André-Philippe Hardy:
Welcome to the Industries in Motion podcast from RBC Capital Markets, where we will be exploring what's new, and what's next in today's fast-moving markets and industries. My name is Andre Hardy, and I'm Head of Canadian and Asia-Pacific Research. Please listen to the end of this podcast for important disclaimers.
Now let's get into today's episode. I'm very happy to introduce our two guests, Greg Pardy and Robert Kwan.
Greg is a Managing Director and Head of Global Energy Research at RBC Capital Markets. He helps lead a team of more than 30 professionals in Canada, the United States, Europe, and Australia, who cover energy and utilities companies. He is also directly responsible for research coverage of Canada's senior oil companies. Greg joined RBC Capital Markets in 2009 and has about 30 years of equity research experience. He consistently ranks as a top Canadian energy analyst in independent investor surveys.
Robert is a Managing Director and energy infrastructure analyst at RBC Capital Markets, primarily covering Canadian midstream companies. Robert joined RBC in 1998 in investment banking, and joined the energy infrastructure research team in 2003. He has been the lead analyst for our Canadian pipelines, power and utilities team since 2007, which has been consistently top-ranked in independent investor surveys.
Today we'll be discussing the Canadian government’s Trans Mountain Pipeline Expansion, or TMX, which is slated to be in service during the first quarter of 2024. We expect this pipeline expansion to transform Canada’s oil egress, and give oil sands producers in Canada greater export access to global markets, including Asia.
So Greg, to start, why is this 590,000 barrels per day Trans Mountain Expansion a big deal for Canada? And when is it expected to be completed?
Greg Pardy:
Thanks Andre. The Trans Mountain pipeline has been in operation for about 70 years and it’s the only major Canadian pipeline transporting oil to the West Coast. And just to be clear, it runs from Edmonton, Alberta to Burnaby, BC.
As a made-in-Canada solution, this expansion of the Trans Mountain pipeline will bring its nominal capacity up to 890,000 barrels a day, and that would be versus 300,000 barrels a day where it sits today. Trans Mountain expects this expansion to be mechanically complete by the end of 2023 and then in service during the first quarter of 2024.
And then as you mentioned, this is important. It will give oil producers in Canada more optionality to diversify their oil exports globally. And just to put that into context, about 97% of Canada’s net oil exports went to the US in 2022.
But there’s more to it than that. As long as I can remember, the Achilles heel for oil producers in Canada has been the inability to ship all of their product out of Canada on export pipelines and achieve global prices. We saw this drama play out again and again over the years. The reason TMX is so important is that for the first time, in my memory at least, Western Canada will have excess export pipeline capacity that we peg at about 200,000 to 300,000 barrels a day once the expansion is in service next year, and we don’t expect that space to be filled until 2026. That is very good news for oil prices in western Canada, which we’ll come back to later.
André-Philippe Hardy:
Thanks Greg, that’s really helpful context. Robert, TMX has experienced some significant cost escalations since it was approved. Can you explain that to us?
Robert Kwan:
Yes, it definitely has, Andre. At C$30.9 billion, TMX has seen its costs balloon from C$7.4 billion when the project was approved back in 2019. This reflects schedule delays and cost overruns related to inflationary and supply chain pressures, severe flooding in British Columbia, the pandemic, as well as community consultation costs.
André-Philippe Hardy:
Thanks. We’re talking here about a fairly significant capacity expansion. Do you expect Trans Mountain to run at full capacity once it comes online?
Robert Kwan:
Trans Mountain is a contracted pipeline and shippers have signed long-term agreements covering 80% of the pipeline’s capacity, so its take-or-pay nature and high fixed toll component of the contract creates a sunk cost for shippers. It is possible that the 20%, and that’s about 178,000 barrels per day, and that 20% spot capacity that’s been reserved on Trans Mountain for unconctracted shippers may not be fully utilized.
André-Philippe Hardy:
And then what happens to Enbridge’s Mainline pipeline once TMX is on?
Robert Kwan:
The Mainline is an uncontracted common carrier pipeline. We expect producers to shift barrels largely off of that system and onto Trans Mountain based on shippers’ contractual commitments, as we just talked about. We expect Mainline volumes could fall about 200,000 to 300,000 barrels per day when TMX is fully in service, with that capacity slowly filling back up over time.
André-Philippe Hardy:
And what’s the proposed toll associated with the use of the pipeline, following completion of TMX? And what are some important considerations you’d associate with that?
Robert Kwan:
Yeah, in June 2023, Trans Mountain filed Interim Tolls to reflect the flow through of the escalation of certain expansion capital costs. The Trans Mountain spot toll likely makes some shipping routes uneconomic, which benefits the competing pipelines. The recently filed interim toll for the roughly 20% of Trans Mountain’s uncontracted capacity is approximately $13.50 per barrel for heavy oil, which maps to about US$10 per barrel. That toll though is subject to Canada Energy Regulator approval, and that process is ongoing. At this level, we believe the cost of shipping spot barrels down Trans Mountain plus the tanker cost and the Panama Canal expense to the U.S. Gulf Coast now makes this route uneconomic versus competing pipeline routes such as the Keystone pipeline system, as well as the Enbridge Mainline onto the Flanagan South pipeline, and then Seaway into the Gulf Coast.
André-Philippe Hardy:
So, on that topic Greg, what is the cost to ship a barrel of oil on an Aframax oil tanker these days?
Greg Pardy:
Aframax tanker freight costs are volatile in the daily rate, but directionally we understand that it would cost about US$0.90, so call it a dollar a barrel, to move a barrel from Burnaby into Long Beach, California, somewhere in the neighbourhood of $3.50 to $4.00 per barrel from Burnaby into China, and US$6.50 to US$7.00 per barrel from Burnaby into India.
André-Philippe Hardy:
So how big of a deal is Trans Mountain’s higher toll for Canadian oil producers?
Greg Pardy:
Yeah, this is not trivial by any stretch. The higher Trans Mountain toll, which is applied to all Trans Mountain barrels then, it just serves to erode the netback, the margin, of these barrels as they seek export markets, including Asia.
André-Philippe Hardy:
Should a higher Trans Mountain toll impact the price of Canadian oil? How are you thinking about the spread between Western Canada Select (or WCS) and the WTI oil prices?
Greg Pardy:
Yeah, we have had to really think through that. And I think where we’ve landed is that the toll is just not the determining factor just given the low variable cost, that’s around C$0.95 a barrel, which should be a greater driver of producer decision making. In our minds it’s far more important that western Canada will move into a period of excess export pipeline takeaway capacity next year once TMX is in service. And again, we don’t expect that excess pipeline space to be filled until 2026.
Now this is a bit technical, but structurally, the expansion of TMX then should serve to dampen volatility and compress what we refer to as geographical or location spreads but remember, WCS-WTI spreads, that is comparing a heavy sour barrel, which is WCS, to a light sweet barrel, which is WTI, so the light-heavy spread matters and will be impacted by OPEC+ output policy decisions amongst other factors.
André-Philippe Hardy:
And on that topic, why were WCS-WTI spreads so tight back in June?
Greg Pardy:
Yeah, a bit of a perfect storm and lots of reasons. But it’d say China’s voracious appetite for heavy barrels coming out of its Zero-COVID policy, oil sands maintenance and supply limitations elsewhere, shut-ins due to Alberta’s wildfires, relatively low commercial oil inventories in western Canada, and negligible apportionment on the Mainline were all factors. WCS spreads have widened out recently as supply has returned to the market.
André-Philippe Hardy:
So sticking with you Greg, we spoke earlier about the Trans Mountain expansion improving the ability for Canadian oil sands producers to export to global markets. Where will Canadian heavy oil barrels go once TMX is on-line? And are the Canadian oil sands growing much?
Greg Pardy:
Yeah, the majority of Trans Mountain’s current 300,000 barrels a day capacity, let’s just start there, is exported to PADD V in the US, so mainly to Washington State, about two thirds of those exports going into Washington State, with just under call it 30,000 barrels per day or 10% exported to California. But once TMX is on-line, we expect additional oil sands barrels to penetrate Asia, but more importantly California, and as those barrels move into California we expect to see some displacement of waterborne imports.
And the question you’re asking is also very important. The short answer with respect to oil sands growth is that we don’t expect much over the next several years. And we peg oil sands growth from 2022 to 2027 to grow at a compound annual growth rate of just 2%. And that reflects a couple of things. The first is just decarbonization initiatives and lack of social license to grow high GHG emissions barrels, and the second one is something that we’ve seen really resonate in the energy sector, which is shareholder preferences for distributions (i.e. dividends and buybacks) versus production growth.
André-Philippe Hardy:
Thanks Greg. Going back to the Trans Mountain pipeline expansion, Robert, you’ve published that we’re waiting for the “for sale” sign to go up. Can you talk us through that, and who might ultimately buy it?
Robert Kwan:
Yeah, thanks Andre. So timing wise, Trans Mountain expects the expansion to be operational in early 2024, although absent potentially significant contingent payments, we assume potential buyers will need to see the pipeline's tolls finalized by the Canada Energy Regulator, which could be several months after the expansion is placed into service, particularly given current shipper concerns with the interim tolls.
Now ultimately, we expect an Indigenous-led consortium to acquire the project. That being said, due to the likely size of the transaction, we believe the number of strategic parties that could be involved will be very limited, with only Pembina in our Canadian midstream coverage universe publicly expressing an interest via its Chinook Pathways partnership with the Western Indigenous Pipeline Group. We also see the potential for interest from financial players, whether in partnership with Indigenous communities and/or joining an existing consortium such as Chinook Pathways.
André-Philippe Hardy:
Well Greg and Robert, thank you very much for your time. This has been really informative, and the Trans Mountain expansion will certainly transform Canada’s oil egress picture when it comes online.
So what else lies ahead in today's ever-evolving markets and industries? We'll be keeping track right here on Industries in Motion. Thank you for joining us on this episode recorded on August 2nd, 2023. Please make sure you subscribe to Industries in Motion wherever you listen to your podcasts. And if you'd like to continue the conversation, or if you are interested in more information, please contact your RBC representative directly, or visit our website at www.rbccm.com. Thank you very much.
Speaker 4:
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