Altacopr Energy Update Oct 23 2018

October 23, 2018 AltaCorp Energy Update
Companies mentioned in this Canadian Heavy Oil Is Not a Discounted Product, It’s A
report: Stranded Product
BP p.l.c. (BP-L; Not Rated)
Bullish Heavy Oil: While we are cognizant that the appetite to invest in the
Enbridge (ENB-T; Not Rated) Canadian energy space has seldom been worse than it is currently, we believe that
there are structural reasons why investors can be bullish heavy oil. While Canada’s
ExxonMobil (XOM-N; Not Rated)
ability to participate to the fullest extent is hindered by its inability to build pipeline
infrastructure, the eventual ramp-up of crude-by-rail and the increasing need for
heavy oil in the global marketplace will support commodity prices in the medium
term. For the purposes of this report we have not addressed the dire nature of the
Canadian pipeline situation but direct readers interested in this topic to our recent
report on the topic here.
WCS Trades at a Premium to WTI: Global heavy oil benchmark crudes are
routinely being imported into the US Gulf Coast (USGC) at premium prices to WTI
while Canadian heavy oil priced in Alberta is trading at historic lows relative to the
benchmark. Many investors (and Canadians in general) would be surprised to know
that Western Canadian Select (WCS) barrels that are able to get to the USGC have
been earning a premium to WTI at times throughout H2/18 (albeit pricing at a slight,
US$2.80/bbl, discount at the time of publication).
Rail the Only Accessible Option for Now: Pipeline apportionments in Canada
are causing barrels to become stranded, forcing operators to place them into storage
or selling them at unjustifiably low prices. Oil in storage in Alberta surged during the
summer to ~85% of capacity currently available. Rail transportation may be the only
near term tool accessible to drain the storage as pipelines are likely to be
bottlenecked for at least twelve months (until the Enbridge [ENB-T; Not Rated] Line
3 Replacement Pipeline may be placed into service). Comments from Large Cap and
Integrated E&P’s point to rail costs being in the range of US$17.00-$19.00/bbl –
leaving us to believe that WCS differentials should average in the US$20-$25/bbl
range until additional pipeline capacity is in service (justifying far narrower
differentials than the >US$50/bbl seen in Oct. 2018).
The Punch Line: Despite sentiment towards Canadian energy being extremely
negative (heavy oil in particular), the reality is that heavy oil production is becoming
Nicholas Lupick, CFA an increasingly scarce commodity on the global stage and as such is beginning to
Daniel Morgan (Associate) warrant a premium commodity price. Investors with a long term investment horizon,
and the patience to allow market forces to debottleneck the Canadian transportation
landscape (be it pipelines or crude-by-rail), should evaluate further investment in the
Contact details provided at the back of
this report. sector, counter to the market’s short term sentiment.
Regulatory Disclosures and policy on the dissemination of research: www.altacorpcapital.com

ALTACORP CAPITAL INC. I NSTITUTIONAL EQUITY R ESEARCH: ENERGY
Summary
In early 2017, AltaCorp introduced a thesis on the heavy oil market which is predicated on the
growing dislocation of supplies of different qualities of crude oil. Specifically, we highlighted
expectations for declines of heavier crudes to accelerate around the world and suggested that the
vast majority of global production growth (driven mostly by US shale) was coming in the form of
ultra-light hydrocarbons (which in many basins could be considered condensates vs black oil –
being in the >45°API range).
We are reiterating this thesis and show that the unprecedented discounts being applied to
Canadian heavy oil is solely the result of locational discounts rather than a lack of demand for the
heavy barrels – with Western Canadian Select (WCS) recently commanding a premium
price relative to WTI in the PADD III Houston market. When we initially introduced our
thesis, we suggested that it would not be incomprehensible for heavy crude oil to trade at a
premium to WTI, which has occurred a number of times since then.
Within this report we highlight the fundamental reasons for investors to be bullish on heavy oil
prices today. However, the only way for Canada to participate in our bullish outlook for global
heavy oil is to build much-needed and adequate transportation infrastructure to deliver barrels to
tidewater which would enable access to the global marketplace. For the purposes of this report
we have not addressed the dire nature of the Canadian pipeline situation but direct readers
interested in this topic to our recent report here.
Western Canadian Select Is Trading At a Premium to WTI

While it may come as a surprise for many, investors should be aware that Canada’s WCS heavy
oil has been trading at a premium to WTI. As shown in Figure 1, while the forward curve for a
WCS barrel in Houston is being sold at a di minimis discount of -US$0.50-$0.25/bbl to WTI, it
has at times traded at a premium to WTI in that market by as much as +US$1.25/bbl (October 9th
2018). The catch is that producers must reach the US Gulf Coast in order to receive this
premium.
WCS Differential (USD) to WTI in Edmonton and Houston

$10
$0
-$10
WCS @ Houston (Oct. 9,

-$20
US$/bbl
2018)
WCS @ Houston
-$30
-$40 WCS @ Hardisty
-$50
-$60
Figure 1. WCS Discount to WTI at Houston, TX and Hardisty, AB

Source: Net Energy, ATB Financial, Atlas Petroleum Markets, AltaCorp Capital Inc.
Energy 2
th
WCS USD Differential to WTI at Houston – October 9 2018
$1.40
$1.20
$1.00
$0.80
$0.60
US$/bbl
$0.40
$0.20
$0.00
($0.20)
($0.40)
($0.60)
Figure 2. WCS Discount to WTI at Houston on October 9th, 2018

Source: Net Energy, ATB Financial, Atlas Petroleum Markets, AltaCorp Capital Inc.
Money to Be Made By Those Who Have Transportation Capabilities
With ongoing apportionments materially curbing takeaway capacity (the Enbridge [ENB-T; Not
Rated] system is seeing 40%-45% of nominations ‘kicked back’ on a regular basis in 2018), all
incremental barrels leaving the basin will have to depart on railcars until further pipeline capacity
is constructed.
However, there are some Canadian E&Ps which have the ability to capture this arbitrage. We
recommend contacting your AltaCorp salesperson for our top ideas on ways to invest in
companies exposed to USGC-priced production with firm transportation commitments and/or
companies which provide transportation logistics.
‘Thanks for the Subsidy Canada’ – USA Refiners

The most important takeaway from this report is the fact that WCS is not a discounted product
in the global marketplace – it is simply a stranded product (due to lack of infrastructure) which
must price at an unjustifiable discount in order to clear the market.
With 2.92 mmbbls/d of heavy crude being exported to the United States for feedstock into the
domestic refining market (see Figure 22 on page 18), US based refineries are reaping the benefits
of Canada’s misfortune as they have recently been purchasing a WCS barrel for US$30/bbl less
than they would if they had to buy the exact same barrel off of a seaborne tanker in Houston
(even after rail transport costs). This discrepancy is shown (once again) in Figure 5, with the
recent pricing of WCS barrels in Houston at a US$2.50/bbl discount vs a US$50.00 discount in
Edmonton. It should be noted that WCS has traded at a premium to WTI numerous times in
2018 (most recently on Oct. 9th, shown in the chart at a US$1.25/bbl premium to WTI for Nov.
2018 delivery).
Energy 3
Said another way, of the ~5.0 mmbbls/d of heavy crude oil being consumed by the US refining
market (see Figure 3), Canada has recently been supplying nearly 60% of this demand at a
US$30/bbl cheaper cost to the refiner than if the same barrel were purchased in Houston (where
global prices prevail).
U.S. Refining Capacity
Total US Refining Capacity
PADD I 1,300 mbbl/d
PADD II 4,000 mbbl/d
PADD III 9,700 mbbl/d
PAD IV 700 mbbl/d
PADD V 3,000 mbbl/d
TOTAL 18,700 mbbl/d
Heavy Oil Refining Capacity

PADD I 100 - 125 mbbl/d
PADD II 1,300 - 1,500 mbbl/d
PADD III 2,500 - 3,000 mbbl/d
PAD IV 180 - 220 mbbl/d
PADD V 700 - 800 mbbl/d
TOTAL 4,780 - 5,645 mbbl/d
Figure 3. U.S. Refining Capacity

Source: EIA, AltaCorp Capital Inc.
Why is WCS Trading at A Premium in Houston?

The reason is because heavy crude oil is a sought after feedstock for the global refining market
which is in short (and declining) supply.
Domestic Market Dynamics: Before we reference the global market we once again reiterate that
the US refining market (the largest refining market in the world) is configured to consume ~5.0
mmbbls/d of heavy crude oil, but that the US Lower 48 produces very minimal volumes of heavy
oil (see Figure 11 on page 9) – leaving the US to import nearly all of its heavy oil refining
feedstock.
…Because the Global Heavy Oil Market Is Declining Everywhere

(Other than of Canada)
One of the reasons why heavy crudes have begun to receive a strong bid in the global
marketplace is because international output of heavy oil has been in consistent decline since the
start of the oil correction, and is expected to continue to do so for the near term – with the only
barrels growing during this timeframe being on the ‘light end’ of the API spectrum (namely US
shale) – as shown in Figure 4.
Energy 4
Y/Y Change in Global Crude Oil Production by Type (mmbbls/d)
Figure 4. Y/Y Change in Crude Oil Production by Type

Source: Energy Aspects
As shown in the graph above, Canada is the only country to exhibit noticeable growth over the
past 24 months and should have been positioned to capitalize on capturing global market share –
but instead has been selling its crude for a large discount due to lack of infrastructure. This
decline in global supply in heavy crude has caused many medium and heavy crude slates to begin
to price at a premium to WTI (see Figure 5) – challenging the misnomer that all heavy barrels are
a ‘discounted product’.
Global Heavy and Medium Blends – Price Differential to WTI

$30
$20
$10 Premium to
WTI
$0
WCS
US$/bbl
-$10
Mars
-$20
Arab Heavy
-$30 Oriente
-$40 Maya
-$50
-$60
Dec-12
Dec-13
Dec-14
Dec-15
Dec-16
Dec-17
Mar-13
Jun-13
Mar-14
Jun-14
Mar-15
Jun-15
Mar-16
Jun-16
Mar-17
Jun-17
Mar-18
Jun-18
Sep-12
Sep-13
Sep-14
Sep-15
Sep-16
Sep-17
Sep-18
Figure 5. Heavy Oil Grade Price Differentials to WTI

Source: Bloomberg, AltaCorp Capital Inc.
Energy 5
Most Notable Global Declines
Mexico
Mexico’s state-owned oil company PEMEX has seen its heavy oil production decline by an
average of -5% each year since 2013, removing 292 mbbls/d of the crude from the market over
that time. The current President-Elect of the nation aims to restore production capability back to
2.5 mmbbls/d (a level not achieved since 2013), within two years, though this is highly unlikely
given the limited amount of capital the Mexican government is expected to feasibly attain to
explore and develop its offshore oil fields. As a result, macro forecaster consensus is that declines
are likely to continue for the foreseeable future, opening opportunity for other nations to fill the
US’ demand for heavy oil.
Mexico Crude Oil Production

3.0
Light & Extralight
Heavy
2.5
2.0
mmbbls/d
1.5
-5% Annual Decline
1.0
0.5
0.0
2013 2014 2015 2016 2017 YTD 2018
Figure 6. Mexico Crude Oil Production

Source: PEMEX, AltaCorp Capital Inc.
Venezuela
It’s no secret that Venezuela has been suffering major political and economic turmoil over the
past two years, impacting the efficiency of its energy sector. Since 2015, Venezuelan oil
production has declined by -1.1 mmbbls/d, or -19% annually, to ~1.20 mmbbls/d according to
OPEC secondary sources. Declines are highly likely to continue, with some macro forecasters
expecting production to fall below 1.0 mmbbls/d by mid-2019. US sanctions on the country have
made it difficult for the national oil company to repair key infrastructure, reducing export
capacity and ability to import much-needed naphtha blendstock.
US imports of crude oil from Venezuela have hovered around 500 mbbls/d over the past year,
though the rise in WCS blend prices in the US Gulf Coast leads to our conviction that refineries
are demanding Canadian crudes to replace barrels from other heavy oil producing nations in
decline such as Venezuela.
Iran
US sanctions being imposed on Iran has made a significant impact on crude oil production from
the Islamic Republic. Waterborne exports in September from the OPEC member reportedly
declined by -960 mbbls/d y/y and -400 mbbls/d m/m to 1.75 mmbbls/d. Exports are likely to
continue to fall precipitously in the coming months and could reach ~2.0 mmbbls/d by early 2019
– below its 2012-2015 level of ~2.7 mmbbls/d (during the sanctions imposed by the Obama
administration). As shown in Figure 12 on page 9, Iran crude oil is heavier than many may
realize at an API grade of ~27°, and will continue to have wide reaching effects on the market.
Energy 6
Venezuela, Mexico, and Iran Crude Oil Production

10
9.0 mmbbls/d Forecast
9
8
<5.0 mmbbls/d
7
mmbbls/d
Venezuela
5
Mexico
4 Iran
3
0
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Figure 7. Venezuela, Mexico, and Iran Crude Oil Production

Source: Energy Aspects, AltaCorp Capital Inc.
Origins of U.S. Foreign Heavy Imports; Increasingly

(Discounted) Canadian
As would be expected given the aforementioned decline in global heavy oil production, US
imports of heavy crude from countries other than Canada has been diminishing steadily over the
past decade. As shown in Figure 8, Canada’s share of US imports of heavy crude has been
increasing steadily, from 26% in 2009 to more than 60% today – reiterating that Canadian
heavy oil is not discounted because it is an unwanted product.
U.S. Imports of Heavy Crude Oil by Country

6
4 Others
mmbbls/d
Colombia
3 Mexico
Venezuela
2
Saudi Arabia
Canada
1
0
Jul-16
Jul-09
Jul-10
Jul-11
Jul-12
Jul-13
Jul-14
Jul-15
Jul-17
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Jan-18
Figure 8. U.S. Imports of Heavy Crude Oil by Country

Energy 7
…And Because of Gasoline vs Diesel Output and Market

Dynamics
While the inner workings of the chemical and process engineering of the refining business model
falls outside of the scope of this report, we do need to highlight that the chemistry of feedstock
does play a vital role in the output of the refining complex.
One of the issues which has begun to emerge within the US refining market is the fact that the
lightening of the country’s production slate has started to cause issues with the product output of
the complex refiners, with our friends at Energy Aspects recently stating the following after a trip
to visit US refiners:
“The growth in US shale production and the rapid growth in US exports since the lifting of the
export ban three years ago have resulted in a significant lightening of the crude slate around the
world. Refiners we met during our recent visit to Texas were very vocal about just how much
gasoline uplift they were receiving from running the domestic light slate, despite every attempt to
maximise diesel yields. And with sour crudes far more expensive compared to landlocked
domestic sweets, their LP models continue to choose the lighter slates.”
Source: Energy Aspects Perspectives Report, Oct. 15, 2018
Importantly, this highlights the struggle to continue to produce the desired diesel but also
underscores the fact that global heavy crude has begun to trade at a premium due to both its
declining supply and desirable chemistry.
In fact, European refinery runs (which we highlight later as taking increasing volumes of US
Light barrels) have fallen y/y by -180 mbbls/d (during the summer of 2018) and yet gasoline
output has increased by +110 mbbls/d (underscoring our comments about altering the product
slates with lighter feedstocks).
Gasoline Not as Bullish as Diesel
The global outlook is far less bullish for gasoline (with some arguing that the world is nearing
peak demand) than it is for diesel and middle distillates which continue to see growing industrial
demand in non-OECD/developing nations. As can be seen in Figure 9 and Figure 10, growth in
gasoline demand is paltry (averaging +180 mbbls/d over the next fifteen months) compared to
that of diesel (estimated at +622 mbbls/d over the same time period).
World Gasoline Demand – y/y Change (mmbbls/d) World Diesel Demand – y/y Change (mmbbls/d)
2.0 2.0
1.5 1.5
1.0 1.0
mmbbls/d
0.5 0.5
World World
0.0 0.0
-0.5 -0.5
-1.0 -1.0
Q1/12
Q1/14
Q1/10
Q3/10
Q1/11
Q3/11
Q3/12
Q1/13
Q3/13
Q3/14
Q1/15
Q3/15
Q1/16
Q3/16
Q1/17
Q3/17
Q1/18
Q3/18
Q1/19
Q3/19
Q3/14
Q3/16
Q3/18
Q1/10
Q3/10
Q1/11
Q3/11
Q1/12
Q3/12
Q1/13
Q3/13
Q1/14
Q1/15
Q3/15
Q1/16
Q1/17
Q3/17
Q1/18
Q1/19
Q3/19
Figure 9. World Gasoline Demand – y/y Change (mmbbls/d) Figure 10. World Diesel Demand – y/y Change (mmbbls/d)
Source: Energy Aspects, AltaCorp Capital Inc. Source: Energy Aspects, AltaCorp Capital Inc.
Energy 8
U.S. Production is Ultra-Light and is Hardly a Crude that U.S.

Refiners Want
As we have alluded to thus far, the US shale oil complex is shouldering the majority of global oil
supply growth, but at the very ‘light-end’ of the hydrocarbon spectrum. In fact, the vast majority
of US crude oil production comes in the form of hydrocarbon product with an API grade of at
least 40°. As we show in Figure 11, 4.8 mmbbls/d (32%) of the country’s 15.0 mmbbls/d of total
liquids production is ultra-light crude, and 5.3 mmbbls/d (35%) is in the form of
Condensate/Natural Gas Liquids (NGLs).
U.S. Lower 48 Production by API Grade as of July 2018
5.0
4.5
4.0
WTI Benchmark = 39o Extremely Light Crude
3.5
3.0
mmbbls/d
Condensate, NGLs, etc.

2.5
2.0
1.5
1.0
0.5
0.0
Figure 11. U.S. Lower 48 Production by API Grade as of July 2018

What’s more, is the fact that the two growth engines in the surge of US shale production are the
Eagle Ford and Permian basins. However, as Figure 12 shows, both basins have an API of nearly
45° - far beyond the 32° API average crude slate desired by the US refining market (discussed
next) and is likely to cause a dislocation in the global crude balance given the heavier API gravity
of all of the basins in decline (as noted previously).
Select Crude Slate API and Sulphur Content vs U.S. Refining Diet
Figure 12. World Oil Production Volume and Quality – 2017

Source: Argus, Eni S.p.A., AltaCorp Capital Inc.
Energy 9
Shown differently, Figure 13 and Figure 14 illustrate the production growth by crude slate in
Texas and New Mexico (i.e. proxies for the Permian and Eagle Ford) as well as the steady state
of heavy oil imports into PADD III (and the elimination of light imports) – highlighting the
continued need for a supply of heavier feedstock.
Texas and New Mexico Production of Crude Oil by Type

6
mmbbls/d 4
Light (>40⁰ API)

3
Medium (30-40⁰ API)
2 Heavy (<30⁰ API)
0
Apr15
Apr16
Apr17
Apr18
Jan15
Jan16
Jan17
Jan18
Jul15
Jul16
Jul17
Jul18
Oct15
Oct16
Oct17
Figure 13. Texas and New Mexico Production of Crude Oil by Type
Imports of Crude Oil to U.S. PADD III (Gulf Coast) by Type

7
5
mmbbls/d
4
Light (>35⁰ API)
3 Medium (27-35⁰ API)

Heavy (<27⁰ API)
2
0
Jul-09
Jul-10
Jul-11
Jul-12
Jul-13
Jul-14
Jul-15
Jul-16
Jul-17
Jan-09
Jan-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Jan-18
Figure 14. Imports of Crude Oil to U.S. PADD III (Gulf Coast) by Type
Energy 10
Shale Basins Do Not Contain the Barrels U.S. Refiners Want

Summarized differently, the US refining market is not configured to consume vast amounts of the
crude slate being produced from US shale basins. As we show in Figure 15, the weighted average
API grade of the US refining complexes’ crude diet is ~32°. We believe that it lower than this in
practicality as there has been recent upward pressure on this due to the construction of Exxon’s
(XOM-N; Not Rated) hydrocracker at its Beaumont, TX facility.
U.S. Lower 48 Production and Refining Capacity by API Grade by API Gravity (Degrees)
33
32
31
30
29
28
Oct-2013
Mar-2014
Aug-2014
Jan-2015
Jan-2010
Nov-2010
Sep-2011
Feb-2012
Jul-2012
Nov-2015
Sep-2016
Feb-2017
Jul-2017
Apr-2011
Dec-2012
May-2013
Apr-2016
Dec-2017
May-2018
Jun-2010
Jun-2015
Figure 15. Refining Capacity by API Grade by API Gravity (Degrees)
Where Are These Light U.S. Barrels Going Then?

As we show in Figure 16, the vast majority (71%) of US exports (and nearly all of the growth)
have been destined for Asia and Europe. We would note that Asia is home to some of the largest
producers of petrochemical in the world which use the Ultra-Light feedstock to produce
fertilizers, and propylene’s (the primary ingredient in plastics [after the conversion from naphtha
and then ethylene]), while in Europe, refineries have tried to opportunistically run the volumes
and have seen their runs fall y/y by -180 mbbls/d (during the summer of 2018) and yet gasoline
output has increased by +110 mbbls/d (underscoring our previous comments on page 8 about
altering the product slate towards what are going to be an oversupply of gasoline barrels).
U.S. Exports of Crude Oil by Destination

2.5
2.0
Africa
mmbbls/d
1.5
LatAm
1.0 Canada
Caribbean
0.5 Europe
Asia Pacific
0.0
Mar-2018
Mar-2017
Aug-2017
Oct-2016
Jul-2017
Oct-2017
Nov-2016
Jan-2017
Feb-2017
Sep-2017
Nov-2017
Jan-2018
Feb-2018
Jul-2018
Dec-2016
Apr-2017
May-2017
Dec-2017
Apr-2018
May-2018
Jun-2017
Jun-2018
Figure 16. U.S. Exports of Crude Oil by Destination

Energy 11
For Canadian Heavy Oil, It’s All about Location,

Location, Location
Why Did the Differential Become Irrational in H2 2018?

Although the forward market does not believe that it is likely to stay, Canadian differentials have
widened to unprecedented levels – trading as wide as US$54.00/bbl, forcing heavy oil producers
to sell production at a loss at a time when global benchmark crudes are at their highest levels
since the commodity correction began in Q4/14. There are a number of reasons for this widening:
1) Q2/Q3 2018 marks the first time in which all of the major oil sands mining growth projects
of the last decade are on line (Suncor’s Fort Hills, Canadian Natural’s Horizon Phases 1-3
and Imperial’s Kearl Phases 1-2).
2) The US Refining complex saw a much larger turnaround season in the Fall of 2018 with
PADD II in particular seeing ~270 mbbls/d of capacity offline beyond what is typical (see
Figure 17). The most notable facility to go offline for an extended period is BP’s (BP-L; Not
Rated) 430 mbbls/d Whiting facility in Indiana (which is the single largest consumer of
Canadian heavy at ~250 mbbls/d).
U.S. PADD II Refinery Outages (Planned & Non-Planned)

900
800
700
600
18/19
mbbls/d
500
17/18
400
16/17
300
200
100
0
Mar. Apr. May. Jun. Jul. Aug. Sep. Oct. Nov. Dec. Jan. Feb.
Figure 17. U.S. PADD II Refinery Outages (Planned and Unplanned)

Source: Energy Aspects, AltaCorp Capital Inc.
3) Making the market reaction even more violent in response to the intense turnaround season
is the fact that Alberta Energy Regulator (AER) reported Alberta inventories have been
climbing and are approaching the estimated capacity of ~84 mmbbls (see Figure 18) –
leaving little room in the system for future interruptions and causing the market to trade with
a significant risk premium.
Energy 12
Alberta Crude Oil in Storage
Figure 18. Alberta Crude Oil in Storage

Source: AER, AltaCorp Capital Inc.
Line Of Sight To Improvement in Canadian Oil Differentials: With the return of the refining
complex from turnarounds and the ramp-up of crude-by-rail, investors can expect to see the
differential eventually narrow to a level much more reflective of fundamentals – which we now
deem to be in the US$20.00-$25.00/bbl range (reflective of the forward curve at time of
publication). This level is the result of normalized transportation differentials in a debottlenecked
crude-by-rail environment:
~US$18.00/bbl rail transport from Edmonton to the USGC

+ ~US$1.50/bbl loading
+ ~US$1.00/bbl offloading
+ a nominal risk premium for Canadian transportation risk and IMO 2020 uncertainty.
= a WCS Differential in the range of US$20.00-$25.00/bbl
At this differential the forward curve would be reflecting rail economics for the foreseeable
future (i.e. not reflecting normalized pipeline economics which would justify a ~US$12-$15/bbl
differential).
Energy 13
Canada Crude by Rail

Though crude-by-rail in Canada has made a far slower ramp-up than we had previously expected,
deals between E&P’s, railroad operators, and railcar loading infrastructure owners leads us to
believe that economics will prevail in the western Canadian sedimentary basin (WCSB) in the
coming year and barrels will eventually make it to global markets via rail.
As well, comments from management teams of a few of the largest crude oil producers in Canada
have stoked expectations for rail to export more than 450 mbbls/d of crude oil (in H2/19) from
206 mbbls/d in the summer of 2018.
Canada Exports of Crude Oil by Rail

250
5-Yr. Range 2018
2017 5-Yr. Avg.
200
150
mbbls/d
100
50
0
Feb.
Apr.
Jul.
Oct.
Sep.
May.
Aug.
Jan.
Mar.
Jun.
Nov.
Dec.
Figure 19. Canada Exports of Crude Oil by Rail
Source: Statistics Canada, AltaCorp Capital Inc.
We estimate an average net price improvement of ~US$14.50 in 2019 (based on recent strip
pricing and our estimated rail transport cost of US$18.00/bbl) for each barrel that is able to reach
the US Gulf Coast from the WCSB via rail (see Figure 20).
WCS Locational Differentials to WTI and Implied Netback Uplift

$10
$0
-$10
WCS @ Houston
-$20
US$/bbl
Margin uplift vs. Edmonton

Pricing uplift
-$30
WCS @ Hardisty
-$40
WCS @ Houston (Oct. 9,
2018)
-$50
-$60
Figure 20. WCS Differentials to WTI and margin uplift vs. Edmonton
Source: Net Energy, ATB Financial, Atlas Petroleum Markets, AltaCorp Capital Inc.,
Energy 14
The Punch Line: Heavy Oil Is Not a Discounted Product; It’s

Just Stranded in Canada
Broadly speaking, long-term investors in Canadian Energy since the ’08-’09 market crash should
rightfully be disappointed in the performance of their investments – and for the most part it is not
the result of poor management decisions, but rather the result of Canada’s inability to install
adequate transportation infrastructure to enable the sector to receive a global price for its product
justified by supply/demand fundamentals.
Despite sentiment towards Canadian energy being extremely negative (heavy oil in particular),
the reality is that heavy oil production is becoming an increasingly scarce commodity on the
global stage and as such is beginning to warrant a premium commodity price. Investors with a
long term investment horizon, and the patience to allow market forces to debottleneck the
Canadian transportation landscape, should evaluate further investment in the sector, counter to
the market’s short term sentiment.
Energy 15
APPENDIX
IMO-2020; Some Food For Thought
Ultimately the impact of the International Maritime Organization’s (IMO) new regulations
limiting the sulphur content from 3.5% to 0.5% beginning in 2020 is still yet to be determined.
However, we must point out that the market analysis on the impacts of IMO 2020 are among the
most polarizing we have ever seen, spanning from apocalyptic predictions of the regulations
causing the next global recession/financial crisis to others citing the regulations as being the most
overblown market fear seen in decades. As with most extreme views, we believe reality is
somewhere in the middle and here are a few points to remember:
1) Impact of 2.0 mmbbls/d; Not 4.0 mmbbls/d: Of the estimated 4 mmbbls/d of bunker fuel
demand estimated to be impacted by IMO 2020 the actual amount of excess bunker fuel
product expected to be in the market following the regulations is likely closer to 2 mmbbls/d.
This is because estimates are suggesting that roughly half of the bunker fuel produced is
likely to be reprocessed again through secondary coker runs – converting high sulphur
bunker fuel into Marine Gasoil (MGO) which is sulphur compliant. How much does the
extra processing cost? Likely a few dollars (but well less than $8 given that total opex of
complex refiners is in the $7-$12/bbl range typically).
a. We remind investors that the North American refining complex underwent a massive
buildout of investment in the 1980s to take a heavier (and more sour) crude diet. As
such, the North American refining market is well equipped to handle (and remove)
this sulphur as described via coking processes (it may just require additional
processing).
2) Global Heavy Oil Production is Becoming Short of Supply: Outside of Canada, global
heavy production is widely in decline (as we highlighted previously). As such, major
consumers of heavy barrels around the world (the largest growth areas being China and
India) are going to be increasingly in short supply of heavy crude oil (which typically have
higher sulphur content) and which their refineries are designed to consume. In fact, the only
barrels showing material growth around the world (outside of Canada) are on the light end of
the API spectrum (namely US Shale). As a result, for those Canadian entities who can get
their product to tidewater, the rest of the world is likely to bid for their heavy barrels.
a. For context the current cost to ship to Asia is US$2.00-$3.00/bbl.
3) Product Yields Need a ‘Full Bodied’ Barrel: Following on point two, in order for a
complex refinery to produce a wide spectrum of heavier middle distillates they will need a
more full bodied barrel as feedstock (sulphur content aside). Facilities configured to do this
are not able to run their facilities with light US shale oil barrels – and those which try are not
receiving the distillates they desire but are producing greater quantities of less desirable
gasoline (as we highlighted on page 8).
4) Differential Impacts Need the Context of Timing: For Canadian heavy producers, the timing
of IMO 2020 needs to be put into the context of the broader market dynamics. In 2020 it is
possible that Enbridge’s Line 3 replacement (adding 357 mbbls/d of southbound pipeline
capacity) could be in service and the Canadian federal government-owned 590 mbbls/d
TransMoutain expansion could be well on its way to being constructed. Once in service, these
pipelines should see Canadian heavy differentials return to the US$12.00-$15.00/bbl range
(justified by transportation costs + a moderately wider IMO 2020 sulphur discount) vs the
US$50.00/bbl differential recently. As such, hypothetically, even if the new regulations add
US$5.00/bbl (for example) to the differential the realized price will be much more supportive
of Canadian heavy than what the market is currently pricing in.
Energy 16
5) Economics 101: When a cost needs to be borne within a value chain it get shared by both the
consumer and the producer. In this case, maritime shipping companies are going to pass along
higher costs to all consumers via higher prices on consumable goods shipped globally (as diesel
demand makes fuel costs higher) and high sulphur crudes will be somewhat discounted for
being less desirable feedstocks – coming with higher processing fees to handle said sulphur.
But to assume that 100% of the burden will be shouldered by one section of the value chain
(upstream producers in the way of differentials) simply isn’t how supply and demand
economics work.
6) (Some) Scrubbers Appear to be Coming: For the most part the shipping industry has not
adopted the use of onboard scrubbers through retro-fits of existing fleets (which would
enable compliance with the high sulphur fuel oil rules [HSFO]). As the price of HSFO
continues to fall, the economic incentive to install scrubbers increases (the spread between
HSFO and MGO is ~US$28/bbl). As shown in Figure 21, ~1,850 ships are slated to have
scrubbers installed (in a market of ~94,000 ships) (Source: Norwegian consultancy firm
DNV GL).
Scrubber Instalations Are Coming; Just Not Fast Enough

2,000
Retrofit
1,800
Newbuild
1,600
Unknown
1,400
1,200
1,000
800
600
400
200
0
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022
Figure 21. Confirmed Heavy Fuel Oil Scrubber Installations

Sources: Reuters: “Shippers scramble to install sulphur filters ahead of rule change”; Norwegian consultancy firm DNV
GL; AltaCorp Capital Inc.
Energy 17
Other Exhibits
Canadian Heavy Oil Exports to the U.S.
3.5
3.0
2.5
mmbbls/d
2.0
1.5
1.0
0.5
0.0
Jan-10
Sep-10
Jan-11
Jan-12
Jan-13
Jan-14
Jan-15
Jan-16
Jan-17
Jan-18
Sep-11
Sep-12
Sep-13
Sep-14
Sep-15
Sep-16
Sep-17
May-10
May-11
May-12
May-13
May-14
May-15
May-16
May-17
May-18
Figure 22. Canadian Heavy Oil Exports to the U.S.
Source: NEB, AltaCorp Capital Inc.
U.S. Imports of Crude Oil by Type

12
10
8
mmbbls/d
6 Light (>35⁰ API)

Medium (27-35⁰ API)
4 Heavy (<27⁰ API)
0
Dec-11
Apr-14
Nov-14
Jun-15
Oct-10
Jul-12
Oct-17
Feb-13
Sep-13
Aug-09
Aug-16
Jan-09
Mar-10
May-11
Jan-16
Mar-17
May-18
Figure 23. U.S. Imports of Crude Oil by Type

Energy 18
Global Crude Slates –World (Eni World Oil Review 2018)
Figure 24. World Oil Production Volume and Quality – 2017

Source: Eni S.p.A.
Energy 19
Global Crude Slates – Europe
Figure 25. European Oil Production Volume and Quality – 2017

Source: Eni S.p.A.
Energy 20
Global Crude Slates – FSU
Figure 26. Former Soviet Union Oil Production Volume and Quality – 2017
Source: Eni S.p.A.
Energy 21
Global Crude Slates – The Middle East
Figure 27. Middle East Oil Production Volume and Quality – 2017
Source: Eni S.p.A.
Energy 22
Global Crude Slates – Africa
Figure 28. Africa Oil Production Volume and Quality – 2017

Source: Eni S.p.A.
Energy 23
Global Crude Slates –Asia Pacific
Figure 29. Asia Pacific Oil Production Volume and Quality – 2017
Source: Eni S.p.A.
Energy 24
Global Crude Slates – Americas
Figure 30. Americas Oil Production Volume and Quality – 2017

Source: Eni S.p.A.
Energy 25
Direct @altacorpcapital.com
_____________________________________________________________________________________________________________
Institutional Equity Research
E&P- Domestic
Nicholas Lupick, CFA, Head of Research 403 539 8592 nlupick
Daniel Morgan, Associate 403 539 8635 dmorgan
Patrick J. O’Rourke, CFA, Analyst 403 539 8615 porourke
Jon Horsman, MBA Kyle Styner, Associate 403 539 8626 kstyner
Chairman & CEO Thomas Matthews, P.Eng., CFA, Analyst 403 539 8621 tmatthews
403 539 8611 Nicholas Koch, Associate 403 539 8581 nkoch
jhorsman@altacorpcapital.com
Infrastructure & Renewable Energy
Nate Heywood, CFA, Analyst 403 539 8584 nheywood
Ben Chiu, Associate 403 539 8590 bchiu
Paul Sarachman, CFA, FCSI
Oilfield Services
President
Tim Monachello, CFA, Analyst 403 539 8633 tmonachello
647 776 8250 Patrick Tang, CPA, Associate 403 539 8594 ptang
psarachman@altacorpcapital.com
Diversified Industries
Chris Murray, P.Eng., CFA, Senior Analyst 647 776 8246 cmurray
Lovish Gupta, Associate 647 776 8245 lgupta
ATB Financial Healthcare & Life Sciences
Curtis Stange David Kideckel, PhD, MBA, Senior Analyst 647 776 8240 dkideckel
President & CEO Matthew Pallotta, CPA, CA, Associate 647 776 8236 mpallotta
All Sectors
Jessica Kakoske, Assistant 403 539 8598 jkakoske
_____________________________________________________________________________________________________________
Institutional Sales
Calgary
Kerk Hilton 403 539 8608 khilton
Toronto
Paul Sarachman, CFA, FCSI 647 776 8250 psarachman
Adam Carlson 647 776 8242 acarlson
Tim Miller 647 776 8237 tmiller
Anya Khomik 647 776 8222 akhomik
Denver
Colin Fatti* 720 683 6701 cfatti
_____________________________________________________________________________________________________________
Institutional Trading
Calgary
CALGARY Shane Dungey 403 539 8605 sdungey
410, 585 – 8 Avenue SW Toronto
Calgary AB Canada T2P 1G1 Mervin Kopeck 647 776 8040 mkopeck
403 539 8600 Main Chris Petrow 647 776 8231 cpetrow
403 539 8575 Fax Denver
Brian Racanelli* 720 683 6700 bracanelli
_____________________________________________________________________________________________________________
TORONTO Investment Banking

66 Wellington Street West, Suite 3530 Debt Capital Markets
Toronto, ON Canada M5K 1A1 Jason Caldarelli 647 776 8243 jcaldarelli
John Cloghesy 403 539 8628 jcloghesy
647 776 8230 Main
647 776 8248 Fax Energy
Mike de Carle 403 539 8597 mdecarle
Brian Heald, P.Eng, CFA, ICD.D 403 539 8596 bheald
Arturo Vilas (Latin America) 54 11 3528 5013 avilas
DENVER Roland Walters 403 539 8618 rwalters
AltaCorp Capital (USA) Inc. Patrick Stables, CFA 403 539 8604 pstables
551, 100 Filmore Street Ward Hallett, CA 403 539 8514 whallett
Denver, CO USA 80206
Agriculture & Diversified Industries
720 683 6700 Main Jeff Fallows, CFA 647 776 8221 jfallows
720 683 6709 Fax Alf Sailer, MBA 587 226 6812 asailer
Vincent Kong, CFA 780 392 9289 vkong
Chris Arseneault, CFA 403 539 8619 carseneault
Mark Wang, CFA 780 408 6502 mwang
BUENOS AIRES
Av. Del Libertador 5975, Floor 5, Of. A All Sectors
Greg Smiddy 403 539 8595 gsmiddy
1428 Buenos Aires, Argentina Yarik Zakrevsky, CFA 647 776 8155 yzakrevsky
54 11 3528 5013 Main Tyler Press 647 776 8224 tpress
Alex Chang 647 776 8156 achang
Dylan Morrow 403 539 8630 dmorrow
Arsalan Farooqui 647 776 8098 afarooqui
Morgan Tort 403 539 8609 mtort
www.altacorpcapital.com _____________________________________________________________________________________________________________
Acquisitions & Divestitures
member CIPF • IIROC • FINRA • SIP
Bruce Alexander, P.Geol. 403 539 8616 balexander
Amy Trynor, P.Eng. 403 539 8623 atrynor
Kelly Wylie 403 539 8589 kwylie
_____________________________________________________________________________________________________________
Private Wealth
Hari Mohan, Investment Advisor 403 539 8603 hmohan
*Employee of AltaCorp Capital (USA) Inc.

Altacopr Energy Update Oct 23 2018

Hochgeladen von

Dokumentinformationen

Copyright

Verfügbare Formate

Dieses Dokument teilen

Dokument teilen oder einbetten

Freigabeoptionen

Stufen Sie dieses Dokument als nützlich ein?

Sind diese Inhalte unangemessen?

Copyright:

Verfügbare Formate

Altacopr Energy Update Oct 23 2018

Hochgeladen von

Copyright:

Verfügbare Formate

October 23, 2018 AltaCorp Energy Update

Regulatory Disclosures and policy on the dissemination of research: www.altacorpcapital.com

Western Canadian Select Is Trading At a Premium to WTI

WCS Differential (USD) to WTI in Edmonton and Houston

WCS @ Houston (Oct. 9,

-$40 WCS @ Hardisty

Figure 1. WCS Discount to WTI at Houston, TX and Hardisty, AB

Figure 2. WCS Discount to WTI at Houston on October 9th, 2018

Money to Be Made By Those Who Have Transportation Capabilities

‘Thanks for the Subsidy Canada’ – USA Refiners

TOTAL 18,700 mbbl/d

Heavy Oil Refining Capacity

TOTAL 4,780 - 5,645 mbbl/d

Figure 3. U.S. Refining Capacity

Why is WCS Trading at A Premium in Houston?

…Because the Global Heavy Oil Market Is Declining Everywhere

Y/Y Change in Global Crude Oil Production by Type (mmbbls/d)

Figure 4. Y/Y Change in Crude Oil Production by Type

Global Heavy and Medium Blends – Price Differential to WTI

Figure 5. Heavy Oil Grade Price Differentials to WTI

Most Notable Global Declines

Mexico Crude Oil Production

Figure 6. Mexico Crude Oil Production

Venezuela, Mexico, and Iran Crude Oil Production

Figure 7. Venezuela, Mexico, and Iran Crude Oil Production

Origins of U.S. Foreign Heavy Imports; Increasingly

U.S. Imports of Heavy Crude Oil by Country

Figure 8. U.S. Imports of Heavy Crude Oil by Country

…And Because of Gasoline vs Diesel Output and Market

Source: Energy Aspects Perspectives Report, Oct. 15, 2018

Gasoline Not as Bullish as Diesel

U.S. Production is Ultra-Light and is Hardly a Crude that U.S.

Condensate, NGLs, etc.

Figure 11. U.S. Lower 48 Production by API Grade as of July 2018

Figure 12. World Oil Production Volume and Quality – 2017

Texas and New Mexico Production of Crude Oil by Type

Light (>40⁰ API)

2 Heavy (<30⁰ API)

Imports of Crude Oil to U.S. PADD III (Gulf Coast) by Type

3 Medium (27-35⁰ API)

Shale Basins Do Not Contain the Barrels U.S. Refiners Want

Where Are These Light U.S. Barrels Going Then?

U.S. Exports of Crude Oil by Destination

Figure 16. U.S. Exports of Crude Oil by Destination

For Canadian Heavy Oil, It’s All about Location,

Why Did the Differential Become Irrational in H2 2018?

U.S. PADD II Refinery Outages (Planned & Non-Planned)

Figure 17. U.S. PADD II Refinery Outages (Planned and Unplanned)

Alberta Crude Oil in Storage

Figure 18. Alberta Crude Oil in Storage

~US$18.00/bbl rail transport from Edmonton to the USGC

Canada Crude by Rail

Canada Exports of Crude Oil by Rail

WCS Locational Differentials to WTI and Implied Netback Uplift

Margin uplift vs. Edmonton

The Punch Line: Heavy Oil Is Not a Discounted Product; It’s

a. For context the current cost to ship to Asia is US$2.00-$3.00/bbl.

Scrubber Instalations Are Coming; Just Not Fast Enough

Figure 21. Confirmed Heavy Fuel Oil Scrubber Installations

U.S. Imports of Crude Oil by Type

6 Light (>35⁰ API)

Figure 23. U.S. Imports of Crude Oil by Type

Global Crude Slates –World (Eni World Oil Review 2018)

Figure 24. World Oil Production Volume and Quality – 2017