In recent years, Canadian oil sands producers' performance has significantly lagged that of its peers targeting U.S. tight oil formations, such as Texas' Eagle Ford and North Dakota's Bakken. Part of the reason is a huge disparity between the price of Canadian crude and other North American crudes, which has eaten into oil sands producers' margins.
TransCanada's (NYSE:TRP) proposed Keystone XL pipeline promises to change that by providing a huge boost to outbound capacity from Canada. But if the U.S. government rejects the project, oil sands producers could be in big trouble.
The trouble with Canadian crude
Over the past couple of years, Western Canadian Select -- the benchmark for Canadian heavy crude oil -- has traded at a steep discount to West Texas Intermediate, the main American crude oil benchmark, which is costing the Canadian oil sands industry about C$18 billion a year, according to estimates from Chevron.
The proposed Keystone XL pipeline, which could transport as much as 830,000 barrels of crude from Canada to refiners along the U.S. Gulf Coast, could help boost Canadian heavy crude prices significantly by easing existing supply bottlenecks. But if the U.S. government rejects the pipeline, it could have major implications for Canadian oil sands producers such as Cenovus Energy (NYSE:CVE), Suncor Energy (NYSE:SU), and Canadian Natural Resources (NYSE:CNQ).
Oil sands producers' other options
These companies rely overwhelmingly on production from Canada's oil sands, and a sustained discount for Canadian crude would continue to weigh on their margins. Luckily, however, they've found ways to work around the possibility of a Keystone rejection by investing in alternative transport options and ramping up refinery capacity.
Cenovus, for instance, has invested heavily in rail, leasing 800 rail cars last year that are expected to begin arriving later this year. By the end of 2014, the company expects to ship as many as 30,000 barrels of oil per day by rail, more than three times as much as it was shipping last year. Canadian Natural Resources also currently ships 15,000 barrels of Canadian crude per day by rail.
Suncor also plans to add rail capacity, though it wasn't shipping any crude by rail as of early last year. However, it enjoys a major advantage because of its refineries in Montreal and Sarnia, Ontario, which allow the company to price the vast majority of its production to Brent. Indeed, even as peers such as Cenovus plan to reduce spending this year, Suncor expects to spend 7% more and is forecasting 10% growth in 2014 oil production.
Why rail could fill in for Keystone
As these examples suggest, companies are preparing themselves for the possibility that Keystone won't be approved. In fact, over just the past six months, plans have been announced to build three rail loading terminals in western Canada that would have a combined capacity of 350,000 barrels per day, which is approximately 40% of Keystone's expected capacity.
Furthermore, Keystone XL isn't the only pipeline in town. Kinder Morgan Energy Partners (UNKNOWN:KMP.DL) is currently seeking approval to expand its Trans Mountain Pipeline, which runs from Edmonton, Alberta, to Vancouver, British Columbia. If the expansion is approved, the line's capacity would nearly treble to 890,000 barrels per day by late 2017.
Enbridge is also seeking approval for its Northern Gateway pipeline, which could transport roughly 525,000 barrels of oil sands crude to the port of Kitimat. While these proposed pipelines do face harsh opposition from environmental groups, they would be able to transport almost exactly the same quantity of oil as Keystone XL if approved and built.
The bottom line
While a rejection of Keystone XL would almost certainly affect the stock prices of Canadian oil sands producers like Suncor, Cenovus, and Canadian Natural Resources, it may not be as detrimental as some might expect. Even if all three major proposed pipelines are rejected, rail could probably suffice in getting their output to market. According to some estimates, Canadian rail-loading capacity could quintuple to 900,000 barrels a day within a few years, up from 180,000 barrels a day currently.