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Bitumen Bottleneck and Pipelines Fix a Myth: Economist

No basis for claims of $50 million a day losses, says new Allan report.

Andrew Nikiforuk 3 Apr

Andrew Nikiforuk has been writing about the energy industry for two decades and is a contributing editor to The Tyee. Find his previous stories published in The Tyee here.

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Pipeline supporting reports of 'double discount' losses misleading, says Allan. Bitumen image: Shutterstock.

Industry and government claims that Canada is losing as much as $70 million a day on bitumen exports due to "double discounts" in oil markets and a lack of pipeline capacity are untrue, says a new financial analysis.

In a 35-page report B.C. economist and former business executive Robyn Allan tried to track down sources for the discount story, but says she ran into a dead end.

Nor is the oil sands industry really losing money on bitumen discounts for two vital reasons, says Allan.

For starters, bitumen prices have steadily increased overtime.

And whatever revenue losses upstream oil companies might have sustained due to fickle bitumen markets, their integrated downstream refineries recouped them with what the Canadian Imperial Bank of Commerce calls "super-normal cash flows" in 2011 and 2012. Oil sand producers including Suncor, Imperial, Husky, Nexen, Canadian Natural Resources Ltd., Shell, Cenovus and Chevron all own upgraders or refineries downstream. 

A seasonal and long-standing price differential between bitumen, a heavy sour crude, and light oils such as West Texas Intermediate (WTI), has always existed, adds Allan in her report.

Moreover, asserts Allan, the highly variable discount has nothing to do with pipeline capacity but is primarily related to the higher cost of refining heavy crudes such as bitumen as well as petroleum's increasing global price volatility.  

Although the average price spread between poor quality bitumen and high quality light oils hasn't substantially changed in recent years, Alberta is now exporting more bitumen to U.S. markets. Added refining challenges are a main reason heavy bitumen experiences greater price volatility than conventional oil blends.

Allan finds that although the price of West Texas Intermediate temporarily separated from global oil prices in 2010, that difference (an average of $16 dollars in 2012) has not created any substantial losses for the Canadian economy or doubled the discount for bitumen. 

Contrary to headlines about multi-billion "opportunity cost" losses for the megaproject, the oil sands industry has recorded hefty price gains for oil sands products as the global value of oil, the world's most lucrative commodity, has increased fivefold over the last decade, Allan says.

In fact, Allan found that oil sands companies received annual price increases of 9.5 per cent a year on the export of bitumen blends as well as an annual price increase of 11 per cent for the export of synthetic crude over the last four years.

The discount against West Texas Intermediate (a light oil) gives "the impression that prices for our various crudes have declined, or they have fallen to lower than historical levels, threatening the ability of the industry to operate. This is not true," states Allan.

Calculations weren't shared: Allan

The economist, who has challenged the economics behind the Northern Gateway proposal, wrote the report after she asked various financial institutions and think tanks to document how they arrived at estimates of losses ranging from $50 million to $70 million a day to the Canadian economy due to bitumen discounts.

Allan says those entities couldn't produce calculations or even figures to justify their claims, which have been marshalled to push the expansion of three proposed and highly controversial pipelines by Enbridge, TransCanada and Kinder Morgan.

Some industry reports confirm Allan's analysis. A 2011 report by Ernst and Young, for example, explained that narrowing discounts between bitumen blends and other oils were in reality driving Canada's pipeline mania. "The tightening of differentials has influenced the expanding of pipeline capacity."

Alberta basically exports three grades of its unconventional heavy sour crude to U.S. markets where they sell at different discounts to light oils such as West Texas or Brent (that's North Sea oil) due to their lower quality.

About half of total oil sand exports (1.7 million barrels a day) consist of raw diluted bitumen. The degraded crude is difficult to process and refine. (It also takes about 1.2 barrels of bitumen to make a barrel of oil.) As a consequence, it typically commands a 20 per cent price differential.

Raw bitumen also can't move through a pipeline without being blended with a high cost gasoline-like solvent. Canada is now a net importer of condensate to dilute bitumen. 

Upgraded bitumen or synthetic crude oil (SCO), which provides more jobs and value for the Canadian economy, commands a much a higher value in oil markets because it's easier to refine.

The price for SCO rose from $69 to $93 dollars a barrel in the last four years -- an annual increase of 12 per cent. Its discount against West Texas crude has shrunk to an average of $2. (Last March, synthetic crude actually sold at a premium or $7 higher than WTI.)

Another oil sands blend called Western Canadian Select (WCS), first introduced in 2004, has seen its price rise from $43 to $73 or 9.5 per cent a year. Its discount has shrunk from 30 per cent to 20 per cent. It now sells at $20 a barrel less than West Texas crude.

Less money made at one end, more at another

The oil sands industry not only operates mines and steam plants but actively invests in upgraders and refineries largely in the Canadian west and the U.S. Midwest. They realize increased revenues from using bitumen blends and synthetic crude by selling value-added products to consumers as though they paid the going world price for oil set by the North Sea market. Many refiners have recorded what industry calls "super-normal cash flows" over the last two years.

In fact, prices at the pumps in western Canada were 14 cents a litre more in 2012 than normal refinery margins would have suggested, reports Allan.  

"They pretend they are losing out and need these bitumen export pipelines, when they are charging western Canadians as if they already had them," Allan told the Tyee.

As a consequence the industry not only plans for these discount differentials, but profits from them.

Adds Allan in her report: "Contrary to the deep discount story that leaves the impression of depressed oil prices; real oil prices for synthetic crude and blended bitumen such as WCS have increased significantly. There has been no collapse in price levels. Although volatile, and prone to wide swings -- as is the nature of the oil market -- the general trend for Canadian oil prices during the past decade is undeniably upward."

Forecasts from CIBC challenged

Last year the Canadian Imperial Bank of Commerce (CIBC) released two separate forecasts that a volatile and natural price gap between bitumen and other oils was costing oil sand companies about $50 million a day or $18 billion a year and that only pipelines could solve the problems.

Allan tracked down reports by bank energy analyst Andrew Potter and asked how he arrived at the numbers. According to Allan, the bank did not provide the requested numbers. "Its analyst was unwilling to provide price and volume figures. He said, 'I don't have that data anymore.'"

Reached by The Tyee and asked to comment on Allan's report, Potter elected not to go on the record.

CIBC has repeatedly quoted its $50 million a day loss numbers, as have Canada's national media and Tory politicians. Natural Resource Minister Joe Oliver adopted the figure for a December 2012 speech. Cenovus CEO Brian Ferguson doubled the figure in January 2013. The Canadian Chamber of Commerce also made the number a key point of a 2013 report.

So where did the CIBC get its numbers from? 

Allan calculates that the bank looked at the difference in price between synthetic crude and West Texas in February 2012. But the discount, as it typically does, can vary widely. One day it was $23, and five days later the discount narrowed to $1 and almost disappeared.

"If CIBC had elected to select the narrowest differential instead of the widest differential of WTI-SCO in February 2012 for its report, there would have been no SCO deep discount story for CIBC to tell. What a difference a day makes," reports Allan.

In fact, no doubling existed at all. For 2012 the differential between West Texas and synthetic crude averaged about $1.60 a barrel -- "well within the historical and expected range of the natural discount between these two grades." Since then synthetic crude has sold at approximately the same price as West Texas or higher.

The discount for Western Canadian Select compared to West Texas averaged $21 dollars and that didn't change much either. "That's only slightly wider than the eight-year historical and anticipated natural discount related to quality."

All "Institutional Equity Research Industry" updates and reports by the CIBC typically come with this disclaimer: "CIBC World Markets does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report."

Alberta government's analysis disputed

Last January, Alberta's Finance Minister Doug Horner claimed that Alberta's bitumen was fetching $40 less in the marketplace compared to other crudes and that Canada was losing about $27 billion a year. He also claimed that the province was losing about $6 billion a year in royalties due to low bitumen prices.

But Horner did not mention the volatility of bitumen pricing, the cost of imported condensate or the profits made by refiners when the prices for crude stocks fall.

For the 2012 - 2013 Alberta budget, Horner and the Alberta government forecasted "significant price hikes for Alberta crude, favourable exchange rates, and unrealistically inexpensive prices for imported condensate."

None of that happened. "When the forecast proved false, he (Horner) blamed pipelines," says Allan. "It's like buying a lotto ticket and when it doesn't win saying you lost money. The absence of winning is not always losing."

Cenovus CEO Brian Ferguson last January proclaimed that oil price discounts had doubled. Furthermore this discount now cost each and every Canadian $1,200 a year. Only more export pipelines could stem these losses, said Ferguson.

Allan says that these large discounts didn't exist. At the time the difference in price for West Texas and synthetic crude was very slim (about $2) and the spread for Western Canadian Select (a bitumen blend) was approximately $27. Ferguson's speech turned it into a $71 difference. Moreover Cenovus, an integrated company with lots of refining capacity, depends on the discount to capture more value while turning bitumen into diesel, gasoline and jet fuel for U.S. markets, notes Allan.

Where are the headlines, asks Allan, that proclaim "Integrated operations reduces volatility and substantially benefits oil sands producers: Cenovus CEO"?

Bottleneck to be 'sorted out'

Industry and Tory politicians also have blamed the bottleneck in Cushing, Oklahoma, a big transportation oil hub, for volatility in bitumen pricing. If only there were more pipelines, the bottleneck wouldn't exist and bitumen would receive higher prices, goes the argument.

Yet Allan found this argument misleading too. The bottleneck or supply glut is "largely of the industry's making and expected to be sorted out within the next year, or so, as industry solves its management inefficiencies and technical difficulties." The realignment will come without any of the three bitumen export pipeline approvals.  

Allan compares the construction of a maze of bitumen export and condensate import pipelines -- at the expense of value-added and energy security in Canada -- to "breaking windows to create work for glaziers."

Canadian oil exports (2.7 million barrels a day) to the U.S. now account for 25 per cent of America's imported oil.

Yet U.S. oil consumption has dropped by nearly two million barrels a year while domestic production has increased by the same amount. Americans are spending less on oil due to the 2008 recession, new fuel standards, increased ethanol production and higher oil prices. They are also driving less.   

As a consequence many U.S. refineries have additional capacity to refine raw petroleum resources such as Canada's bitumen (the bulk of Canadian oil sand exports are unrefined bitumen) into value-added products such as diesel and gasoline for export.

The U.S., which served as the world's oil pioneer 50 years ago, is no longer allowed to export oil, because it must import about 45 per cent of its petroleum from foreign sources.

But in an unprecedented development, the U.S. has now increased the export of highly valued petroleum products to Canada, Mexico and Brazil from 1.2 million barrels a day to 2.9 million barrels a day in 2011 due to freed-up refinery capacity as a result of falling oil demand in the United States.  

There is widespread concern that increased supply of heavy sour crude from Canada to the Gulf Coast may result in larger petroleum product exports from the U.S. rather than contributing to lower domestic fuel costs in that country.

Case for pipelines contested

Allan concludes that inflated numbers with little basis in fact have been cited by industry and government in pushing unpopular pipeline proposals.

These export pipelines would lock the country into a pattern of oil development that largely enriches foreign oil companies at the expense of the owners of the resource. Canada will have less incentive to refine and add value to bitumen within its own borders, according to Allan.

"Exporting vast quantities of diluted bitumen will hollow the oil sector as value added opportunities are shipped to the U.S. and Asia.

"Exporting diluted bitumen at the expense of upgrading in Alberta increases Canada's condensate import dependency and requires twice the pipeline capacity and double the tanker traffic than bitumen upgraded in Alberta," she adds.

Building the pipelines that industry and the federal government say are necessary would expand bitumen exports by two million barrels and make it impossible for the nation to meet its greenhouse gas reductions. The infrastructure would also lock the nation into exporting raw and unrefined bitumen, notes Allan.

But Allan says the claimed financial losses those pipelines are supposed to avert didn't stand up to her scrutiny. They deserve the closest scrutiny, she says, because they are being used to make a case for "the world's wealthiest industry to achieve supernormal profits by granting them an unfettered public license to build 'all pipelines, going anywhere' for an unrefined resource."  [Tyee]

Read more: Energy

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