Longer term constraints risk stranding over a million barrels a day of potential oil growth

CALGARY, Dec. 17, 2012 /CNW/ - While pipeline expansion in 2013 will add nearly a million barrels a day of capacity, it won't be enough to eliminate the discount Canadian producers are getting for their oil, finds a new report from CIBC World Markets.

The report notes that while the consensus view is the new Seaway expansion (250,000 barrels a day in Q1/2013) and the south portion of Keystone XL (700,000 barrels a day in late 2013) will solve the pricing gap faced by Canadian producers, detailed analysis shows otherwise.

"In our view, they will help narrow the Brent-West Texas Intermediate discount but that discount will remain in the US$10 a barrel range," says CIBC oil and gas equity analyst, Andrew Potter. "Our rationale is that these new pipes simply push the current (Midwest) PADD 2 glut into (Gulf Coast) PADD 3, which will knock out PADD 3 light oil imports in early 2013 and prompt Light Louisiana Sweet (LLS) pricing on the Gulf Coast to begin discounting vs. Brent.

"We believe LLS will move to an approximately US$5 a barrel discount vs. Brent. And WTI will move to a transportation discount vs. LLS of approximately US$5 a barrel, leading to a long-term Brent-WTI differential of US$10 a barrel. We believe consensus expectations overstate the value of domestic oil producer exposed to this theme and understate valuations of Brent-exposed and downstream-exposed producers."

Mr. Potter says the bank's modeling shows North American oil production can grow by approximately 800,000 barrels a day per year through 2016. The growth can be distilled down to approximately 500,000 barrels a day per year from U.S. on-shore oil; ~45,000 barrels a day per year from U.S. offshore; ~100,000 bbl/d per year from Canadian light oil; and ~230,000 barrels a day per year from the oil sands. Over this same period this growth is offset by ~100,000 barrels a day per year decline in Mexican production.

For Canadian producers, pipeline constraints have the potential to strand this increase in production growth.

"Pipeline capacity out of Western Canada is adequate for the short term, but substantial progress must be made on this front in 2013," says Mr. Potter. "Progress, or lack thereof, will have a big impact on sentiment towards Canadian oil producers. We estimate that pipeline capacity out of the Western Canadian Sedimentary Basin could effectively be full in the 2014 time frame, suggesting little room for error/politicking in bringing on new pipeline capacity."

He notes that there are ~2.9 million barrels a day of long-haul pipeline proposals on the table out of Western Canada. "That sounds like a lot until one considers that two of the largest - the proposed 525,000 barrels a day Gateway and 450,000 barrels a day TMX expansion through B.C. - face ever increasing political risk. We assign no better than 50/50 odds that these pipes are built before the end of the decade."

He adds that the proposed TransCanada Mainline conversion (estimated ~600,000 barrels a day) is compelling but very early stage and could also provoke some political backlash in Québec. "The 2.9 million barrels a day proposed capacity is quickly depleted given our forecast of 100,000 barrels a day per year growth in Canadian conventional oil and 230,000 barrels a day per year growth in oil sands. Canada needs pipe - and lots of it - to avoid the opportunity cost of stranding over a million barrels a day of potential crude oil growth."

Upside for Refiners

However, Mr. Potter sees growth opportunities for Canadian and certain U.S. based refiners. The pipeline constraints have allowed certain refiners to reap super-normal cash flows in 2011 and 2012. While most investors believe this phenomenon to be very short term and have assigned very low valuations to refiners or integrateds that are gaining from this theme, he believes there will be a recognition in 2013 that price differentials are here to stay, and that will keep downstream margins elevated in the long term.

"As investors recognize the strategic value of downstream, we expect to see a gradual re-rating of downstream-oriented names - in Canada that is Suncor Energy Inc. (SU-SO), Cenovus Energy Inc. (CVE-SO), Husky Energy Inc. (HSE-SP) and Imperial Oil Limited (IMO-SP)]. If producers are losing out given price differentials, it means that refiners are benefiting and refinery economics are massively sensitive to every dollar change in crack spreads."

The complete CIBC World Markets report is available here: http://files.newswire.ca/256/Oil_-_Uncertainty_Reigns_Again.pdf

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PDF available at: http://stream1.newswire.ca/media/2012/12/17/20121217_C9496_DOC_EN_22002.pdf

SOURCE: CIBC