil and the sour crude which yields it. In Canada, that could extend — or worsen — the biggest price slump in nearly five years.

As surging production runs up against limited pipeline space, Western Canada Select’s discount to West Texas Intermediate widened to more than US$31 a barrel this month from an average of about US$13 a barrel last year, data compiled by Bloomberg show. The bigger discount is needed to incentivize shipping by rail, which costs more, Kevin Birn, a director on the North American crude oil markets team at IHS Markit, said.

While the pipeline bottleneck is expected to ease up next year, a new International Maritime Organisation rule which goes into effect in 2020 will keep heavy crude at a discount of US$31-US$33 a barrel against WTI, according to a July report by the Canadian Energy Research Institute, or CERI.

“We think you get a double whammy effect” in 2020, he said. “You have prices set by rail and, compounding that, is the IMO rule.”

Under the new rules, ocean-going ships worldwide will either have to install expensive, sulphur-removing scrubbers or use a fuel which has 86 percent less sulphur. The resulting increase in demand for lighter crude will push more crude toward the complex North American refineries which currently turn heavy Canadian oil into higher-value fuels such as gasoline and diesel, putting downwards pressure on heavy crude prices, according to CERI.

The rule change will come just as Canadian producers should be getting some relief in the form of greater pipeline access to US and international markets.

Enbridge Inc’s expanded Line 3, is scheduled to start operating in late 2019, delivering heavy oil from Alberta to Wisconsin. The C$9.3 billion (US$7.1 billion) expansion of the Trans Mountain oil pipeline from Alberta to the British Columbia coast is scheduled to start about a year later and TransCanada Corporation’s Keystone XL pipeline awaits a final investment decision but could start operating early in the next decade.

IMO Opportunity

There is still reason for optimism, however, as diminishing heavy oil production from strife-torn Venezuela and Mexico could help raise prices for Canada’s crude, Mr Birn said.

The Alberta government’s pledge earlier this year of C$1 billion to partial upgrading projects also may help Canadian producers overcome the challenges of the IMO rule, Dinara Millington, vice president of research at the CERI, said.

Unlike massive full upgraders, a smaller and cheaper partial upgrader would lighten the bitumen just enough so that it can flow through pipelines with little or no added condensate.

Such plants could also remove impurities like sulphur, Ms Millington said. No such plants have been built in the oil sands yet as various partial upgrading technologies are still in early stages of development.

Still, “the industry could take this challenge and turn it into an opportunity,” Ms Millington said.

Source: Rigzone