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CALGARY, Alberta (Reuters) - Bargain-basement discounts on Canadian crude are more than just a short-term irritant for producers as surging supplies and a limited U.S. Midwest refining market threaten to cut industry-wide revenues by as much C$18 billion ($18 billion) a year, an analyst said on Monday.
Wide light and heavy crude price spreads plaguing the Canadian market since the start of the year could expand even more in the coming two months as numerous refineries begin maintenance, and the end of that work and start of a reversed pipeline to Texas from Oklahoma won't bring permanent relief to fundamental problems, Andrew Potter, analyst at CIBC World Markets, said.
"Discounts are severe," Potter told investors in a conference call. "If you don't think this is a big issue, think again."
He said the situation could last beyond 2013, when the Keystone XL southern portion starts to drain large volumes of supply from the Cushing, Oklahoma, storage hub and moves it to Texas refineries.
The northern, cross-border portion of Keystone XL and or new pipeline capacity to Canada's West Coast are not expected to start up until the second half of the decade.
Another factor that may ease the situation could be a reversal of Royal Dutch Shell's (RDSa.L) 1.2 million barrel a day Capline pipeline to Illinois from the Gulf Coast, Potter said. One source told Reuters on Monday that the concept is under discussion.
Canadian synthetic crude, derived from the Alberta oil sands, and Bakken light oil, from North Dakota shale deposits, are selling for around $16 a barrel and more under U.S. Benchmark West Texas Intermediate crude and $34 under the international Brent marker.
That compares with premiums to WTI as late as December, and comes at a time when supply is constrained by the unplanned outages at oil sands upgrading plants run by Syncrude Canada Ltd and Canadian Natural Resources Ltd (CNQ.TO).
Last week, Canadian Natural executives said they are among those who believe differentials will improve by around mid-year. Then, maintenance at refineries equaling capacity of 350,000 barrels a day will have wrapped up, and the Seaway Pipeline, run by Enterprise Products Partners EDP.N and Enbridge Inc (ENB.TO), begins shipping 150,000 barrels a day to the Gulf Coast from the over supplied Cushing, Oklahoma, storage hub.
Seaway is due to be expanded to 400,000 barrels a day by the early part of 2013.
However, Potter said his view has changed to the more pessimistic over the past three weeks as he delved into expectations for supply increases as well as the impact of three major U.S. Midwest projects to shift to heavy from light oil feedstock.
Conversions at the Wood River, Illinois, refinery run by ConocoPhillips (COP.N) and Cenovus Energy Inc CVE.TO, Marathon Petroleum's (MPC.N) Detroit refinery and BP Plc's (BP.L) Whiting, Indiana, plant will add a total of 470,000 barrels a day of capacity for Canadian heavy crude.
However, those projects will also displace 430,000 barrels a day of light crude in an already glutted market, with Bakken supplies surging at a rate of as 10,000-20,000 barrels a day each month. Such gains were not anticipated when the conversions were first being planned.
That is expected to create competition between light and heavy grades as refiners could choose to run light barrels with so much available, pointing to deeper discounts for all Canadian grades, Potter said.
Stocks most at risk under the scenario include producers that do not have refineries and produce much of their oil in Canada, such as Canadian Natural, Canadian Oil Sands Ltd COS.TO, all of whose cash flow is derived from its 37 percent stake in Syncrude, as well as shale-oil producers Crescent Point Energy (CPG.TO) and PetroBakken PBN.TO, he said.
Integrated companies, including Suncor Energy Inc (SU.TO) and Cenovus, would benefit as their refineries have access to cheap feedstock.
Despite the fact that they are forgoing revenue on exploration and production due to the deep discounts, "they're absolutely printing money on the downstream side," Potter said.
Additional reporting by Bruce Nichols in Houston