Have we seen it all? Changes from rig to rail to refinery

The North American crude complex has encountered a wide variety of changes, everything from Rig to Rail to Refinery, but have we seen it all? Recently, Hillary Stevenson presented at the 7th Opportunity Conference on this theme. View the full presentation here or read the summary below.

The changes in the North American crude complex, from rig to rail to refinery can be broken down into four sections:

  • North American Crude Supply (the rig part)
  • Canadian Supply Chain (the rail part)
  • US Supply Chain (the refinery part)
  • The Energy Transition and Regulations

North American Crude Supply

In the US, 2020 was set to be the biggest year yet with crude supply topping 12mn bpd in the first quarter, but lack of demand shut in supply in mid-2020. Even as demand returned, the most active hurricane season on record hampered recovery efforts. Then, in February 2021, Winter Storm Uri caused a major supply disruption. Even as refined product demand has mostly rebounded, US crude production has not returned to pre-COVID levels. This may be a new normal – with upstream companies hesitant to ramp up rig programs even in a $70-80/bbl WTI crude world – Q1 2020 may have been a relative maximum for the US for total production. And given active production locations, we may see US production trend lighter.

In Canada, production also dropped off at the beginning of the pandemic. COVID-related demand decreases helped to drain inventories and lower crude prices pushed production lower. However, returning demand, higher prices, and incremental pipeline capacity expansions led Canadian crude production to rebound to pre-COVID levels. Curtailment was also lifted at the end of 2020. With Line 3 expansion now online, Canadian production is expected to return to or eclipse pre-COVID levels. This is great news because demand for heavy crude is strong globally and Canada is positioned to supply that demand especially given the gaps in traditional supply (Mexico, Venezuela, and continued OPEC restraint).

Canadian Supply Chain

Canadian production has battled against a pipeline bottleneck for the last several years. Production surpassed pipeline capacity in 2018, causing an extreme widening of the WCS spread. In 2019 curtailment was mandated because there still was not enough space. That meant that crude-by-rail was needed to help move the additional production. We see high crude-by-rail levels through early-2020. Then COVID came, reducing production and making space available on pipelines for the first time in years. This, in turn, decreased the need for rail movements. But with production back to pre-COVID levels at the end of 2020, the bottleneck returned and rail needed again to clear the incremental barrel.

But hark! Pipelines to the rescue. In October, Enbridge completed the Line 3 expansion adding 370,000 bpd of pipeline take away. This should cover the Canadian production levels through 2022. Then in 2022 and 2023 another 540,000 bpd will be added with the TransMountain expansion which will provide more than enough space for Canadian production growth for the next several years.

The completion of these projects likely means:

  • less volatility for Canadian crude prices
    narrow to pipeline economics ($7-8/bbl)
  • crude-by-rail volumes will decrease, but not go to 0
    non-pipeline connected areas and USD Hardisty Dru-bit project will move some rail barrels

With production decreasing during the beginning of the pandemic, exports also dropped. Most of the production decreases during COVID were for heavy oil with US PADD 2 getting the lion share of Canadian exports.

But have we seen it all? I don’t think so. One potential shift is more exports to non-US destinations. There is a minimal amount of crude that goes to other destinations in recent history either from the existing TransMountain pipeline or re-exported from the US Gulf Coast but those volumes could increase with the TransMountain expansion and Capline reversal. The pipeline reversal will enable more re-exports or additional US PADD 3 demand. Either way, US PADD 2 will have more competition for Heavy Canadian barrels, supporting crude prices.

US Supply Chain

Unlike Canada, the US has been building pipelines aggressively. Over 5mn bpd of pipeline capacity either came online or is in construction since 2020. The work has been mostly concentrated in three areas:

  • US side of the Canadian debottlenecking: Line 3, Capline, Southern Access
  • US Mid Continent – particularly to better connect the Rockies and Cushing areas: Freedom, Saddlehorn, Equality, Matador, Red River, Cushing Connect, Pony Express
  • Texas production connectivity with coastal export centers: EPIC, Wink-to-Webster and Midland to ECHO III, Ingleside, Ted Collins, Augustus, Seahawk

The Rockies and Bakken regions are better connected and Permian barrels have plenty of routes to export markets. This has tightened differentials and pipeline tariffs as well as decreased trucking volumes which have a big impact on emissions.

This is also good news for foreign buyers. At Validere we help market participants manage crude quality. We’ve heard from foreign buyers that they want a supply source with a consistent quality especially after other supply sources (OPEC, Nigeria, Iran) have been less consistent either due to mandated cuts or politics. The US Gulf Coast now has the ability to move Permian crude directly to the coast particularly in Corpus Christi that hasn’t been comingled with other crude grades. This could mean that Corpus Christi remains a main export location, especially after the channel dredging is complete – expected next year.

While pipelines provide better market access and decrease trucking emissions, they also require a lot of tankage. More tanks mean more volumes sitting in tank bottoms which eats into total available stocks, plus the volumes that are underground in linefill. The EIA breaks out US crude in storage into three different categories – Alaska in transit, Stocks at Refineries, and tank farms and pipelines – the majority of crude storage.

Over time, more and more of the total stocks are sitting in pipelines, reducing what’s available above ground. Additional tankage also eats into crude availability. Data from the EIA shows that only 83% of available storage capacity is working storage capacity. Given the 80 mn bbls US crude stock draw from March to September, tank farm storage decreased to levels not seen since 2014. We have far more tanks since then, so the volume is more spread out and harder to source.

What does this mean?

  • The storage market is quite tight
  • Storage logistics could point to a more bullish trend, Despite the backwardated forward curve
    We aren’t sitting on a huge cushion – legislation sold considerable SPR volumes

The Energy Transition and Regulations

Pipelines have certainly been in focus from a regulatory view this past year.

  • Dakota Access Pipelines – allowed to keep flowing while a new Environmental Impact study is complete
  • Line 5 – risk of closure, covered under a cross border treaty which is protecting flows at the moment.
  • Bahalyia connector – protests in the Memphis shut down efforts
  • Line 3 replacement – finally came online after originally slated for service in 2018

Another consideration when we think about building or replacing pipelines is system resilience.
When pipelines can’t move product, we often have to fall back to less environmentally friendly transportation methods: ships and trucks.

The Energy Transition has focused on reducing emissions. Minor logistical decisions are becoming more important in a GHG perspective (easier to change midstream functions in the short term). Market participants are looking more and more at marketing movements to optimize for lower emissions among trucking, rail, facility, and custody transfer emissions. Sometimes that means more facilities to reduce trucking.

If a pipeline doesn’t get built or gets shut down, we see additional trucking happen which increases the emission profile. Validere has seen this first hand particularly in Canada where pipeline-connected volumes had to be trucked to new destinations adding emissions, cost, and man hours.

So, while we hear a lot about the environmental impact of building pipelines, we should also consider the opportunity cost of not having pipelines.

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Hillary Stevenson
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