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EXCLUSIVE: Panic in the (Oilpatch) Suites

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Last August 30 was not just a ‘wake up and smell the coffee’ moment for federal and Alberta politicians pushing to accelerate future tar sands/oil sands expansion plans.

It was a morning where the coffee urn figuratively tipped over and bestowed third-degree burns.

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First, Federal Court of Appeal judges unanimously quashed [2] construction permits for the pending new Trans Mountain pipeline because consultations with First Nations had been a sham, and related marine protection studies had holes big enough to send a fleet of oil tankers through.

A mere 30 minutes later, terror turned to glee for Kinder Morgan shareholders as they voted 99% in favour of selling the existing TMX pipeline and Vancouver area terminal to the Canadian government for C$4.5 billion. This allowed them to sprint away from a potentially doomed $9.3-billion gamble building a parallel pipeline to boost export-bound Alberta bitumen by some 600,000 barrels per day for decades.

The FCA ruling, and the Kinder Morgan shareholder vote tally, were scalding signals that the Trans Mountain expansion project was is deep legal and fiscal trouble. Prior to that, no private sector company had even showed up to kick tires, let alone make a formal offer to Kinder Morgan.

Then, without even waiting to carefully read the 263-page court ruling, or consult Parliament, or file a notice of appeal, federal Finance Minister Bill Morneau announced [3] the following morning that Ottawa had already completed the TMX purchase deal with Kinder Morgan.

This made pan-Canadian taxpayers hapless new owners of old assets (the existing TMX pipeline and Burnaby terminal were built five decades ago), effectively conscripted every citizen into being investors in tar sands/oil sands expansion “in the national interest”, and made the federal government both the owner and self-regulator of a project that had just been stopped cold by judicial edict.

Addicted. Outwitted. Conscripted. Conflicted. If there was any doubt that Alberta and Ottawa are obsessed with accelerating tar sands/oil sands exports at any fiscal, legal, or ecological cost, or that petro-politics and panic can vanquish sober judgement at the speed of a sound bite, those few hours during the last dog days of August were proof enough.

Now there is plenty more.

Most fatally, the price at which U.S. refiners are willing to purchase Alberta bitumen has plunged since early September. Currently, those refiners are paying almost US$75 per barrel for oil from Texas, the Gulf Coast, or North Dakota, or for imported high-quality crude. But they will now pay less than US$30 for a barrel of Alberta bitumen.

At that price, no new tar sands/oil sands projects can be financed. Even existing ones will throttle back production. That is the stark math.

Are the U.S. refiners singling out Canada for punitive pricing? No, they are supplier-agnostic, equal-opportunity, privately-owned, profit-seeking petro-predators. Their business model is to maximize margins by buying crude as cheaply as possible, then selling refined products (gasoline, jet fuel, chemical feedstocks, marine diesel, heating oil) at the highest price possible.

Nothing delights refiners (in the U.S., China, Europe, Russia, the Persian Gulf, or India) more than a surplus of available crude oil. It drives down their biggest input cost, allows them to choose between suppliers and grades/blends, schedule deliveries months in advance, and even configure “runs” to receive and refine oil to maximize operating efficiency and obtain the highest margins possible.

In effect, refinery managers don’t buy crude oil—that is done by sophisticated software that models oil prices, availability, refinery design, and demand for high-value refined products like gasoline or chemical feedstocks.

Currently, U.S. refinery software algorithms are deciding [4] the discount gap between Texas oil and Alberta bitumen. Refineries in the midwestern U.S. that are configured to process bitumen are already at full capacity, and those on the U.S. east and west coasts are negligible potential candidates. Only a few refineries in the Texas Gulf Coast area have theoretical capacity to process more Alberta bitumen (via the proposed Keystone XL pipeline), but that will likely vanish soon.

The main reason is that a boom in shale oil production in the nearby Texas/New Mexico Permian Basin is flooding U.S. refineries [5] with much higher quality oil. It is more costly to buy than bitumen but cheaper to refine, does not impair refinery circuits, and produces significantly higher portions of premium refined products that garner the highest prices. These can be sold in the U.S., or exported via ocean supertankers to customers in Europe and Asia.

By contrast, northern Alberta bitumen must be pipelined to refineries much longer distances, at a cost of about $10 per barrel. It must also be diluted by 30% to flow in pipelines, and that net condensate cost [4] is US$14 per barrel. Bitumen is also laced with contaminants [6] like sulphur, nitrogen, and acidic compounds which corrode refinery circuits; it produces the highest proportion of bottom-of-the barrel petcoke (which has essentially no commercial value); and it converts smaller portions of the refined products which garner the highest margins.

In short, Permian Basin oil is a far better fit for the only U.S. refineries capable of handling more bitumen, and will likely be for at least the next decade. In the last week of September, the Permian output was so prodigious that, even despite domestic refinery demand and surging exports [7], U.S. oil inventories jumped eight million barrels. This spelled glad tidings for U.S. refiners, but dismal news for bitumen producers.

Equally ominous, global oil behemoth Saudi Arabia has now entered North America as a major competitor. Last year, state-owned Saudi Aramco bought full control [8] of this continent’s largest refinery complex, the Motiva plant in Port Arthur, Texas.

In the last year, Saudi Arabia has also doubled [9] the volume of oil exports to the U.S., to one million barrels per day. With an oil well production cost of about US $10 per barrel, the world’s largest proven reserves of high quality oil, and a fleet of ocean tankers capable of carrying two million barrels in a single cargo, the Saudi-owned Motiva refinery is assured high margins for the foreseeable future, and already has co-owned petrochemical plants and a gas station chain in the U.S.

So the Saudis have zero reason to buy or refine extra Alberta bitumen in the U.S. In fact, a planned expansion at the Motiva refinery has been scrapped [10], and Aramco is displacing Canadian oil with its own imports. Moreover, the Saudis are a decade ahead of Canada in establishing major oil customers in Asia, and are accelerating new joint venture refinery projects in India, Malaysia, South Korea, Pakistan, and China.

Their game plan is obvious: co-finance mammoth new refineries adjacent to Asian ocean ports which use Saudi oil delivered by Saudi mega-tankers to make high-value petrochemicals, and low-sulphur marine shipping and vehicle fuels which meet stiffer imminent pollution standards.

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Last week, two events highlighted this undeclared, pending market share battle between prospective Alberta bitumen projects and Saudi oil exports to Asian refineries.

At the Malaysian deep tidewater port of Pengerang, a Saudi supertanker arrived [11] with two million barrels of Persian Gulf crude, which was pumped directly into the circuits of a giant, state-of-the-art refinery complex for commercial test runs.

The US$27-billion plant was co-financed and built by the state oil companies of Malaysia and Saudi Arabia. Within weeks, it is expected to convert 300,000 barrels of low-sulphur crude each day into feedstock for an adjacent petrochemical complex, and high-quality fuel for marine shipping and vehicle fleets in Japan, South Korea, and China.

The refinery location is perfect to supply those Asian markets via Saudi supertankers. (An even larger, $44-billion tidewater refinery complex is slated [12] for the west coast of India, to be built by oil companies of both countries. It, too, will be supplied by Persian Gulf oil delivered by Saudi supertankers.)

At virtually the same time the first Saudi cargo arrived at the new 300,000-barrel-per-day Malaysia refinery, hearings into another new tar sands/oil sands mine began in northern Alberta. The C$20.6-billion Frontier project is being promoted by the Vancouver-based mining company Teck Resources Ltd. It is projected [13] to produce 260,000 barrels of bitumen per day, and 3.2 billion barrels over four decades.

The daily oil output and capital costs of the two projects are roughly similar, and both the Malaysian refinery and Frontier tar sands/oil sands mine are slated to sell all their product to Asian customers for decades to come. (Teck hopes to export its bitumen via the proposed Trans Mountain pipeline to Vancouver, then ship by Aframax [6] tanker to undetermined Asian ports).

But any comparison ends there.

For starters, Saudi Aramco is the world’s largest oil and gas conglomerate, and apparently its most profitable. Business analysts have estimated its value at between US$1 and $1.5 trillion. Its annual net income is estimated at four times that of Exxon Mobil, and it dwarfs all other oil majors in every category. Most important, it controls estimated reserves of about 268 billion barrels of high-quality oil inside the Kingdom, and currently refines about 10 million barrels per day at a production cost [14] of under US $10 per barrel.

By contrast, Teck Resources has market capitalization of $13 billion. Because it has other coal and copper projects in development, the planned $20.6-billion Frontier capital cost will almost certainly sink the company unless it can enlist other deep-pocketed partners. If not, it risks [15] punishing debt interest costs, or a shareholder exodus if its stock value is diluted.

A bitumen deposit of 3.2 billion barrels in northern Alberta is an alluring prize—but only if those barrels can be mined at a profit for the next four decades, then pipelined to Pacific tidewater, with eager Asian refiners lined up to buy all that bitumen.

Yet Teck has provided no evidence that these conditions exist. There is no approved second Trans Mountain pipeline, and may never be. There are currently no exports of Canadian raw bitumen to Asian refineries. Most fatally, production cost estimates for the Frontier tar sands/oil sands project are in the US$85 per barrel range—which will require decades of West Texas Intermediate (WTI) oil prices above an estimated US$130 per barrel to recover capital, debt interest, and operation costs, and earn significant profits.

And even if global oil prices did reach or exceed a plateau of US$130 per barrel, Teck would still be competing for future Asian refinery contracts with Saudi Aramco—which has almost unimaginably vast oil reserves that can be pumped for eight times less cost per barrel.

Inexplicably, Teck seems to be betting its future on optimistic global oil price projections, while forgetting that lower-cost Saudi, American, Russian, or Iraqi oil producers only need to beat its Frontier mine production cost of $85 per barrel to knock it out of any future refinery supply contests. And it is discounting the reality that US$130-per-barrel oil will both drive down world demand and ignite new shale oil and deepwater drilling and output.

In short, building the biggest tar sands/oil sands project in Canadian history makes no fiscal sense. But maybe mining the politicians who constantly crave such marquee projects does.

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One largely unreported but compelling detail of Ottawa’s C$4.5-billion buyout of Kinder Morgan’s Canadian assets is that the purchase terms contained no escape clause [16] in the event of an adverse Federal Court of Appeal ruling. Such legal protection is taught in commercial law 101, and clauses which void a purchase (no clear title, building code violations, tainted water test) are typical in any ordinary real estate purchase.

Incredibly, Ottawa failed to insist [17] on such a clause. If it had, it could have walked away from the mess, or torn up the deal and squeezed the company for a far lower purchase price. Instead, Kinder Morgan shareholders got rich the minute they voted for the deal, while Canadian taxpayers inherited an ancient pipeline and expansion project that was, at best, in legal limbo.

This explains why federal Finance Minister Bill Morneau, who negotiated the purchase terms with Kinder Morgan, announced the deal had closed mere hours after the shocking FCA ruling and corporate shareholder vote. He already knew an escape clause did not exist.

Adding salt to the wound, the U.S. parent company of Kinder Morgan Canada took proceeds from the sale to pay down debts and invest [18] in a US$2-billion Permian Basin gas pipeline. It was further rewarded when the Moody’s credit rating firm upgraded its status [19] for these adroit corporate maneuvers.

Perhaps the way Kinder Morgan played compliant Canadian politicians for all they were worth was not lost on Teck. It is a century-old adage of mine promotion that stock profits rise most on the sizzle, not the steak. A modern variation might be that a new, approved Alberta tar sands/oil sands construction permit might be worth more than actual production decades from now—especially if it can be sold to a government desperate to show success or salvage political survival. And if money is no object.

Kinder Morgan just proved it. It spent an estimated $1 billion on approvals and permitting for the Trans Mountain expansion project, then sauntered south with $4.5 billion. Even accounting for its past purchase of the original pipeline and terminal, that’s a handsome return for building nothing.

Currently, Teck is seeking approvals for a mammoth tar sands/oil sands mine in northern Alberta that has no foreseeable prospect of being competitive, and no refinery customers committed to purchases. No pipeline to connect the mine site with Asia exists. It does not even have confirmed partners to help share a looming $20.6-billion capital risk. Nor has it secured debt financing from banks, or tested shareholder loyalty with a share dilution plan.

The proposed Frontier mine does not appear on the company’s pending capital expenditure reports. The current costs to conduct studies and defend the giant tar sands/oil sands project at joint federal/Alberta hearings amount to ‘mad money’.

But what Teck has lined up, for free, are legions of Alberta and federal politicians who are stumbling over themselves to be another tar sands/oil sands operator’s BFF—fiscal feasibility and carbon emissions [20] be damned.

Examples of this all-in attitude abound:

What is most alarming is that these prominent politicians, often playing to the applause of most of Canada’s business press, seem resolutely oblivious to the most glaring fiscal facts about future tar sands/oil sands expansion.

The most decisive is the price refiners are willing to pay for Canadian bitumen, and the volumes they commit to take. This is the product’s real-world value, stripped of political posturing and business press boosterism [21].

Currently, they will pay only about US 30, or US$50 less per barrel than Teck’s projected average cost of production at the Frontier project. Moreover, refineries on this continent are highly unlikely to increase purchase volumes significantly because there are surpluses of closer, cleaner blends that generate much higher profit margins. No amount of pleading, praying, or pony-for-Christmas promises by Canadian politicians will change those realities.

Prospects are equally grim in Asia, because a decade ago Saudi Arabia began partnering on major new refinery projects in the very countries Alberta tar sands/oil sands operators hope to supply. Now they are coming online, and will use Saudi oil delivered by Saudi supertankers. Those that don’t can buy oil from other Persian Gulf countries, the U.S., or Russia.

But because politicians and companies like Teck live or die at the uncertain command of voters and shareholders, they share a mutual interest in conjuring a short-term aura of success. Approved construction permits and ribbon-cutting photo ops on giant projects have very high value, even if the actual asset is as viable as the next tour by Elvis.

The payoff could be in government buyout cash. Or election victories. Or both. Even if, as Kinder Morgan showed, nothing gets built.

Paul McKay is an award-winning investigative reporter and author. His reports have appeared in the Ottawa Citizen, Globe and Mail, Toronto Star, and Vancouver Sun. He can be reached at: paul@paulmckay.com [22].

8 Comments (Open | Close)

8 Comments To "EXCLUSIVE: Panic in the (Oilpatch) Suites"

#1 Comment By Gloria Taylor On October 9, 2018 @ 10:02 AM

Whoa. Great work!

This analysis is far ranging and backed by facts and figures. A lot is being written now on climate change but this piece is a must-read and adds to the body of knowledge.

#2 Comment By Frances Deverell On October 9, 2018 @ 1:21 PM

The sad thing is that Alberta is quite able to build a sane economy based on renewable energy which over and over has been demonstrated to provide 7 times more jobs if you get into the complexity of that type of energy economy. In addition, Canada could use its oil subsidies to clean up the mess in the tar sands, providing transitional employment to oil workers. As it is now, when the tar sands eventually slow down, we will still be left to clean up the mess.

#3 Comment By David Hughes On October 9, 2018 @ 1:30 PM

Unfortunately there is misinformation in this article. Maya heavy crude, which is an exact match for Canada’s Western Canada Select (WCS) benchmark, is trading on the US Gulf Coast at a $2 premium to WTI, and at parity with Maya delivered to the Far East. The reason for this premium is that US Gulf Coast refineries are set up for heavy crude, having relied on declining production from Venezuela and Mexico. Contrary to what Paul says, the light oil from shale in the US is not optimal for these refineries – they can make more high value products like diesel from heavy oil, and are set up to strip contaminants like Sulphur and other toxics. Thus there is no price benefit for Asia export – in fact there would be a further price discount as transport costs to Asia via TMX are higher than to the US Gulf Coast.

The reason for the steep discount on WCS is lack of pipeline capacity causing oil to be backed up in storage or transported using higher cost trucks and trains.

Like it or not, the Line 3 and Keystone XL pipelines will likely be built long before TMX which will return WCS to its normal quality-transport discount of $13 per barrel.

#4 Comment By Mitchell Beer On October 12, 2018 @ 11:42 AM

Thanks very much for reading and responding, David. By the time your comment arrived, Paul was hard at work on a sequel in which he’d already set out to address (and, I think he would say, correct) some of the points in your comment. So please stay tuned…I think he’s hoping to have it ready for our Monday edition, and if our lead spot isn’t bumped by another IPCC report (not on the horizon), super-hurricane (not likely), or megaproject announcement (who knows?), it should be out in the world soon.

#5 Comment By Martin Golder On October 9, 2018 @ 5:06 PM

It is as though climate change doesn’t exist. A brief mention of Trudeau’s about face over Paris but no mention of the general need to decarbonize the economy now.

#6 Comment By Glen Porter On October 9, 2018 @ 7:01 PM

Just a small correction: the existing TMX pipeline and Burnaby terminal were built not five decades ago, but six and a half decades ago.

#7 Comment By Susanna Dokkie-McDonald On October 12, 2018 @ 12:59 PM

Just a thought here. What if the reason for Trudeau buying this pipeline was to protect Canada from Chapter 19 of the USMCA and the reason he fought so hard to keep chapter 19 in the new agreement. It may be that the US can’t sue Canada for projected profits because Canada owns the future of a dying pipeline, not the USA anymore.

#8 Comment By Geoffrey Pounder On October 12, 2018 @ 9:06 PM

“There are currently no exports of Canadian raw bitumen to Asian refineries.”

“China snapping up cheap Canadian oil, lured by $50 discount over U.S. crude”
Bloomberg News, October 11, 2018
“China bought 1.58 million barrels of Canadian crude for loading in September, almost 50 percent higher than the 1.05 million barrels in April, data from cargo-tracking and intelligence company Kpler show. State-run refiner Cnooc Ltd. has chartered a tanker, Nordtulip, to load oil from Vancouver in October, according to shipping fixtures.”