May 6, 2023 [RBN Energy] – In the past, Canadian heavy oil was all too often the sick man of the North American oil market.
Plagued by a limited number of refinery outlets and numerous episodes of insufficient pipeline export capacity from Western Canada, it was often subject to far larger price discounts versus the light crude oil price benchmark of West Texas Intermediate (WTI) than was justified by quality and pipeline transportation costs alone.
In the past few years, however, improved pipeline export capacity to and through the U.S. has expanded the number of refineries Canadian heavy oil can reach, and the expansion of crude oil export terminals along the Gulf Coast has resulted in greatly improved exposure for Canadian barrels to buyers in international markets.
The end result has been a closer alignment of Canadian heavy oil pricing in its home base of Alberta with those in the Midwest and Gulf Coast.
The machinations of Western Canadian Select (WCS), the price benchmark for the region’s heavy oil production, remain a hot topic for the crude oil market and RBN blog readers.
With more than 90% of Canada’s crude oil exports to the U.S. being heavy in nature — and typically linked to the WCS benchmark in some way — the price drivers of this closely watched price marker have affected billions of dollars in investment decisions from the production to the refining side of the business.
They also generated an overt political response a few years ago in Alberta, home to the vast majority of Western Canada’s heavy oil production in the form of bitumen from the oil sands.
The key thing with the WCS price is that because of the Canadian heavy oil’s characteristics (low API, high sulfur, etc.) it would be expected to trade at a discount to benchmark lighter crude oil.
In the case of WCS, this is usually expressed as a discount to WTI to factor in the additional costs associated with transporting the heavy oil to other parts of North America and processing it, as well as other extraneous factors ranging from regional inventory levels, the availability of pipeline export capacity, the price of competing heavy oil supplies, and refinery demand (or lack thereof), just to name a few.
For top value to be realized, Canadian producers of heavy oil prefer a narrower price differential to WTI that more accurately reflects quality and transportation differences, rather than wider discounts where other factors beyond quality and transportation might further undercut the value of heavy oil.
As we mentioned, the magnitude of the WCS price discount to WTI has been a frequent topic in the RBN blog space. Reaching back to 2018, our five-part series (see The Shape I’m In) examined a broad spectrum of factors affecting what was a steadily deepening discount for the price of WCS and how rising heavy oil production from Alberta’s oil sands was pushing beyond the capability of available pipeline export capacity at the time. The WCS price discount (WCS Hardisty-WTI, green line in Figure 1) at the trading hub of Hardisty, AB, the kick-off point into Enbridge’s Mainline for the shipment of oil to the Midwest, became so extreme (near $50/bbl in late 2018; dashed black oval #1) that Alberta’s provincial government ordered a reduction in the province’s oil production to force an improvement in the WCS price discount (and all-important oil-price-linked royalties on which the province relies).
That government-imposed reduction did the trick, causing an immediate snap back in the discount closer to its historical average of $10-$20/bbl. (Those restrictions were suspended at the end of 2020 — see Livin’ on a Prayer.)
In early 2020, along came COVID and the price destruction it wrought on the oil market (see Rock Bottom), with a WCS Hardisty-WTI differential that widened back near the $25/bbl range (dashed black oval #2) and absolute WCS prices that were in the single digits for a short period of time. Once COVID became less of a factor later in 2020 and into 2021, the discount settled back into a range of $10-$20/bbl, partly assisted by a long-awaited increase in pipeline export capacity with the completion of Enbridge’s Line 3 pipeline replacement project on its Mainline to the Midwest, which increased export capacity by 370 Mb/d.
That was followed by another short-lived period of discounting late in 2021 (dashed black oval #3) thanks to soft refining demand in the U.S. and the temporary outage of a major Canadian oil export pipeline to the West Coast (see Lost Without You). Additional developments came with the reversal of the Capline pipeline from the Midwest to the Gulf Coast in January 2022, which provided an additional outlet for Canadian heavy oil to the Gulf Coast, as well as improved refining runs.
That narrower differential didn’t last long, however, as infrastructure issues in North America (pipeline capacity, refinery upsets) as price-discount drivers for WCS were replaced by a host of international factors pressuring the WCS price discount wider over the course of 2022 (see I Go to Extremes), such as the nearly yearlong sale of competing medium-sour barrels from the U.S. Strategic Petroleum Reserve (SPR) and the heavy discounting of Russian medium-sour Urals crude that came about after its invasion of Ukraine and the international sanctions on that country as a result. Finally, the discount hit $30/bbl again in October 2022 when a major outage at a refinery in the Midwest, a big user of Canadian heavy oil, suffered a devastating fire and explosion, undercutting demand (dashed black oval #4).
Before getting to what we think are the latest drivers for the narrowing of the WCS price discount in Part 2 of this series, we also have to consider what has become a broader suite of WCS price discount markers at other important locations: WCS at Cushing, OK (red lines in Figures 1 and 2), the traditional home of the WTI domestic sweet benchmark (see Trading in the USA), against which its price discount is determined, and WCS in the Gulf Coast (USGC; blue lines in Figures 1 and 2), with both pricing series courtesy of our friends at Link Data Services (LDS).
What will be noticeable from the pricing relationships between the three flavors of WCS (Hardisty in Alberta, Cushing in Oklahoma, and the Gulf Coast) is that they have had a tendency to move more in sync since early 2022 (zoomed up in Figure 2 above). We think this primarily reflects the improved pipeline export capacity situation from Western Canada since the startup of Enbridge’s Line 3 replacement.
In effect, a previous major infrastructure constraint (lack of sufficient pipeline export capacity from Western Canada) has been removed, allowing the freer flow of Canadian heavy oil to other parts of North America and allowing its pricing at the margin to be driven by factors more downstream from Western Canada.
This shift to other factors downstream was no more apparent than when in late November and into December 2022 TC Energy’s Keystone Pipeline, an important conduit for Canadian heavy oil into the southern reaches of the Midwest, suffered a line break (inset box in Figure 3 below).
What was notable about this incident was that the line break took place north of Cushing, but south of Keystone’s eastbound spur line to key oil storage facilities in Wood River and Patoka, IL. This allowed enough crude to continue to exit Western Canada without a sudden additional discounting of WCS Hardisty prices, which normally would have happened as supplies backed up in Alberta. Moreover, shippers of heavy crude from Canada also had the option of shifting over to spare capacity on the Enbridge Mainline to continue to get their crude to market, if need be.
The line break reduced the supply of Canadian heavy oil barrels into Cushing and, by extension, the Gulf Coast on the southern portion of Keystone called Marketlink, resulting in far-narrower WCS price differentials at these locations for a short period of time (dashed black oval in Figure 2), meaning even higher prices for Canadian barrels in those locations. Once the line break was repaired a few weeks later, the Cushing and Gulf Coast discounts eased off quickly and re-synced with Hardisty prices and have more or less moved in lock step with one another since that time.
This might be one of a few examples — or perhaps the first — where a pipeline upset affecting Canadian oil exports did not result in a material blowout (larger discounts) for WCS Hardisty. In fact, there was barely a ripple in the WCS Hardisty price because of the ability to move barrels into Wood River and Patoka — again, the freer movement of crude and optionality in its transport allowing for more efficient pricing of the Canadian heavy barrel.
We think this greater price hub synchronicity (hence the name of this blog series) has become much more prevalent in the past year or so, especially since the completion of Enbridge’s Line 3 replacement project. Canadian heavy oil barrels can now move about the continent far more freely, with few or no impediments that might create a sudden or lengthy discounting in the price of heavy oil barrels at Hardisty.
Having reviewed a number of important market developments in the past few years that have allowed the pricing of Canada’s heavy oil in Alberta to more closely align with pricing hubs at other market locations in North America, we will review in Part 2 of this series the drivers behind the latest narrowing of the WCS price differential (regardless of location) and how international oil market developments are having a growing influence on the relative price of WCS.
“Synchronicity I” and “Synchronicity II” were written by Sting (Gordon Sumner) and appear as the first and sixth song on side one of The Police’s fifth studio album, Synchronicity. “Synchronicity I” was released as a single only in Japan, while “Synchronicity II” was released as a single in the U.S. and the UK in October 1983. It went to #16 on the Billboard Hot 100 Singles chart.
According to Sting, the synchronicity lyrical theme in both songs refers to Carl Jung’s theory on the subject. With lyrics referring to “the din of Rice Krispies” and “the slime of a dark Scottish lake,” one has to ponder if the reference is to Jungian Theory or Aleister Crowley eating breakfast at Boleskine House. Both songs feature a heavy use of synthesizers. Personnel on the record were: Sting (vocals, bass), Andy Summers (guitar, keyboards), and Stewart Copeland (drums, percussion).
The album, Synchronicity, was the final studio album from The Police. Recorded between December 1982-February 1983 at AIR in Monserat and Le Studio in Quebec, the album was released in June 1983. Produced by The Police and Hugh Padgham, it went to #1 on the Billboard 200 Albums chart and has been certified 8x Platinum by the Recording Industry Association of America. Five singles were released from the LP.
The Police were an English rock band formed in London in 1977. The popular lineup of the band featured Sting, Andy Summers and Stewart Copeland. Four people have passed through the band since its inception. Emerging from the late-seventies British New Wave scene, the band played a blend of punk/pop, reggae and soft jazz. They released five studio albums, three live albums, four soundtrack albums, seven compilation albums, one EP, and 26 singles. They have sold more than 75 million records worldwide. They have won five Grammy Awards and were inducted into the Rock and Roll Hall of Fame in 2003. The band broke up in 1986 but have reunited a few times for select shows and appearances.
All three band members have gone on to success in solo ventures. As a solo artist, Sting has released 15 studio albums, five live albums, 10 compilation albums, five EPs, and 51 singles. He has sold more than 25 million records worldwide. He has received a CBE from Queen Elizabeth II, was awarded a Polar Music Prize, a Kennedy Center Honor, a star on the Hollywood Walk of Fame, and is a member of the Songwriters Hall of Fame.