Crude Canada: Most expensive to extract; sold cheapest

Despite supply cuts after another outage at Canadian Natural Resources' Horizon oil sands plant the price the US pays for Canadian crude remained stuck at multi-year lows on Wednesday.

The price oil sands producer receive has now fallen between $40 – $50 behind international prices as Canadian crude and increased domestic output swamp the US.

More than 50% of Canada’s oil production came from the oil sands and it accounts for the bulk of exports. Alberta production is set to more than double to 3.7 million barrels by 2025 out of a total of 4.7 million. Production in the US particularly from the Bakken basin in North Dakota will see the country ramp up current output of 7.8 million barrels/day to 10.9 million barrels over the next few years.

Canada exports 2 million barrels of oil per day and almost all of it ends up in the US Midwest, the pricing point for the US benchmark West Texas Intermediate (WTI), where inventories have been piling up and refining capacity is limited.

The discount for Syncrude, a light oil made from oil sands after undergoing an expensive upgrading process, is now the widest it has been in at least six years after dropping to $23 below the value of US crude.

It marks a stunning $40-plus reversal from July last year when it attracted a premium of $18. That premium which remained as high as $12 into November before Horizon came back on stream following a 6-month shutdown.

The latest outage won't do much for the price longer term. Reuters reported that Horizon should only be shut for the unplanned maintenance for two to three weeks and Canadian Natural Resources, Canada's largest oil sands independent, said it shouldn't affect its annual output targets.

Western Canada Select – a blend of heavy oil sands oil and conventional crude – has also been languishing at lows not seen in years. On Wednesday it was trading at $32.50 below WTI recovering from a $35.50 discount the day before and levels last seen in 2007. In September last year the discount was only $8.00.

Reuters reports although the blow-out in spreads should begin to reverse in coming weeks chances of the small discounts or premiums seen in 2011 is remote:

"We've been saying for quite awhile that for 2012 we're going to see wider price differences between Canadian crude generally and global crudes," said Jackie Forrest, who leads oil sands analysis at energy consultancy IHS CERA.

On top of that oil sands producers have to deal with the difference between the US crude benchmark and international prices in the form of North Sea Brent which on Wednesday was changing hands at $116 per barrel, a $18 premium over WTI. In November that spread had narrowed to $10, from a record margin of $26.87 early September.

Historically WTI has traded at a premium to Brent, but has steadily declined since the Saudis dropped the WTI contract as their benchmark in 2009.

The Globe & Mail quotes Martin King, an analyst at First Energy Capital in Calgary as saying short term oil sands producers can take the knock, but if the differential remains for longer, revenues at the likes of Syncrude and Suncor, will be materially affected:

“On a logistical basis, it points to the vulnerability of having all our eggs in one basket as a nation. It makes more sense to diversify your customer base for crude oil.”

After the Obama administration torpedoed the $7 billion Keystone XL project that was supposed to carry Canadian crude from the Midwest to refineries on the Texas coast, the Canadian government and the Alberta oil industry have turned their attention to the Northern Gateway pipeline project.

The $5.5 billion project which has significant Chinese backing would stretch for 1,170km from Brudenheim in Alberta to a new marine terminal in northern British Columbia to serve Asian markets. But it is already almost a year behind schedule and would not go into operation in 2017 at the soonest, even if it gets approval in the face of fierce opposition.

MINING.com has argued that the lack of pipelines may not be the greatest threat to the oil sands:

Even if TransCanada’s (NYSE:TRP) Keystone XL is resurrected and Enbridge’s (TSE:ENB) Northern Gateway pipelines is built, bitumen is expensive to extract, upgrade and refine and cannot compete with the many new shale oil plays – particularly in the Bakken oil basin – which have pushed US production to its highest level in a decade and could see it become the planet’s number one producer of crude.