February 21, 2019 / 6:23 PM / in 2 months

Canada's Cenovus bets on rail to move crude, fearing full pipelines

WINNIPEG, Manitoba/NEW YORK (Reuters) - Cenovus Energy is pressing ahead with aggressive plans to transport more crude by rail, contrasting itself with peers who have hit the brakes, as the Canadian oil producer bets that pipeline bottlenecks are likely to return.

FILE PHOTO: Pipelines carrying steam to wellheads and heavy oil back to the processing plant line the roads and boreal forest at the Cenovus Energy Christina Lake Steam-Assisted Gravity Drainage (SAGD) project 120 km (74 miles) south of Fort McMurray, Alberta, August 15, 2013. REUTERS/Todd Korol/File Photo

Pipeline congestion depressed Canadian oil prices last year, prompting Cenovus and other producers to increase their reliance on rail to move crude to U.S. refineries. Alberta’s provincial government imposed mandatory production cuts in January, an unusual step that succeeded in narrowing the gap - called a differential - between Canadian and U.S. prices.

That tightening has inadvertently made rail transport less profitable, and producers like Imperial Oil and Suncor Energy pulled back.

But Calgary-based Cenovus, which committed to three-year railway deals last September, is boosting rail shipments five-fold to 100,000 barrels per day (bpd) this year. The company expects the plan will prove shrewd once Alberta lifts curtailment orders and Canada finds ways to satisfy growing U.S. heavy crude demand after sanctions against rival supplier Venezuela.

“The way you get to a conclusion that rail doesn’t make sense is if you believe differentials are going to remain at $10 forever,” Cenovus CEO Alex Pourbaix said in an interview. “I certainly wouldn’t make that bet.”

Shipping crude by rail costs more than by pipeline, so a minimum discount of $15 to $20 per barrel for Canadian oil is generally required to cover the extra expense for buyers. Rail shipments were robust late last year after the discount on Canadian heavy oil topped a record $52 per barrel, but chugged along more slowly this month as the discount shrunk to $10.

Rail shipments are a critical relief valve for Alberta’s oil production, which has grown in recent years while pipeline expansions stalled due to opposition. The resulting glut of Alberta crude in storage depressed prices, hurting corporate profits and accelerating investors’ flight from Canada’s oil patch.

LESS APPEALING

The discount on Canadian heavy crude hovered on Thursday around $13, according to Net Energy Exchange. The Alberta government said on Tuesday that it will launch its own crude-by-rail program, a move that it forecasts will shrink the discount by $4 per barrel and, ironically, weaken railway economics.

“The incentive to move crude by rail has been erased,” Imperial Chief Executive Rich Kruger said on Feb. 1.

Overall rail loadings from Canada plummeted to 156,000 bpd for the week ending Feb. 1 from a weekly record-high average of 356,000 bpd set last month, data from Genscape showed.

The conditions are different for Cenovus than for integrated producers.

Cenovus’s business depends more on spot crude prices, as it mainly produces and sells to other refiners. Imperial and Suncor feed their own refineries with the crude they produce, allowing them to benefit even when prices are low.

For Cenovus, shipping part of its production by rail makes strategic sense because spot prices for the bulk of its output are supported when Canadian oil is flowing smoothly, said Matt Murphy, analyst at Tudor Pickering Holt & Co.

U.S. sanctions against Venezuela have resulted in U.S. refiners paying higher prices for Canadian crude in the Gulf than for U.S. benchmark West Texas Intermediate, Pourbaix said.

“I am highly, highly confident that rail is going to be in the money, certainly by the latter half of this year,” Pourbaix said, adding that Cenovus’s costs are also lower because it owns a loading facility.

The Alberta government has also said it expects Canadian oil prices to widen enough to support rail shipments this year.

Those higher prices in the Gulf absorb some of the hit to Canadian shippers from a narrow differential, resulting in them limiting losses to an estimated $2 to $6 for each barrel moved there by rail, said Jackie Forrest, senior director of Calgary-based ARC Energy Research Institute.

By contrast, some shippers with long-term rail contracts lose as much as $10 by not shipping because of sunk costs and penalties, she said. 

But for many, the economics no longer work.

“As a refiner, I’m not shipping by rail. I don’t need to tighten the market further,” one U.S-based trader of Canadian crude said.

“We’ve gone from an unsustainable wide discount for Canadian heavy to an unsustainably narrow discount,” said Greg Garland, chief executive of refiner Phillips 66, on a quarterly call.

Reporting by Rod Nickel in Winnipeg, Manitoba and Devika Krishna Kumar in New York; Editing by Susan Thomas

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