Will TransCanada Corporation (USA) (NYSE:TRP)’s Keystone XL pipeline save the oil sands? Probably not.
Even if the U.S. State Department approves the Keystone XL pipeline, Canadian crude will continue to trade at a discount, hampering production growth.
Massive production growth
According to the Canadian Association of Petroleum Producers, total western Canadian output is expected to increase 30% to 3.7 million b/d by 2015. Most of this growth will be driven by the oil sands as dozens of new in-situ projects come online.
In addition, fracking has transformed North Dakota into America’s second largest oil producer producing 770,000 b/d in 2012. According to the U.S. Department of Energy, Bakken production is expected to rise to 1.15 million b/d by 2014.
Basically we have two rivers of oil all converging at the same spot in the upper Midwest. Whoever is willing to take the lowest price wins.
And the situation is only getting worse. This year, only 120,000 b/d of pipeline capacity is expected to open versus 250,000 b/d of new production coming online. Already we’ve seen shippers like Enbridge Inc (USA) (NYSE:ENB) ration capacity on its lines.
Pipeline gridlock
TransCanada Corporation (USA) (NYSE:TRP)’s Keystone XL pipeline is seen as a savior for the industry. If approved, the pipeline would ship 830,000 b/d of Alberta crude south to Gulf coast refineries. However, the project faces stiff resistance from environmental groups and still requires approval from the U.S. State Department before construction can begin.
But even if Keystone XL is built, it won’t be enough to keep up with growing production from the Alberta oil sands and the Bakken.
Assuming both the Enbridge Inc (USA) (NYSE:ENB) Alberta Clipper and Keystone pipelines are built, which will add a combined one million b/d of new capacity, upstream production will still exceed transportation capacity by 2018.
To address this problem, pipeline companies are trying to access Asian markets by shipping crude to the west coast.
Enbridge Inc (USA) (NYSE:ENB)’s Northern Gateway pipeline proposal if approved, would ship 550,000 b/d from Edmonton Alberta to west coast town of Kitimat British Columbia. However, the $6 billion project was rejected by the B.C. provincial government over environmental risks.
Kinder Morgan Inc (NYSE:KMI)’s Trans Mountain extension proposal would increase capacity from 300,000 b/d to 890,000 b/d. However, this project faces mounting pressure from environmental groups. A recent spill on the same route last week has also diminished the chances of this project being approved.
But even if all four projects (Clipper, Keystone, Gateway, and Trans Mountain) are approved, energy production would still exceed pipeline capacity by 2023. Ten years is not a long period of time in the pipeline business.
Rails won’t be enough
Rail roads have supplemented pipelines to cover gaps in transportation capacity. Because rail faces fewer political obstacles, over the past three years the number of crude rail car shipments has tripled.
Canadian National Railway (USA) (NYSE:CNI) has been a big beneficiary of this trend with analysts projecting oil shipments to reach 110,000 b/d this year. By 2014, Canadian National could ship 250,000 b/d by rail; by 2015, crude shipments could hit 300,000 b/d accounting for 7% to 8% of revenues.
But rails won’t be able to cover the gap if pipelines aren’t constructed. Already, the industry is struggling to keep up with demand due to a shortage of crude rail cars and loading terminals.
Investor implications
For Canadian oil producers, investors will have to cut back on their production growth estimates if sufficient pipeline capacity can’t be added . Investors should also be concerned that the price these producers receive for their product will diminish.
Already, Western Canadian Synthetic, a barometer of oil sand crude prices, trades at a $20/brl discount to international benchmarks. This could widen considerably as new production is added and supply chain bottlenecks get worse.
As the largest player in the oil sands, Suncor Energy Inc. (USA) (NYSE:SU) is a bellwether.
In 2012, Suncor’s oil sand operations produced 325,000 b/d with the goal of increasing production 10% annually over the next decade. Those expectations have already been ratcheted down and may need to be reduced further.
Earlier this year, the company slashed $1-billion from its 2013 capital spending budget, cutting spending in the Fort McMurray region nearly in half compared to early expectations for 2012. Suncor also cancelled its $11.6 billion Voyageur upgrader plant.
The decision clouds the outlook on the company’s Fort Hills expansion, another major oil sands development. A decision is expected by the end of the year but the company hasn’t been direct with investors regarding its plans.
Expect similar decisions from other upstream producers in the Canadian oil patch if conditions do not improve.
Foolish bottom line
For the Canadian oil sands, everything hinges on the approval of the Keystone XL pipeline. But even if the project is approved, it might not be enough to save the industry.
The article Keystone Won’t End Canada’s Oil Glut originally appeared on Fool.com and is written by Robert Baillieul.
Robert Baillieul has no position in any stocks mentioned. The Motley Fool recommends Canadian National Railway (NYSE:CNI). Robert is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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