Canada's Oil Producers, in Standoff With Railways, Sit Out Oil-Price Rally

Hard-nosed negotiating by railway companies is keeping Canadian oil producers from cashing in on a world-wide oil price rally.

Oil producers such as Imperial Oil Ltd., Suncor Energy Inc. and Cenovus Energy Inc. have few avenues to ship their oil to the U.S., their primary market. The pipelines that normally take the crude are almost at capacity, which leaves railroads as the only option for larger shipments.

But Canada's largest railway companies, Canadian Pacific Railway Ltd. and Canadian National Railway Co., in recent weeks have signaled that they are in no rush to take the oil. They fear oil companies will fill their cars with shorter-term contracts now but shift quickly to pipelines when new capacity becomes available in a few years.

The rail companies want long-term commitments longer than two years, which the oil companies are loath to give, because shipping by rail is expensive, analysts say. The producers are pushing for short-term deals shorter than a year.

"We don't want to ramp up, spend a lot of money and utilize assets for a market that we know is going to go away," said John Brooks, chief marketing officer for Canadian Pacific, in an interview. "Pipelines will eventually pull this capacity and fill this need. We just want to be diligent in how we grow that opportunity."

As the price of oil has surged in recent months, hitting $66.25 a barrel on Friday, the price of Canadian crude pulled from the oil sands of Alberta has remained mired at lower levels. Canada's oil was priced at a discount of roughly $28 to the benchmark, the largest spread since 2013.

Western Canadian Select blend trades at a discount to the North American benchmark West Texas Intermediate because it is more difficult and more expensive for Canadian oil producers to ship their oil from wells to U.S. refineries, and those costs come off the price. The pipelines that normally pump the oil from Western Canada are almost full.

Compounding the issue: TransCanada Corp.'s Keystone pipeline, one of the major arteries taking the oil to the U.S. Gulf Coast, is running at only 80% capacity after suffering a leak late last year in South Dakota.

These factors have given railroad companies a strong hand in recent negotiations for capacity.

"They realize they are the shipper of only resort now," said Michael Tran, global energy analyst for RBC Capital Markets in New York.

The capacity logjam is also weighing on Canadian rail terminal operators, which serve as middlemen between oil producers and railroads. Available rail capacity is about one-half to two-thirds below what oil producers are currently requesting, according to some terminal operator executives.

Jarrett Zielinski, chief executive of Calgary-based Torq Energy Logistics Ltd., which operates six rail terminals, said oil producers are looking to secure crude shipments well over the 50,000 barrels a day the company can currently handle. "We just don't have access to rail," he said.

Representatives for Imperial and Suncor declined to comment. Cenovus CEO Alex Pourbaix said at a conference on Jan. 25 that his company was negotiating shipping terms with the two rail operators. He said there was "ample margin" for both sides to come together.

The railroads are being careful because they were hurt a few years ago after spending millions of dollars to build new loading terminals and trains carrying more than 100 railcars of crude during an oil price surge between 2012 and 2015. But the business generated by the oil producers ebbed in 2016 after oil prices tumbled and more pipeline capacity came online in the U.S.

Canadian crude-by-rail shipments peaked in 2014 at 58.7 million barrels, nearly all of it exported to the U.S., according to Canada's National Energy Board. The crude-by-rail shipments fell afterward, but partial data for 2017 indicates a rebound. During the first nine months of 2017, Canadian trains transported 38.9 million barrels, a 58% increase from the same period the prior year.

There's no easy fix for oil producers' problem. Pipeline expansion, a costly and slow process during the best of times, has become a controversial political issue. TransCanada is being sued in Nebraska by landowners who want to stop an expansion of the Keystone pipeline.

TransCanada also announced in October that it had nixed plans to move ahead with the Energy East and Eastern Mainline pipeline projects in Eastern Canada, partially because of a tougher regulatory environment.

Kinder Morgan Canada Ltd., another pipeline operator, is facing a firestorm in Western Canada as it tries to finalize plans to build its Trans Mountain pipeline to the Pacific Ocean. Politicians and environmentalists in the Canadian coastal town of Burnaby, in British Columbia. oppose the project even though the federal government, led by Prime Minister Justin Trudeau, has said building it is in Canada's national interest.

"Producers are looking for a way out, but it's an issue that's not going to get solved soon," said Chris Bloomer, chief executive of the Canadian Energy Pipeline Association. He said many in the industry have seen the capacity problem coming for some time but were caught off guard by the Keystone leak, which caused supply to back up at storage facilities.

"There's a big bulge in storage that's got to be worked off," said Mr. Bloomer. "Any hiccup in the system will create problems getting barrels to the market. And we only have one market."

Write to Vipal Monga at vipal.monga@wsj.com and David George-Cosh at david.george-cosh@wsj.com

(END) Dow Jones Newswires

January 28, 2018 08:14 ET (13:14 GMT)