Canada’s oil supply continues to surpass expectations, and aided by technological advancements, namely solvent-assisted technology, there is no shortage of economic growth opportunities.
But pipelines are operating at maximum capacity, leaving few options to move new supply out of the country. To make matters worse, needed expansion projects continue to hit road bumps.
With limited market access, Canadian crude sold at record lows during the fourth quarter of 2018. To combat low prices, Canada’s producers have turned to crude by rail, and the Alberta government ordered mandatory short-term production cuts in 2019. The actions are having a positive impact on pricing, but relief is likely to be short-lived.
To date, Canada’s heavy oil prices have rebounded, but the measures taken are a mere Band-Aid to a larger wound. Unless new pipes are built, Canada will continually suffer from low prices and won’t be able to tap into its vast resource potential.
With record supply, pipelines are desperately needed
Canada's crude supply grew to record levels in 2018. Canadian crude supply averaged a record-high 5.2 million barrels of oil per day during the first quarter of 2018 but dipped to 5.0 million barrels of oil per day during the second quarter because of operators optimizing maintenance; deferred drilling due to high price differentials; and an outage at the Syncrude mining project.
We expect 2018 supply to average a record annual level of 5.1 million barrels of oil per day, which is above our previous forecast of 4.8 million barrels of oil per day (made in September 2017). With supply near record levels, Canada’s major pipelines have been filled to the brim, leaving limited takeaway options.
Canada's shortage of economical takeaway infrastructure limits the sanctioning of the country's vast resource potential. As a result, the heavy oil discount widened to record levels in the fourth quarter of 2018, severely hampering producers' price realizations.
The aforementioned actions are a small bandage for a larger wound, which can only be healed by pipeline expansion. However, pipeline expansion projects have experienced setbacks from the U.S. and Canadian courts, pushing back expected in-service dates and even threatening construction of the Keystone XL and Trans Mountain Expansion.
Expanded market access, lower production costs aid oil sands production growth
We expect the Trans Mountain Expansion, or TMX, TransCanada Corp’s (TRP) Keystone XL, and Enbridge's (ENB) Line 3 replacement to receive final approval and be placed into service by the end of 2022. Until 2022, we expect an increase in rail shipments, which will have a negative impact on oil sands producers' project economics, but not as severe as pure exposure to the heavy oil discount.
Once these pipeline projects are placed into service, technological advancements—namely, solvent-assisted steam-assisted gravity drainage, or SA SAGD methods—will help oil sands production compete with other major marginal sources of global supply.
Given our view on the improving cost structure associated with solvent-assisted technology, we think that Canadian crude supply will be higher than many expect. Our 2023 Canadian supply forecast is 5.7 million barrels of oil per day compared with the Canadian Association of Petroleum Producers' forecast of 5.5 million barrels of oil per day. Although we expect solvent-assisted technology to have a major impact on the country's supply growth, the most significant impact will come in the back half of the next decade when the technology is more widely implemented.
In the world of Canadian infrastructure, wide-moat Enbridge sticks out as our top pick. Our top Canadian E&P pick is Cenovus Energy (CVE), which will be a major player in the new cost-lowering extraction technology.
