Welcome to the caveat edition of Oil Markets Daily!
Markets are full of twist and turn and the latest one is an interesting one. Enbridge announced late on Friday that the Line 3 replacement project is delayed until H2 2020 because it won't receive State permitting until November of 2019 versus the previously expected Q2 2019. On the surface, this is bad news for Canadian heavy oil producers, because the ~370k b/d expansion in takeaway capacity was going to help the bottleneck situation, but the opposite side is the global oil market supply & demand outlook just got even more bullish.
The most interesting caveat arising from the delay is that Alberta's production cut was previously scheduled to end coinciding with the Enbridge Line 3 replacement project coming online. The end of 2019 was the scheduled end of the production curtailment, but with the delay of the Line 3 project, the curtailment will have to be extended into H2 2020. This is to ensure that Alberta storage doesn't get bloated again while crude-by-rail continues to ramp. Our view is that even if a curtailment is not needed, Alberta will likely implement a cap on production output to keep storages from building unnecessarily. After seeing how successful a curtailment is, we believe this is the best policy politicians will use going forward to combat takeaway capacity issues.
This then presents a troubling outlook for global oil supplies. Not only will Canada not be able to grow production in 2019, it implies that 2020 production will also be stagnant further contributing to the oil market supply deficit we see.
Based on our latest projection, it shows an oil market deficit of -1.1 mb/d. This assumes OPEC continues its policy of keeping production controlled, so this figure is likely to be narrowed as we head into 2020. But the math is still in our favor as Canada was originally supposed to grow production by 200k b/d in 2020, but with Line 3 being delayed, this is likely to put it near 0k b/d.
In addition, the Line 3 delay directly impacts US crude storage balances as issues with Mexico production and Venezuela will continue into 2020 further starving the heavy sour crude shortage in the market.
To make matters worse, WCS Houston is now trading at a $3/bbl premium to WTI for April.
This has made April WCS-WTI spread narrowed to just $11.75/bbl.
As we explained in the chat over the weekend, the market is missing a very simple fact. WCS-WTI has a direct correlation to how WCS Houston trades relative to WTI.
If WCS Houston trades at a premium of $3/bbl to WTI, then WCS-WTI will take that into account even using rail economics.
Rail economics is $18/bbl.
If WCS Houston trades at +$3 premium to WTI, and WTI is $57. WCS Houston is $60/bbl.
Using rail economics of $18/bbl, WCS-WTI would be $15/bbl.
$60/bbl (WCS Houston) - $18/bbl (rail economics) = $42/bbl.
$57 ((WTI)) - $42 (WCS) = $15/bbl WCS differentials
Now as we wrote in section 1 of this WCTW, if the combination of lower US crude storage + low US crude imports continues, then it could send heavy crude pricing in the US into unchartered territories. If WCS Houston trades at a $7/bbl premium, then WCS-WTI (using rail economics) would trade to $11/bbl.
We know for a fact not a single sell-side analyst has this modeled into their assumptions, so as the crude quality shortage theme plays out for the rest of the year, the awakening will be sweet to observe.
Thank you for reading. This article was first published to HFI Research subscribers as part of our weekly flagship report, "What Changed This Week." There are much more topics that are discussed in this weekly flagship report like the incoming crude storage draw for April in the US. For those interested, we are offering a 2-week free trial to our HFI Research service. We hope to see you join the community!
Disclosure: I am/we are long CVE.TO, GXE.TO, ATH.TO, BTE.TO, CRC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.