Canadian rails see crude increasing on Keystone XL cancellation, DAPL uncertainty

Houston — Canadian railway executives expect increased crude-by-rail shipments now that US President Joe Biden has essentially canceled the Keystone XL Pipeline project and as the much-litigated Dakota Access Pipeline could still be shuttered.

Canada's crude-by-rail exports began rebounding late last year—after plunging during the strictest economic lockdowns of the coronavirus pandemic—but are currently hovering near the border of economic viability as pricing differentials have tightened in the last few days.

On his first day in office, Biden issued an executive order canceling the presidential permit for the $8 billion Keystone XL Pipeline designed to move 830,000 b/d of heavy Canadian crude ultimately to Texas through the entire Keystone system, potentially killing the decade-long project.

Less pipeline capacity meshes with Canadian Pacific Railway and partners currently building a diluent recovery unit, called DRU, near Hardisty, Alberta, to separate the diluent from the heavy Canadian crude grades and deliver DRUbit, a proprietary heavy Canadian crude oil specifically designed for rail transportation, said CP Railway CEO Keith Creel during the company's Jan. 27 earnings call. The facility is expected to come online in mid-2021 with the potential for continued expansion, he said.

"We do think that the (Biden) administration actions, executive order, the pipeline, that bodes for more strength and more potential demand for crude," Creel said. "We think it creates more support for scaling up an expansion of the DRU. So, we're bullish on that opportunity."

"For crude by rail, we are seeing increased activity as [price] spreads have become more favorable," said CP Railway Executive Vice President John Brooks.

Canadian National Railway Senior Vice President James Cairns said crude-by-rail revenues remained weaker in the fourth quarter, but heavy Canadian barrels remained in demand.

"In Q4, crude revenue declined by close to 65%, but we saw an increase in the relative percentage of heavy crude, which made up almost 60% of our crude revenue in the quarter, demonstrating the resiliency of our heavy crude franchise," Cairns said on the company's Jan. 26 earnings call.

Brooks said the railways also would benefit if the much-debated Dakota Access Pipeline is shuttered that serves as the major crude oil artery from the Bakken Shale.

A federal appeals court ruled this week that the nearly four-year-old DAPL is essentially operating illegally without the necessary federal permitting, and the court is leading it up to the Biden administration and the US Army Corps of Engineers to decide whether to close the pipeline while a more thorough environmental review is conducted.

"We're watching it closely. We do ship Bakken crude out of North Dakota, and, obviously, if something happened with that pipeline, we think that would generate an opportunity," Brooks said. "Of course, there's been a lot of noise around that pipeline for a number of years. We've been able to generate some pretty, I would call it, stable crude-by-rail business out of North Dakota, but I think, certainly, there is an opportunity for upside if they were to move towards shutting it down or putting it on the sideline for a certain amount of time."

Still, the anticipated completion of Enbridge's Line 3 Pipeline replacement project, which will carry more heavy Canadian crude to the US, will keep crude-by-rail exports from picking up too much when demand grows, according to analysts.

Widening diffs start to tighten a bit

Canadian crude-by-rail exports plunged from an all-time high of 411,991 b/d in February 2020 to an eight-year low of 38,867 b/d in July as the pandemic took hold. Exports have since rebounded to 173,095 b/d in November, according to the Canada Energy Regulator.

Crude-by-rail exports rebounded late last year primarily from an increase in Canadian crude oil production and from the limited available pipeline capacity, said Karen Ryhorchuk, a spokeswoman for the CER.

The regulator sees exports remaining flat or decreasing in December due to pricing dynamics.

The price spread between Western Canadian heavy crude in Alberta and on the US Gulf Coast has narrowed in the past several trading sessions, eroding the viability of crude-by-rail shipments just as the pricing environment had begun to recover.

While the Hardisty-USGC spread had widened to $13.95/b earlier this month, above the $13/b level traders say is needed to get trains moving, it has since narrowed to just over $11/b.

It can cost from $12-$18/b to ship crude-by-rail from Hardisty to the Gulf Coast, depending on the contract.

The spread has narrowed as US refiners increased buying of WCS in anticipation of pipeline constraints.

"The spread is trading under rail variable cost," one trader active in Canadian markets said.

Crude-by-rail revenues

Despite some optimism going forward, both CP Railway and CN Railway reported weak crude oil revenues in the fourth quarter and for nearly all of 2020.

CP Railway's energy, chemicals and plastics quarterly revenues, which include crude oil, plummeted 25% from the final three months of 2019 down to about $286 million.

That compares to the company's total revenues only falling by less than 3%. The rail firm also noted continued weakness in frac sand shipments.

Likewise, CN Railway reported its petroleum and chemicals quarterly revenues fell 12% down to about $519 million, primarily driven by lower volumes of crude, while the rail firm's total revenues actually rose by 2%.

The petroleum and chemicals business segment's revenues dipped by 14% for all of 2020.