Canadian Oil Producers' Crocodile Tears
Two reasons why claims that pipeline resistance hurts their bottom line are, well, crude at best.
Cenovus CEO Brian Ferguson, speaking at a Whistler investor's forum Jan. 24, 2013, claimed the double discount in crude prices from a lack of pipeline capacity is a "subsidization to the United States consumer by the Canadian economy" which he calculated is "$1,200 per Canadian."
The message he's sending? If each one of us wants to keep that $1,200 a year instead of providing income support for Americans, then get on the pipeline band wagon and become like him -- "in favour of all pipelines, going anywhere."
Ferguson's message is a variation of a theme we've been hearing from big oil for a couple of years -- echoed by the Canadian and Alberta governments. They get away with this tall tale because most of us do not understand how oil is traded and crude prices are set. Nor do we realize that the majority of crude oil produced belongs to integrated operations that own refineries too -- so if they lose on the one hand, they make it up on the other.
The narrative goes like this: resistance to oil pipelines like Keystone XL, Northern Gateway and Trans Mountain's twinning means an ever increasing supply glut in the U.S. Midwest, forcing the price of Western Canadian crude oil downwards as compared to the North American crude oil benchmark West Texas Intermediate -- WTI.
WTI is trading at about $96 US a barrel while key oil sands blended crude called Western Canadian Select -- or WCS -- is currently selling at a deep discount to WTI at $31 US per barrel. If Canadian oil could find its way to new markets it would command higher prices and improve producer revenues. But the problem, according to pipeline advocates, doesn't stop there.
The discount becomes a double discount when they bring in what's happened since 2010 between WTI and another important world benchmark called Brent. Brent is a pricing mechanism relied on by many export nations including Saudi Arabia and other OPEC countries.
Historically, WTI was considered marginally superior to Brent and traded at a close, but slight premium. This is why for decades it did not matter so much that Atlantic Canada, Quebec, and to some extent Ontario, relied on foreign imports from countries that use Brent pricing to sell their oil to eastern Canadian refineries. Except for the past few years, it was slightly cheaper for them to do so.
Twisting the double discount
Things have changed. Brent priced oil is selling at around $113 US a barrel -- a $17 US per barrel premium to WTI. When the oil sector talks about the double discount, this is what they are referring to -- WTI deeply discounted from Brent and WCS priced against WTI, deeply discounted again. They run the numbers as if western Canadian crude will command world prices once it finds its way onto new pipelines and into new markets -- even though they know this is false.
Oil sands crude takes more energy, and therefore costs more to process into finished products like gasoline, jet fuel and diesel. Even before there was any evidence of a glut in the U.S. due in part to the expansion of U.S. production from the Bakken, there was a natural discount for WCS related to product quality. Between 2005 and 2010 the discount of WCS to WTI ran at an average of $18 US per barrel.
Enbridge CEO Al Monaco told the Toronto Board of Trade last June that pipeline delays on projects like Northern Gateway is costing billions. He said our oil is "selling for $20 to$30 off world prices. If you do the math, that translates to lost value of some $60 million a day. A massive loss of value for Canadians." To get this figure, Monaco took Western Canada's crude oil exports by volume and pretended it captured Brent prices. The discount related to quality was ignored.
CIBC last March estimated the loss at $50 million a day or $18 billion a year. "We consider the current discounting of WTI vs Brent, and the more recent discounting of Canadian crudes vs. WTI (i.e., double discounted vs. global crudes) as a major issue."
Cenovus' Ferguson, in his talk to investors last week, pointed to the CIBC report and claimed "that number, I think is about double that given today's differentials" and raised the CIBC estimate to $36 billion a year.
But if you look at the differentials last March and compare them to today, they are almost the same. Last March Brent traded at about $124 US a barrel, WTI at $106 US and WCS at a discount to WTI of $31 US -- total double discount of $49 US. Awfully close to the current $48 US double discount Ferguson laments.
Not only did Ferguson double the hit, he took the tragedy to new extremes by suggesting this lost opportunity is tantamount to each Canadian handing over a cash subsidy to U.S. consumers.
How is it he could simply double the total, call it $36 billion, divide it by the population of Canada, and claim its costing us each $1,200? Great headlines, but not remotely true.
The refining factor
U.S. consumers are not benefiting at our expense. A benefit from lower-priced Western Canadian crude oil at the refinery gate in the U.S. is not passed onto U.S. consumers in the form of lower prices for gasoline, jet fuel or diesel. U.S. consumers in the Midwest are price gouged.
It's the refining sector that sees the benefit of lower priced WCS in the form of windfall profits from low feedstock costs. To the extent U.S.-based refineries are owned by companies producing oil in Canada, there are no losses -- real or imaginary. Cenovus is one of those companies. After claiming a huge hit for the industry, and by implication, Cenovus, five minutes later Ferguson told his audience, "we are substantially benefiting (from the wide differentials) at our refinery in Wood River" where 130,000 barrels a day -- the majority of crude Cenovus produces -- is delivered.
So Ferguson's company is not suffering. And any other integrated oil company with refinery interests is not suffering. Let's run down the list.
There's Imperial Oil, Canada's second largest integrated oil company who reported a 21 per cent rise in third quarter profits due to higher mid-continent refining margins. Imperial has a dominant position in the oil sands, and they also have refineries where they capitalize on lower feedstock costs.
Husky Oil is also well positioned and benefits from the deep discount. Husky has a half ownership in a Toledo, Ohio plant which processes Canadian heavy crude. This plant is doing very well because of the spread. And its 82,000 barrel a day Lloydminster upgrading plant in Alberta, which turns heavy crude into refinery-ready light synthetic oil, has its highest returns when the spread between the two grades is widest. No pain there.
Canada's largest integrated oil company, Suncor, recorded record cash flow in their latest quarterly report because refinery profits increased due to lower cost feedstocks. Suncor has refineries in Edmonton, Sarnia, Ontario, and Commerce City, Colorado. They all take advantage of lower-priced western Canadian crude.
By the time we run through Ferguson's numbers they are no longer believable. Half his number is apparently from double counting; the next half is from lost opportunity that's not lost opportunity at all -- it's due to a quality differential between grades like WCS and WTI. Any remaining potential loss to large producers is pretty much picked up by their refineries in the U.S. and here in Canada.
So please, stop with the crocodile tears.