In the last few days, a Canadian press baron has dropped a bombshell on the Canadian oil industry, in the shape of a 550,000 bbl/day refinery project. The $13 Billion investment, is designed to unblock a serious problem. Opposition to the Northern Gateway Oil Pipeline Project.
Forget Alberta, ignore Canada, the World needs the heavy crude oil that lies trapped in the Athabasca Sands. Yet all routes to the market look blocked. The Keystone XL Pipeline Project is awaiting a Presidential seal of approval, Enbridge Line 9 Oil Pipeline reversal is running into stiff opposition, whilst the Trans Mountain Pipeline Expansion Project is right at the beginning of a long and arduous journey.
Which ever way you look at it, heavy oil is dirty. It needs to be handled with care, and it has the potential to cause big damage to the environment. However, as these chaps point out, the alternatives are if anything, even worse. So what are pragmatists supposed to do?
David Black, to the sneers of many, has hit on the idea of a refinery in Kitimat, BC. This doesn't address the problem of potential pipeline leaks, but it does remove crude oil tankers from the mix. The oil would be exported not as crude, but as products. What many of the critics don't want to admit is:
a) A burst pipeline is a much lesser disaster than a stricken crude tanker
b) Whilst a gasoline tanker accident would be nasty, the long term environmental impact would be negligible.
So what of the feasibility of the project. Surely refining is a terrible business?
- In Europe, The banks forced Petroplus under
- In the Caribbean, Hovensa closed as did Aruba
- Sunoco got out of refining altogether
- Both Marathon and Conocophillips split their refinery businesses off, jettisoned them if you like.
Given all that, why would someone with no background in the sector think its a good idea to invest $13 Billion in building a new refinery? Is he just being naive?
Well perhaps not! Perhaps he has noticed something that should be obvious to anyone who actually takes a proper look at the market. Profitability is all about feedstock. Every single one of the refineries that closed were using expensive crude.
All of the interesting stories about the sector are connected to the subject of crude supply. So whilst HollyFrontier makes great profits thanks to the WTI / Brent spread, Flint Hills and Phillips 66 plan to increase their access to Eagle Ford crude.
The cheapest crude of all however, is dug out of the ground in Alberta, and is currently even cheaper than it should be thanks to infrastructure bottlenecks. Alberta, and Canada are losing a fortune. Unless enough pipeline capacity is added to get all this crude to market, this loss will continue. Current production levels are about 2 million barrels per day and CAPP expects this to reach 3.8 million barrels per day in 2020. Just $1 a barrel discount more than it should be, means losses of $730 million per year for the industry, rising to $1.4 billion in 2020. But the extra discount is much more than that. The WTI / Brent spread is $18 per barrel today. If this is a good indication of how much extra discount Canadian producers are forced to give, (and I see no reason why its not a reasonable estimate) then the yearly losses amount to $13 Billion, the budget for Mr Black's refinery.
So the question of whether this refinery makes a good investment or not come down to one simple issue. How much of the value created can it capture? Even a small percentage makes a lot of return, and I haven't even looked at the inherent value added that comes from turning one of the worlds lowest value crudes, into clean, modern fuels. It could become one of the most profitable refineries in the world.
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