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Canadian National Railway prepared for more crude-by-rail deliveries

Alberta's government is expected to announce deals with local oil producers for crude-by-rail contracts it signed earlier in 2019 with two large Canadian carriers, and a top executive of one railroad said the company is already prepared for deliveries.

Canadian National Railway Co., one of the two carriers, built out 300,000 barrels per day of crude capacity after Alberta's production curtailments debuted in January, confident that more crude carloads would be forthcoming, the company's senior vice president of rail centric supply chain, James Cairns, said during its third-quarter earnings conference call.

"In September, we moved about 180,000 bbl/d" of crude by rail, Cairns said. "We still have that latent capacity available to move [more] crude if, in fact, it does become available."

As prices for Canadian crude fell in 2018 due to limited pipeline takeaway and government approvals for new pipe capacity stalling, Alberta imposed a production cap of 3.56 million bbl/d, an amount that has since crept up. In October, the cap is 3.79 million bbl/d and December's will be 3.81 million bbl/d.

The province bought rail cars and signed capacity agreements with Canadian National Railway and Canadian Pacific Railway Ltd., expecting it would manage crude-by-rail arrangements with producers. As a result, more crude-by-rail shipments were expected to materialize.

But then Alberta had a change of government, and the new administration decided to offload the contracts to producers instead. That has taken time to digest, and an announcement on those deals is expected by the end of October.

In the meantime, Canadian National Railway now has a lot of spare capacity, Cairns said.

"Indications are pretty clear that we will see the Alberta government crude contracts going to private hands here in short order, possibly by the end of the month, and we're very excited to start moving that crude volume when it does," Cairns said.

Canadian National Railway rail cars moved a record average of 232,000 bbl/d of crude in the fourth quarter of 2018, with December, the peak month, at 250,000 bbl/d.

But the fourth quarter of 2018 was a mixed period for the crude carried by Canadian rail companies generally as Western Canadian Select's, or WCS's, discount to West Texas Intermediate widened, topping $30 in December and on one day, as much as $40, according to S&P Global Platts data. Some producers shipped below their take-or-pay contract levels and idled capacity as a response to Alberta's forthcoming production restrictions.

Canada's crude-by-rail volumes, which averaged 353,789 bbl/d in December 2018, dropped to 122,292 bbl/d in February 2019 as the production curtailments took effect, according to the Canada Energy Regulator, formerly known as the National Energy Board.

But as the WCS discount gradually decreased owing to less output, rail shipments increased. Shipments averaged 286,701 bbl/d in June and 313,283 bbl/d in July, although in August, they ticked down slightly to 310,146 bbl/d, according to the Canada Energy Regulator.

In the fourth quarter of 2019, Canadian National Railway will not match its year-ago record and will also see a small quarter-on-quarter decrease "unless something changes," said Cairns.

Moreover, the price differentials "aren't quite there yet," Cairns added. "It's really going to be dependent on if the Alberta government is successful in placing its contracts in private hands and if they lift the curtailment on production."

On the other hand, Canadian Pacific saw sequential growth in crude-by-rail shipments in the third quarter and expects still higher volumes in the fourth quarter, John Brooks, chief marketing officer, said Oct. 23 during a conference call.

Canadian Pacific moved over 28,000 crude carloads by rail in the third quarter, compared with about 25,000 carloads in the second quarter. It is eyeing 30,000 carloads in the fourth quarter.

Like Canadian National Railway, Canadian Pacific is "increasingly optimistic that the Alberta government will come to a resolution on the transfer of our crude contract," Brooks said.

Brooks also said Canadian Pacific has seen "growing interest with our shippers," adding 30,000 carloads was the carrier's peak level during the last crude-by-rail surge earlier in the decade.

In the last 11 trading days, the WCS discount to WTI has weakened from the $14s per barrel in early October to the $16s/bbl to $17s/bbl. On both Oct. 21 and Oct. 22, the discount was $17.05/bbl, according to Platts data. Analysts and industry executives have cited a spread in the high teens as an incentive for crude-by-rail deliveries.

"Differentials somewhere in the range of [minus] $14/bbl to $15/bbl should be a strong pricing signal moving forward to get back in the game," Cairns said. "But ... I think the government curtailment and the kind of capital and the amount of crude produced puts an artificial cap on the differential."

"Customers look very, very hard about getting back into the crude-by-rail space without some notion of longevity," he said.

Canadian National Railway has 200,000 bbl/d of spare capacity "that is not moving, that's in the ground, that wants to move" if the output caps are lifted, Cairns said.

In order for Canadian National Railway to create the capacity, President and CEO Jean-Jacques Ruest said, its contract with Alberta had an agreement for the carrier "to be protected with some minimum amount of cash, just to have the capacity available — even if we [didn't] move the crude."

Starr Spencer is a reporter with S&P Global Platts. S&P Global Market Intelligence and S&P Global Platts are owned by S&P Global Inc.