The crude-by-rail phenomenon that had led to the rapid build-up of new rail terminals in Western Canada is losing steam.
A few years ago, energy producers and midstream companies piled into the rail business as an insurance against pipeline constraint and as heavy oil benchmark Western Canada Select (WCS) traded at a discount of as high as US$40 per barrel against Western Texas Intermediate.
It made sense at the time to haul barrels on rail, paying US$16-US$20 per barrel to reach Gulf Coast and still turning a profit, and in the process elbowing out the more expensive Maya Mexican crude. It takes around US$7 to pipe a barrel from Alberta to the Gulf Coast.
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“This business took off like a rocket,” driven by heavy discounts of Canadian oil against other North American blends, said John Zahary, president of Altex Energy Ltd., which runs five rail terminals across Western Canada. “But the economics just aren’t there to justify shipping crude by rail, so shippers have lost interest.”
But now the spread has narrowed, with WTI trading at US$43.32 per barrel Tuesday versus US$30.11 for WCS, making rail transportation uneconomic.
“Right now, with a WCS-Maya differential of -$6 per barrel and rail movements about $14 per barrel to ship, the arbitrage window is closed,” says David Arno, editor at Sugar Land, Texas-based energy consultancy Genscape.
Crude shipments by rail fell to just over 95,000 barrels a day in February, the lowest level since July and much lower than the 161,000 bpd on average in 2014, according to the National Energy Board.
Data from the Association of American Railroads shows Canadian tank cars loaded with petroleum and petroleum products have fallen for the past four months, declining by 15.7 per cent in March, compared to the same period in 2015.
Both Canadian Pacific Railway Ltd. and Canadian National Railway Co. reported declines in crude and petroleum revenues in the first quarter compared to the same period last year.
Pipeline companies have also stepped up, with Enbridge Inc.’s Mainline conduit that connects Alberta to North American refineries adding 250,000 bpd of new capacity last year.
“The pipeline companies have done a very good job,” Zahary said. “With relatively small dollars, they have been able to bring a bit more capacity down the pipeline, and that has taken the pressure off.”
Torq Energy Logistics Ltd., which transports heavy conventional oil from southern Alberta and Saskatchewan to refineries across North America is using only a quarter of its 100,000-bpd capacity spread over six crude-by-rail terminals, said CEO Jarrett Zielinski.
“We have seen a drop in conventional heavy output and the production that remains is going to pipe as the economics is better,” Zielinski said.
At Calgary-based Altex, unfavourable transport economics have left the company using just a third of its 100,000-bpd capacity, forcing it to cut its headcount by 50 per cent.
“There is probably about 300,000 or 400,000 bpd unused rail capacity,” Zahary estimate, noting that the 35-odd small ‘mom-and-pop’ rail terminals across Western Canada are mostly “shut and gone.”
“The rail terminals business in Canada is migrating back to where it started six years ago with Altex and (partner) Canadian National focusing on heavy oil,” he said.
Heavy oil’s margins are better as producers do not need to mix bitumen with expensive diluents to ship on tank cars as they do on pipelines.
Calgary-based Torq, which has also seen layoffs, is developing a multi-commodity business to reduce its dependence on crude rail shipments that once made up half its business and enticed private equity giant KKR & Co. to pump $250 million into the business in 2013.
“We also see more niche opportunity in the crude-by-rail space where we take the product from one region to a much shorter haul to another region rather than the Gulf Coast,” Zielinski said.
But rail serves as a safety valve. The week-long shut down of TransCanada’s Keystone pipeline in April highlighted rail as a valuable backup and helped companies such as Altex secure new business, even though the pipeline was shut for only a short time.
Further over the horizon, Enbridge expects a shortage of 500,000 barrels per day of pipeline capacity through 2021 as production increases, which should keep rail terminals engaged.
“We are waiting for the next pinch because production continues to grow,” Zahary said. “If a pipeline went down or there was a crossover point between production and takeaway capacity, people will call their friendly, neighbourhood rail man.”