Saturday, September 21, 2013

Eastern Promise

TransCanada’s Energy East project will help diversify crude oil marketing opportunities for western producers

This article appears in the October issue of Oilweek

By Peter McKenzie-Brown
As this year began, so did the political debates. First to the podium was Ottawa’s Natural Resources Minister Joe Oliver, who said he had given tentative approval to a proposal from industry giant Irving Oil. Irving owns the largest refinery in Canada – conveniently situated along the deep-water, ice-free port of Saint John.

The coincidence of having Canada’s biggest refinery and eastern Canada’s largest deep-water port side-by-side offer a tremendous opportunity. If you could somehow get oil from western Canada to refineries in Montreal and St. John, you could construct loading terminals at St. John’s, which would provide Canada with facilities for large-volume crude oil exports – exports to Europe, of course, but also to India which is more easily served from the Atlantic side of North America than the Pacific.

The irrepressible New Brunswick premier, David Alward, was the next to stand up. “Our government believes a national oil pipeline – bringing Western Canadian crude to St. John – is strategic to Canada’s national interests,” he said in a January speech. “It would open up new markets for one of Canada’s most important exports; help Canada get full and fair world market prices for its energy; and create new jobs and new opportunities right here in New Brunswick.”

“Because of Saint John’s deep-water port and Irving Oil’s world-class refining experience and capacity, New Brunswick can play a central role in connecting Canadian resources with growing world market,” he added in his State of the Province speech. Effusive about “thousands of jobs for our trades people,” and “billions of dollars of investment in New Brunswick,” that could result from such development, he added that “Canada would receive full value for its resources rather than selling at a loss in a saturated market.”

Alward stumped around the country with this pitch, and soon enough Alberta Premier Allison Redford chimed in. The idea seemed to gain momentum, pushed by politicians who wanted to be seen to have a big, bold vision. In reality, though, the idea originated within the petroleum industry itself. To make political hay, these politicians were using an idea first floated by TCPL. This became clear six months later, when TransCanada formally launched its Energy East initiative – an idea it had proposed a year earlier.

Improving Gas Tolls
The Energy East project will require pipeline conversion, new pipeline and new facilities. It will convert an existing natural gas pipeline to oil service, and construct new sections of pipe in Alberta, Saskatchewan, Eastern Ontario, Québec and New Brunswick to link up with the newly converted pipe. In addition, it will require pump stations, tank terminals and marine facilities to move the crude oil from Alberta to New Brunswick and beyond.

The $12 billion project (excluding the transfer value of Canadian Mainline natural gas assets) will move up to 1.1 million barrels per day. It will begin service at year-end 2017, with completion the following year. By diverting one of the company’s gas pipelines to oil, this arrangement should help the company improve its cash-flow.

Last spring quarrelsome hearings before the NEB decision froze TCPL’s mainline gas tolls for five years. The company could improve its cash flow, the board said, by increasing the amount of gas going through the line – no easy task, since during the last five years shale gas developments have greatly diversified the sources of cheap gas through North America.

This was not what the company wanted to hear. It had argued that, since the gas pipeline from western Canada to the east was a critical piece of Canada’s energy infrastructure, producers and consumers should bear the rising costs.

TCPL still has 18-year gas contracts to honour, but it can considerably reduce its shipping costs by converting parts of the pipeline to ship oil. Energy East is not a totally new initiative: some years ago the company converted one of its pipes for use by the Keystone pipeline system. Energy East, though, is much bigger – the most expensive single project the company has ever undertaken.

Some Details
In a news conference, TransCanada boss Russ Girling shared Alward’s view that the pipeline was partly an exercise in nation-building. He described the project as “creating jobs, tax revenue and energy security for all Canadians for decades to come” and compared the line to the east-west ties created by construction of the CPR in the 19th century. Creating delivery points and receipt points in Eastern Canada for Western Canada’s oil will “put the country more in charge of its own destiny,” he said. “This project has the potential to replace all the oil we import from overseas…give new purpose to the underutilised capacity of our pipelines [and] bring new opportunities and revenues to local communities.”

Of more practical value than nation-building, Girling observes that Canada’s eastern refiners want access to western Canadian oil because it is less expensive than oil from foreign regimes.

Of course, western producers are getting hit in two ways: lower prices for their product, plus the high cost of pipeline transportation from West to East. These points notwithstanding, the project is underpinned by 20-year shipping commitments between producers, refiners, and other players. Girling stressed that the companies that had committed to Energy East would also be able to meet their commitments to the Keystone pipeline. “Shippers can meet commitments to both lines,” he said – adding that Keystone would greatly reduce US oil imports.

Added Alex Pourbaix, the president of TCPL’s Energy and Oil Pipelines, 70 percent of the pipe needed is already in the ground. The company will use existing rights-of-way to reduce environmental and community impacts. “Conversion involves changing compressors to pumps, since oil is an incompressible liquid,” he says, adding that “when you do one of these conversions you are regulated by the NEB, and they have exhaustive information as to the integrity of the existing pipe.”

The project needs new pumps, which will be installed where compression facilities now stand. Conversion can be safe and practical, he says, noting that To stress the significance of the imported oil the pipeline would displace, Pourbaix notes that 86% of the feedstock in the affected refineries – 700,000 barrels per day – now comes from overseas.

The North Sea is generally a reliable source of supply, but what about the other sources of supply for eastern Canada – Algeria, West Africa and the Middle East? Surely oil sourced in North America is more desirable than oil from unstable parts of the world.

Rhona DelFrari of oil sands giant Cenovus explains how the large producers are using a portfolio approach to market their bitumen production through the existing pipeline systems. The company has committed 200,000 barrels per day of “marketable production” (defined as bitumen plus up to 30% by volume of diluent) to Energy East. “We already have plans to increase our net production to 500,000 barrels per day by end of 2021” – a number that includes bitumen plus diluent and the company’s conventional oil production. But the company’s gross volumes of marketable oil will be about 1 million barrels per day by that time, because the company will also be marketing production on behalf of its partners.

“We take a portfolio approach to marketing,” according to DelFrari. Cenovus has allocated 175,000 barrels to the existing and proposed pipelines to the west coast, 155,000 barrels to the Gulf Coast (think Keystone), 200,000 barrels per day to Energy East and, “long-term,” 10% by rail. “We need options to move oil to different destinations.”

At present, the company is only moving conventional oil by rail, but the mix will change. “At the end of [June], we were transporting about 8,000 barrels per day of [conventional] oil by rail,” she says. However, the company expects to be railing 30,000 barrels per day by the end of next year – part of that volume from the company’s oil sands production.

How the System Began
While DelFrari provides a current corporate perspective, Nick Taylor takes a longer view. A retired geologist, businessman and politician, Taylor served as leader of Alberta’s Liberal opposition during the Lougheed era. He later served in Canada’s Senate.

Taylor believes Energy East essentially repairs policy imbalances that have been around for half a century. “All we are really doing is getting back markets we shouldn’t have let go in the first place. We gave those markets away.”

Western Canada lost those markets through the National Oil Policy of 1961. Officially, the Borden Commission claimed to be promoting Alberta’s oil industry by securing for it a protected share of the domestic market. Under the policy, Canada was divided into two oil markets. The market east of the Ottawa Valley (the Borden Line) would use imported oil. West of the Borden Line, Canadian consumers would use the more expensive Alberta supplies. For the next decade or so, consumers to the West paid between $1.00 and $1.50 above the $3.00 per barrel world price. As a result, they paid higher prices at the pump than Canadians east of the Borden line.

Taylor, for one, disputes this interpretation. “Companies in eastern Canada wanted to buy overseas oil not so much because it was cheaper,” he says, “but because it came from a branch of the multinational company they were part of.” Commonly called the “seven sisters,” those companies were BP, Chevron, Exxon, Gulf Oil, Mobil Oil, Royal Dutch Shell, and Texaco.

Whatever the reasons for the Ottawa Valley Line, its absurdity became clear during the brief 1973 OPEC oil embargo and price shock. During the darkest moments of that crisis, the industry shipped piped oil from Alberta to Vancouver, where tankers took the cargo through the Panama Canal and up the Atlantic coast to Montréal.

The members of OPEC realized they were in the driver’s seat and soon nationalized oil and gas operations within their own borders. When that happened, Taylor says, “There was greater momentum (in Eastern Canada) toward purchasing oil from the West.” Infrastructure favoured imports, however, and inertia won the day.

The Outlook
According to economist and industry observer Jeff Rubin, taking oil south to the Gulf coast by way of Keystone XL or through British Columbia via the proposed Gateway pipeline would be better options than the circuitous Energy East solution. The main difference is that Energy East has received support from many politicians and from much of the public.

“Given the public and political opposition facing the other routes,” he said in a newspaper column, “the tragedy at Lac Mégantic puts the business of moving oil into the public consciousness as never before. Does Quebec really want more than a million barrels of oil coursing through its territory every day?” He sees few economic advantages to the project. He isn’t alone.

According to an industry executive who asked not to be named, the oilsands are facing a transportation nightmare, and it reflects mismanagement at the top. The industry has doubled production in the last ten years – a tremendous technical achievement – but at roughly three million barrels a day the industry is facing horrible gluts. Surely, he says, “the management of heavy oil producers should be called to account for the mess we are in.”

Senior executives have proposed that their companies should invest billions in building facilities for oil production, and corporate boards have generally approved. However, they seem to have done so without giving much thought to how that product would get to market. “It doesn’t make sense to let production drive your business,” he says. “This generally does not work in business.”

“Given the long-term production projections of the top ten heavy oil producers, what does the picture look like if the various new lines are all built?” he asks. “What happens if some or all of the lines are not built?” If bitumen gluts continue to grow, they would dilute rather than enhance shareholder value.
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