Andrew Nikiforuk's April 3 article was a full and accurate summary of the major points addressed in my inquiry into the transparency and reliability and of the double discount thesis.
Having read the web postings submitted by readers that followed the article, and a new CIBC piece, I thought it useful to provide additional information, address comments raised, and dispel a few of the myths still swirling about.
CIBC World Markets on April 3 claimed Canada stands to lose $50 billion over three years. "Economist Peter Buchanan forecasts that this 'money left on the table' will be about $20-billion this year, $15.2-billion in 2014 and $16.5-billion a year later," reported The Globe and Mail.
The majority of western Canadian crude is produced by a handful of integrated companies -- Suncor, Imperial, Husky and Cenovus -- with direct and indirect refinery interests in Canada and the U.S. There is no "money left on the table" for the majority of our exports because the revenue never lands there. The four major integrated Canadian oil producers account for about 1.13 million barrels a day of U.S. refinery demand for discounted crude.
Debunking the 'double discount'
When western Canadian oil producers have downstream operations and the prices for their refined commodities such as gas, jet fuel and diesel are based on international benchmarks like Brent, refinery margins balloon. Lower crude feedstock prices at the refinery gate become a transfer between profit centres -- like moving money from one pocket to the other in the same pair of pants.
I wrote Mr. Buchanan and asked why he had not considered the benefit Canadian oil producers receive when they purchase western Canadian crude for use in their refineries. They are able to profit because they did not pay Brent, but charge consumers as if they did.
I also asked why the pipeline transportation costs of getting our crude to the US Gulf Coast were not netted off the differential and why no consideration was given to value lost in Canada when bitumen is exported for upgrading and refining in other countries. I asked if he would please provide the prices, differentials, and volumes relied upon to create his vast estimates.
After aggressive public promotion and extensive media coverage of CIBC's estimate and assertion by the bank that "the failure to invest in needed transportation infrastructures could still prove costly for Canadian producers, governments and the economy" Mr. Buchanan refused to address the substantive issues and would not be accountable for his figures. He told me "the details are only available to major institutional clients of the firm, as is the case with the other things that we publish."
If bank economists and financial analysts -- with declared conflicts of interest -- are not willing to be accountable or transparent for the figures they release publicly, their figures should not be trusted.
The double discount thesis is made up of two components -- western Canadian crude discounted to the North American benchmark West Texas Intermediate (WTI) and because WTI has become discounted to international benchmarks such as Brent, we are told there is a further hit.
The thesis ignores the fact that western Canadian crude has always sold at a discount to WTI because of differences in quality. Last year was essentially no different from expected norms. The first part of the double discount narrative is not consistent with the facts -- there is no "double" in the double discount.
The 'opportunity loss' myth
The second step in the double discount thesis tries to go beyond traditional western Canadian crude markets and postulates that our crude could get the international price if it reached the Gulf Coast or Asia.
Proponents argue that when these new markets are accessed, the price received on one barrel will raise the price on all barrels, providing a windfall to government revenues and the economy.
The fallacy of this narrative becomes apparent when the size of the transfer within integrated operations is recognized, and as one reader suggested, we consider the volume of western crude that already makes its way to markets that are not landlocked.
About 650,000 barrels a day -- roughly 30 per cent of western Canadian crude exports --makes their way to international markets along Trans Mountain to the west coast or by way of Seaway and Pegasus to the Gulf Coast.
If these barrels do not receive world prices then the whole double discount exercise is a waste of time. If they do, these barrels cannot be included in the opportunity loss calculation.
Roughly 2.2 million barrels a day of western Canadian crude is exported. Netting off the integrated barrels for Canadian producers receiving the international price through their refinery operations and the barrels that make their way to coastal markets means the number falls by about 1.8 million barrels a day. This leaves us with roughly 400,000 barrels a day.
These remaining barrels are represented primarily by the Koch Brothers through Flint Hills Resources Canada LP. They claim they buy 320,000 barrels a day of western Canadian crude for their Pine Bend refinery in Minnesota. The Koch Brothers have a vested interest in buying low and selling into their downstream operations where they make huge profits through their refinery margins. They don't plan to send that oil to the Gulf Coast any time soon.
We are left with less than 100,000 barrels a day produced in western Canada that might be subject to a potential opportunity cost for producers because of lack of access to world prices.
Some crude is shipped by rail to market. Baytex is moving about 20,000 barrels a day by rail and Cenovus says they are nearing 10,000 barrels a day. Industry estimates place total rail transport out of western Canada at about 100,000 barrels a day. Thus, there are no western Canadian crude volumes to multiply against a pricing discount, even if one existed, particularly since rail is not necessarily a more expensive transportation option than oil pipelines.
In fact, producers are finding rail to be a very competitive option for light oil because of its flexibility and claim it can be cheaper than pipeline transport for bitumen. Unlike diluted bitumen, which requires expensive imported condensate, rail requires little if any diluent and avoids the "diluent penalty" of as much as $9 a barrel above a pipeline toll rate.
Petro industry's interests aren't Canada's
As the industry expands and rapidly extracts bitumen for shipment down pipelines --along with the value-added jobs and environmental standards -- they will try to resort to this fallacious discount argument. They will invoke sophisticated sounding spreads like Brent to SCO and Maya to WCS and use them to claim raw diluted bitumen export is better for Canada than upgrading bitumen to SCO in Alberta before it's exported.
Western Canadian light oil can be represented by Synthetic Crude Oil (SCO), which is upgraded oil sands bitumen. This is the grade Suncor, Syncrude, Shell, Canadian Natural Resources and Nexen make in their upgraders. Capacity is 1.3 million barrels a day but current production is running closer to 900,000 barrels a day. Some SCO is consumed in Alberta's refineries and transformed into higher valued refined products -- the products they charge us for at world prices.
Western Canadian heavy oil can be represented by Western Canadian Select (WCS) but it must be remembered that WCS is the highest quality bitumen blend, and only about 300,000 barrels a day are produced. Other diluted bitumen blends, like Cold Lake Blend, would be expected to sell at an even greater discount than WCS for quality reasons.
Pipeline proponents like to compare WCS to Maya, a heavy Mexican crude imported into the Gulf Coast. WCS is of a slightly lesser quality than Maya because of its sulfur content and there are fewer refineries in the Gulf Coast that can accept it. Prior to the WTI – Brent decoupling when Maya's price skyrocketed, WCS had a quality discount to Maya of approximately $6 a barrel.
To compare SCO to a light oil equivalent like Brent in the Gulf Coast and see if there is an arbitrage opportunity the roughly $10 per barrel transportation cost must be considered. To compare WCS to heavy oil equivalent like Maya, transportation costs and the natural differential must be included. They aggregate to at least $16 a barrel.
On April 5, 2013 the SCO spot price was $104.66 CDN. The differential between Brent and SCO did not even cover transportation as it was negligible at $1.44 CDN and suggests no market incentive to seek out new markets for SCO. No opportunity loss there.
On April 5, 2013 the differential between Maya and WCS was $19.81 CDN. Netting off quality and transportation means the actual opportunity cost of getting a barrel of WCS to the Gulf Coast was less than $4 per barrel -- not the almost $20 a barrel the double discount deceptionists would have us believe. And with all barrels already accounted for, there can be no opportunity lost for Canadian oil producers, regardless of the spread.
The Canadian public is being subjected to a misleading narrative and a misrepresentation of the facts by financial institutions, who like the government of Canada, are behaving as marketing executives for Big Oil.
Read more: Energy, Environment
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