Alberta government works with industry to formulate temporary solutions for Canada’s egress woes.

Nicholas Lupick, CFA 403-539-8592

Before market on October 31, 2019, the Alberta government announced that they are implementing a special production allowance program ("special allowance"), offering producers who have the ability to market their crude-by-rail (CBR) to produce above their mandated curtailment volumes beginning in December (following a simple approval process)—as long as the approved production leaves the basin via CBR. Although there were few details provided in the news release, we firmly believe that the announcement is a positive one for all stakeholders involved—the industry, the citizens of both Alberta and Canada, investors, as well as the Alberta government.

Expect Crude By Rail Shipments to Surge
Given that the economic decision to ship crude on the rail network is no longer solely determined by the economic differential between delivery points, including the economic benefit of producing versus keeping production shut in, we expect CBR shipments will surge to new highs in the new year.

Company Specific Circumstances: Who Benefits the Most?
Given that not all producers have been transparent with the market in terms of their official curtailment allocations, it is difficult to determine the ultimate level of production available to each producer in the event that unbridled access to CBR were available. In order to quantify this, we have highlighted the peak output level for the largest operating assets since the start of 2018 (when no curtailment was in place), as well as the average output level seen thus far in 2019 (under the curtailment framework). In doing so, we attempt to quantify the productive capability available for each company’s major Alberta-based assets in an unconstrained environment.

The Curtailment Was Not Working In Its Existing Form
While the curtailment, announced in December 2018, was done with good intentions, the unintended consequences were causing unnecessary ramifications on the broader industry. While it is true that the original curtailment was successful in narrowing the heavy oil differential from US$50.00/bbl (October 11, 2018 high) to US$6.95/bbl (January 11, 2019 low), it was creating a situation in which market forces, attempting to manufacture an egress solutions (in CBR), were being suffocated. The reason for this is because, across the basin, we estimate that the average cost to ship CBR is approximately US$18.00/bbl, and the differential has averaged just US$11.54/bbl for H1/19, rendering most CBR shipments uneconomic. As a result, the basin was underutilizing an egress solution that was readily available.

The Punch Line
Overall, we believe that the solution being implemented by the Alberta government is a rational policy decision, which will begin the slow process of fully removing the government’s restrictions from the market (as egress become available). For those entities that currently have CBR solutions in place, the Alberta government’s special allowance will allow a pathway for operators to bring the billions of dollars of capital investment currently shut in, back on line—and for those without a CBR solution, a clear pathway to implementing a solution, if they choose to do so. With regard to specific equities under coverage, Imperial Oil (IMO-T; $44.00 TP; SP), MEG Energy (MEG-T; $10.25 TP; OP) and Cenovus (CVE-T; $17.00 TP; OP) are best positioned with readily available CBR solutions in place, while Gibson Energy (GEI-T;$24.50 TP; SP), Secure (SES-T; $9.00 TP; OP) and Tidewater (TWMT; $2.00 TP; OP) are the best ways to invest in the CBR solution from a service provider perspective.