Oil-by-rail deal up in the air ahead of Alberta’s provincial election and CP Rail CEO objection

The Alberta government announced it’s investing CAD $3.7 billion to move the province’s land-locked oil to market by rail by leasing 4,400 railway cars to move up to 120,000 barrels of oil per day by 2020, with shipments to begin as early as July. At a news conference Tuesday, Premier Rachel Notley said, “Pipelines will always be the best, most efficient, most economical long-term solution. We must take action today to provide more relief to our energy workers and the families who rely on these good jobs across this province and this country … Albertans don’t just stand by. We take action.”

The province estimates the plan will lead to a CAD $5.9-billion increase in royalties, tax revenues and profits over three years, meaning a net gain of CAD $2.2 billion. It expects the discount for Western Canadian heavy oil versus U.S. light crude will shrink by USD $4 a barrel.

However, with a provincial election that will be completed by the end of May at the latest, Alberta United Conservative Party (UCP) Opposition Leader Jason Kenney called it “a catastrophic mistake” and said if he wins the spring election, his government will do everything it can to cancel the deal. He is urging Canadian National Railway and Canadian Pacific Railway not to invest too much in the agreement given that it could be shelved. Mr. Kenney says it’s a reckless “corporate welfare” solution that Alberta can’t afford given its multibillion-dollar deficits and rising debt levels. He says the answer needs to be driven by industry and sound economics and suggests that private companies will move more oil by rail when it makes sense to do so.

The CEO of Canadian Pacific Railway voiced his displeasure at the idea, speaking at a conference in Miami on Wednesday: “So the government steps in, we didn’t like it at all,” said Keith Creel, “I don’t think that’s healthy in a commercial space. You can let the commercial deals work and let commerce take place and the deals will drive right good business decisions and investment decisions,” adding that the move caused “uncertainty” and “I was pretty clear about it — I just don’t think it’s healthy.

The railways have drawn on lessons from unfilled contracts following the crude-by-rail boom five years ago, entering into multi-year contracts with oil shippers that set minimum volumes and higher fees to help insulate them from volatile demand. “We realized the risk in dealing with crude, probably more so than any other railroad because we were burned so bad the last time,” Mr. Creel said. Crude-by-rail exports have spiked over the past year amidst a pipeline shortage and a big discount on Western Canadian Select oil, hitting a record 353,789 barrels per day in December, a 133 percent year-over-year increase, according to the National Energy Board.

Alternatively, 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. 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. Cenovus CEO Alex Pourbaix said in an interview, “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. I certainly wouldn’t make that bet.

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

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

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.