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2 Big Challenges for Canadian Oil Sands Producers

Tuesday - 3/26/2013, 12:00pm  ET

The Canadian province of Alberta contains some of the largest known reserves of recoverable oil sands anywhere in the world. Not only can these oil sands provide both the U.S. and Canada with greater energy security, but their continued development could also lead to tens of thousands of jobs and other economic benefits for both nations.

While production from Alberta’s oil sands has ramped up significantly in recent years, transporting the crude oil to U.S. refiners has proved a major obstacle. In fact, limited transportation infrastructure has been one of the biggest reasons for the massive price disparity between Canadian oil sands crude and other crude oil benchmarks like Brent and West Texas Intermediate.

Let’s take a closer look at these transport challenges, as well as some of the methods U.S. refiners have used to overcome them.

Transport difficulties
In transporting crude to the U.S. Gulf Coast, Canadian producers have encountered two main problems.

The first is the delay of the proposed northern leg of the Keystone XL pipeline, operated by Canadian midstream company TransCanada . Its construction continues to face serious opposition on environmental grounds, though it did recently get a major boost from a U.S. State Department study that concluded in its favor.

The second is the strong competition between Canadian oil sands crude and American crude supplies, such as those produced in North Dakota’s Bakken Shale, for the limited pipeline capacity that currently exists.

As a result of these problems, Canadian oil sands crude – as reflected by the benchmark Western Canada Select – has traded at a massive discount to other crude oil benchmarks. Oil sands producers, which already face exorbitantly high production costs due to the complexity of oil sands drilling, have responded by reducing expenses.

For instance, Suncor , Canada’s biggest oil and gas producer by market value, announced in December that it would reduce its capital spending budget for 2013 from C$7.5 billion to C$7.3 billion. And Canadian Natural Resources announced that it will be reducing expenses related to thermal sand production, a process commonly used in Alberta’s oil sands.

Rail emerges as a dominant alternative to pipelines
While Canadian pipeline giant Enbridge has attempted to combat some of these transport issues by boosting capacity on existing pipelines from Western Canada and by reversing some pipelines to transport crude into Eastern Canada, it hasn’t been enough to satisfy U.S. refiners. Faced with limited pipeline options, many are increasingly turning to rail and other methods to quench their thirst for heavy Canadian crude.

For instance, Phillips 66 recently said that it is now delivering Canadian crude to its California refineries via rail. Though it didn’t provide further details, the company does have prior experience in using rail to transport crude, having already purchased about 2,000 general purpose railcars to move inland oil to its refineries.

And Valero is also expecting to boost its use of rail and barge to move Canadian crude to its Gulf Coast refineries, of which the majority are equipped to process heavy oil. For delivering crude to its refinery in St. Charles, La., the company plans on using waterborne transport methods, such as barge.

Use of rail expected to accelerate
As these examples suggest, Canadian and U.S. railroad companies have been hard at work putting down new tracks and installing new loading facilities to move crude from Alberta’s oil sands into the U.S.

Many energy companies, including some of the aforementioned refiners, have even purchased tank cars to lower transport costs. In fact, demand is so high that the waiting period for new tank cars in Canada may be as long as two years, according to industry sources. What's more, experts expect a further acceleration of crude shipments via rail.

Peters & Co., a full service Canadian investment advisory firm with a focus on the oil and gas industry, estimates that Canadian railroads will triple the amount of crude they deliver to 200,000 barrels per day by the end of this year. As it turns out, their calculations may have been too conservative; Canadian railroads are already delivering 150,000 barrels a day, with other sources projecting that number will double by year's end.

Final thoughts
While alternative methods like rail and barge may serve as an adequate temporary solution, pipelines are still the most efficient and economical way for U.S. refiners to reap the benefits of soaring Canadian oil sands production.

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