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Rising Canadian crude output triggering more crude-by-rail again

Highlights

Canadian crude volumes to hit new records by end-2022

Crude-by-rail shipments began to tick up in May

Discounted Canadian barrels increasingly priced to move

Canadian crude oil production has exceeded pre-pandemic levels and is poised to hit new records above 5.2 million b/d by the end of 2022, opening up a crude-by-rail arbitrage until pipeline capacity catches up.

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Likewise, price discounts for the heavy Western Canadian Select blend in Hardisty, Alberta hit their widest differentials against NYMEX WTI since early 2020, regularly pushing the $20/b threshold since early July when WCS flows began ramping up following a prolonged seasonal maintenance period.

Canadian railroads into the US are expected to receive extra crude barrels for the rest of this year and well into 2023 until the oft-delayed Trans Mountain Pipeline expansion is finally completed, again restoring ample pipeline takeaway. Traders say the spread needs to be at least $15/b or so to incentivize rail.

"There's definitely going to be an uptick in crude-by-rail," said AJ O'Donnell, product team director for East Daley Capital. "The (Canadian) producers are setting up for growth, and they need a way out of the basin."

The construction of more pipeline capacity in 2021 and early this year means crude-by-rail shipments will not surge to the record volumes of early 2020, but they easily will hit their highest volumes since then, he said.

"We've been underestimating production growth in Western Canada. Rig activity has been higher than expected," O'Donnell said, noting that the drilling rig count in the Western Canadian Sedimentary Basin is about 175 rigs, up from 145 a year ago. "Toward the end of the year, we're probably going to see new production records consistently."

After starting the year at 132,000 b/d, crude-by-rail volumes to the US could easily hit 200,000 b/d in the coming months, analysts said, although it is unclear if they will rise much higher.

Pipe and rail

The timing just happens to coincide with the ending of Canada's longstanding pipeline bottleneck into the US after the late-2021 completion of Enbridge's Line 3 pipeline replacement project, nearly doubling capacity and upping the capacity of Enbridge's Mainline capacity into the US to more than 3.1 million b/d, as well as the early-2022 opening of the Capline Pipeline reversal to move Canada oil sands to the St. James hub in Louisiana.

Even the record amounts of US Strategic Petroleum Reserve releases in Louisiana and Texas have not put much of a dent in Canadian activity.

While the controversial Keystone XL Pipeline project was canceled by the Biden administration, the base Keystone Pipeline system into the US had its capacity hiked this year from 590,000 b/d to at least 610,000 b/d with more growth on the way through optimization efforts, according to operator TC Energy.

In August, the Enbridge Mainline and Trans Canada pipeline systems are increasing apportionment on their networks, meaning that shippers' nominated volumes are being reduced because of pipeline constraints.

Such concerns are expected to be alleviated by the Trans Mountain expansion, but multiple delays have pushed its completion out to July 2023 at the earliest. The expansion essentially twins the existing 300,000 b/d Trans Mountain system from the Edmonton area to Burnaby, British Columbia, increasing total capacity to 890,000 b/d.

In the meantime, rail can benefit. Just prior to the global breakout of COVID-19, Canadian crude-by-rail export volumes hit an all-time high of 411,991 b/d in February 2020 because of severe pipeline constraints. After bottoming out at 38,867 b/d in July 2020, those rail volumes had rebounded to 165,000 b/d in September 2021 just before the Line 3 replacement came online, according to the Canada Energy Regulator. The crude-by-rail volumes then fell to 132,000 b/d for several months.

Now, crude-by-rail volumes have risen from 144,000 b/d in April to 173,122 b/d in May, which is the latest update from the CER, with more growth anticipated.

This week, WCS at Hardisty was assessed at NYMEX WTI CMA minus $19.80/b, compared to a discount of closer to $13/b in much of May.

That meshes with rising Canadian crude production.

Canadian crude oil production has grown considerably over the last 30 years, from 1.7 million b/d in 1990 to nearly 4.7 million b/d in 2019. Because of heavier-than-usual seasonal maintenance, Canadian crude production fell from 4.8 million b/d in March down to just 4.5 million b/d in May and June, according to Platts Analytics. However, with the conclusion of maintenance, volumes quickly ramped back up to an estimated 4.9 million b/d for July and August. Canadian flows are forecast to hit a record high of 5.23 million b/d by December, according to Platts Analytics.

Some rail projects are fighting to become more economically competitive. Canadian Pacific Railway is working with partners ConocoPhillips, Gibson Energy and USD Partners to currently move about 50,000 b/d of new DRUbit crude, a proprietary heavy Canadian crude oil specifically designed for safer rail transport. CP has a new crude-by-rail terminal in Port Arthur, Texas, to receive the Canadian crude processed specifically for rail travel along the CP and Kansas City Southern networks.

"This pattern of supply eventually exceeding pipe takeaway capacity is driving the demand for a crude-by-rail egress solution," said USD Partners Chief Commercial Officer Brad Sanders in an August earnings call. "Given these milestones and potential advantages relative to egress alternatives, we are focused on transitioning 100% of our rail capacity to support the growth of our DRUbit-by-rail network."