Why it still makes sense to be bullish on heavy oil.

Nicholas Lupick, CFA

While we are aware that the appetite to invest in the Canadian energy space has seldom been worse than it is currently, we believe there are structural reasons why investors can be bullish on heavy oil.

Bullishness and Pipelines
While Canada's 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 readers interested in this topic can request the full report.

WCS Trades at a Premium to WTI
Global heavy oil benchmark crudes are being routinely 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 at times earned a premium to WTI throughout H2/18 (albeit pricing at a slight USD 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 USD 17.00 - 19.00/bbl, leaving us to believe that WCS differentials should average in the USD 20 - 25/bbl range until additional pipeline capacity is in service (justifying far narrower differentials than the >USD 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 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 de-bottleneck the Canadian transportation landscape (be it pipelines or crude-by-rail) should evaluate further investment in the sector - counter to the market's short term sentiment.