Houston — The $25 billion combination of Canadian Pacific Railway with Kansas City Southern creates the first single-path crude-by-rail gateway from Alberta to the Houston-area refining and export network, but it does not mean overall Canadian crude volumes to the US Gulf Coast are going to surge.
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While the combined company Canadian Pacific Kansas City may offer cheaper shipping rates for Canadian heavy oil sands when it is integrated in mid-2022, analysts said notably greater crude-by-rail volumes would only come if major oil pipelines are shuttered, such as the in-progress Line 3 Replacement project, the four-year-old Dakota Access Pipeline, and the pending Trans Mountain Pipeline expansion.
The combined entity would have more efficiency in scheduling, and likely would reduce the cost of movements from Canada to the US Gulf Coast, since there would no longer be interchange fees for switching rail lines, according to S&P Global Platts Analytics.
"Any lowering in an offered railing rate to the Gulf Coast would not be enough to be able to compete with pipeline capacity; it just may be able to better compete with other railing volumes, such as on Canadian National," said Kendrick Rhea, energy analyst with East Daley Capital Advisors.
Indeed, rival Canadian National Railway currently offers the only seamless crude-by-rail route from Edmonton to the USGC. However, Canadian National only terminates in the refining hub of St. James, Louisiana. By scooping up Kansas City Southern, Canadian Pacific will offer routes to St. James and Lake Charles, Louisiana, as well Texas destinations near Houston, Beaumont and Corpus Christi.
Notably, the combined Canadian Pacific Kansas City also would bank on growth by shipping more refined crude oil products into Mexico. That is expected to prove more beneficial thanks to the revised United States-Mexico-Canada Agreement trade deal.
In recent years, Canadian Pacific has focused on improving oil sands crude transportation into the US, while a key source of Kansas City Southern's growth was its increased movements of refined products into Mexico. The two companies' rail networks do not overlap, and they link up, not coincidentally, in Kansas City, Missouri.
The integrated company would count 20,000 miles of rail network stretching from the Alberta oil sands down past central Mexico.
Canadian oil production has recovered from its pre-pandemic volumes of about 5 million b/d of crude oil, condensate and diluent, while US production is still down by about 2 million b/d from its pre-COVID-19 volumes.
Imports of Canadian crude to the US Midwest and USGC combined were expected to recover to around 2.9 million b/d in March from less than 2.6 million b/d in May 2020, according to Platts Analytics.
However, crude-by-rail volumes are not yet recovered and may not rebound for quite some time.
A decade ago, Canada's crude-by-rail exports were borderline insignificant, but that changed when production started outpacing pipeline capacity. Rail volumes really surged from 2018 until the pandemic took hold in March of last year. 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.
Exports have since rebounded to 195,531 b/d in January, according to the Canada Energy Regulator.
But since early this year the price spread between Western Canadian Select at Hardisty, Alberta, and the USGC has narrowed to levels that make most spot rail shipments uneconomical. Shipping crude by rail from Hardisty to the USGC can cost anywhere between $12/b and $18/b, traders say.
That is why Platts Analytics projects crude-by-rail exports to dip within the 100,000-150,000 b/d range for most of the rest of 2021 and stay depressed in 2022 and potentially beyond.
So, the crude-by-rail aspect of the merger will focus more on competing for market share than anything else, while also take some crude volumes from the trucking industry.
Another dynamic expected to help on the market-share front is a joint project that Canadian Pacific and Kansas City Southern partnered on with operator US Development Group before the merger.
The companies are nearing a mid-2021 completion of a new diluent recovery unit at US Development Group's Hardisty terminal hub and a new Port Arthur terminal in Texas that would receive the oil sands crude by rail. The diluent recovery unit removes the diluent from the Canadian bitumen. The resulting crude is called DRUbit, a proprietary heavy Canadian crude oil specifically designed for safer rail transport along the Canadian Pacific-Kansas City Southern network.
The crude-by-rail networks remain temporarily buoyed by pipeline shortages, but that is about to change if pipeline operators' plans are seen to fruition.
The main one is Enbridge's Line 3 Replacement project that would increase crude pipeline capacity from 370,000 b/d now up to 760,000 b/d as it moves Canadian crude from Alberta to Superior, Wisconsin, linking up with networks to the USGC.
The Line 3 project is 50% built and slated for a fall 2021 completion, but legal challenges remain in effect, and the next, long-shot effort to stop the project is expecting a court ruling within 90 days.
Then there is the Canadian government's delayed, but still progressing, Trans Mountain Pipeline expansion, slated for a 2023 completion, that would further deplete crude-by-rail demand.
"With Canadian pipeline projects such as Enbridge's Line 3 expansion this year and the potential start-up of the Trans Mountain twin pipeline in 2023, the Canadian market is unlikely to see railing volumes return to pre-pandemic levels going forward as these pipelines will provide more economic egress to railing," Rhea said.
On the other hand, US President Joe Biden already has canceled the competing Keystone XL Pipeline project, although TC Energy still plans to add optimization capacity to the base Keystone system later this year.
That is why the politicians and environmental activists fighting pipeline projects provide the biggest wild cards. And that includes crude-by-rail demand from the Bakken Shale, as well as from the Canadian oil sands.
If the Bakken's major crude artery, the Dakota Access Pipeline, is shuttered by court order or by the US Army Corps of Engineers, then Canadian Pacific Kansas City would see demand pick up from North Dakota.
"This combination of railways also provides direct access out of the Bakken to the Gulf Coast, similar to BNSF, which could see an increase in railing volumes if DAPL were to be shut-down for a period of time," Rhea said.
A federal appeals court ruling in January said DAPL is operating without the necessary legal permitting and that it is up to the US Army Corps of Engineers, now under the Biden administration, to determine whether it will let the Energy Transfer-operated pipeline continue to flow Bakken crude during an ongoing environmental review.
US District Judge James Boasberg, who supported shuttering the pipeline last year, will lead an upcoming April 9 hearing to discuss the Corps of Engineers' plans. Either Boasberg or the Corps could order the pipeline closed.