Canadian Pipelines Remain in Limbo

U.S. 2020 production cuts were a blessing for Canadian producers.  The opportunity created for Canada is at risk of being undermined by egress problems that just won’t go away.

The energy sector in Canada has spent years dealing with frustrations around market access.  By late 2019 things were looking up as a number of pipeline developments and expansions on the horizon promised to bring adequate capacity to move Canadian crude oil to downstream markets.  While the COVID-19 pandemic triggered an unprecedented collapse in crude demand, it permanently wounded the US shale sector by forcing these companies to pull rigs out of the field and shut-in production.  The shale treadmill doesn’t stop, and it is clear that production is going to be hard pressed to get back where it was before the pandemic hit with producers hesitant to increase capital spending in the near term. 

The decline in US production served as a huge opportunity for Canadian producers – production north of the US border recovered to pre-pandemic levels by December 2020.  With US supply declining and market access improving, Canadian producers had reasons to be optimistic.  Not-so-fast, Canada.  Just as production was back and flows to downstream markets seemed to be hitting its stride, there has been headline after headline on potential egress disruptions that keep analysts responsible for “what-if” scenarios gainfully employed. 

Dakota Access Pipeline (DAPL)

We have covered DAPL fairly extensively and are following two separate but related arguments:

1)      The now disputed January 2021 ruling that the Energy Transfer LP owned DAPL pipeline was approved without an adequate environmental study under the National Environmental Policy Act

-        DAPL intends to seek Supreme Court ruling on whether the environmental impact review is within the scope of the National Environmental Policy Act (April 29)

-        This action by DAPL lawyers comes after the pipeline lost a rehearing bid at the appeals court level on April 23rd.

2)      The D.C. Circuit Court’s decision on whether the pipeline must shut-in while the US Army Corps of Engineers completes an environmental review.

-        This decision is solely in the hands of District Court Judge James Boasberg (who has ruled to shut the pipeline down before) after the US Army Corps of Engineers deemed the pipeline safe to operate while the Environmental Impact Statement is prepared (estimated to be completed by March 2022).

-        The Corps has publicly stated that it sees no cause for the shutting in the pipeline during the review.

There is no historical precedence for determining whether a major operating pipeline will be shut-in for operating without an easement that it thought it had.  Removing 570 MBbls/d of capacity will have ripple effects in regional crude pricing as barrels find their way to rail to reach markets.

Energy Transfer is pushing forward with a planned expansion of the pipeline that is expected to be operational by 3Q 2021.  Wood Mackenzie reported that their aerial surveillance shows that Energy Transfer began laying the foundation of two crude oil tanks that will service a pipeline breakout station in Patoka, IL.  The expansion will increase capacity on DAPL by 250 MBbls/d to 820 MBbls/d. 

Enbridge Line 5

The next contentious pipeline is the Enbridge Line 5.  Line 5 is part of the total Enbridge pipeline system and moves 540 MBbl/d crude oil and natural gas liquids from Superior, Wisconsin to Sarnia, Ontario.  The pipeline is part of the much larger Canadian Mainline and Lakehead systems that ultimately supplies refineries and petrochemical plants in Ontario, Quebec, Ohio, Pennsylvania and Michigan, as well as residential and commercial propane customers in Michigan.   The 70 year old pipeline travels underneath the Straits of Mackinac and has garnered fierce opposition from the regular cast of conservationists, environmentalists, Tribal Authorities as well Michigan’s top elected officials.  Michigan Governor Gretchen Whitmer has ordered the pipeline to be permanently shut down by May 12, 2021 citing the potential environmental and economic catastrophe that a pipeline rupture would cause. 

So what would happen if Line 5 is shut down? 

Line 5 is a not only a key supply pipeline to refineries in three states and two provinces, but a very important pipeline for moving Western Canadian crude oil to market.   The implications of a full shutdown would affect:

• Enbridge Mainline utilization
• WCSB crude differentials
• Downstream crude pricing
• Product availability in Eastern Canada

The Superior hub would likely become a bottleneck creating additional constraints on Enbridge Mainline.  Enbridge Mainline inbound capacity of 2.65 MMBbls/d is balanced with outbound capacity at Superior.  Line 5 represents 540 MBbl/d of this outbound capacity.  Removing Line 5 from the equation means that the inbound capacity will exceed outbound capacity that will force Enbridge to operate at reduce volumes upstream of the Superior Hub (Enbridge Mainline). 

Synthetic crude oil will experience the largest price impact given its current reliance on Line 5.  Approximately 300-400 MBbl/d clear through the pipeline, according to Genscape.  WCS, MSW and Bakken Clearbrook barrels are likely to see secondary impacts – this due to the bottlenecks created on the Enbridge Mainline/Lakehead system.

The refineries that depend on Line 5 would have to turn to other means to source their crude, likely at a higher cost.  Sarnia will be most disadvantaged as Line 5 is a direct conduit for crude into the refining region.  Alternative pipeline paths, rail and waterborne crude can provide short-term fix for supply shortages, but longer-term solutions would require substantial infrastructure investment.

Recent court battles have favoured Enbridge.  An October 2019 ruling by the Michigan Court of Claims rejected the Michigan Attorney General’s opinion of the constitutionality of a state law that authorized Enbridge to build a tunnel to house Line 5 below the lake bottom of the Straits of Mackinac.  A subsequent Court of Appeals decision in June 2020 affirmed the lower court’s decision. 

The battle is far from over.  In November 2020, Michigan Governor Whitmer filed a complaint to revoke Enbridge’s 1953 easement under the premise that Enbridge has failed to satisfy the conditions of the easement by not exercising “due care” when maintaining and operating the pipeline. 

Canadian Inventories Continue to Balloon

Notable news to keep in mind that could further complicate the outlook for Canadian differentials is the rising crude stocks.  AER data out for March shows that Alberta’s crude inventories increased by 4.8 MM Bbls to 73.4 MM Bbls.  Not included in the AER data are April builds which means we are likely at or above the peak of 75.6 MM Bbls that was reached in October 2018. 

Crude prices continue to march higher and fairly tight differentials have allowed Canadian producers to participate in the uplift.  However, recent headlines are a never-ending reminder of how things can go sideways in a hurry and create a perfect storm of events that widen the differentials.