Is the juice worth the squeeze?

Nicholas Lupick, CFA 403-539-8592

What’s the Goal?
Ultimately the goal of building diluent recovery units (DRU) in Alberta is fourfold: 1) improve bitumen producer economics (by reducing the requirement of diluent for heavy oil transport); 2) improve the safety of transported product (as ‘Neat-Bit’ should not be considered a dangerous good by the rail network operators); 3) improve broader transportation egress out of the basin (as a reduced level of diluent in solution means more production being transported) and; 4) provide a more valuable product for downstream heavy oil refiners.

The Benefits of ‘Neat-Bit’ CBR versus Dilbit CBR
There are multiple economic and social justifications for building a DRU, with the following being the most pertinent:

1. Safety: Given the reduced volumes of flammable diluent present in Neat-Bit (at ~10-15% versus ~30% in Dilbit), as we understand it today, the product should no longer be considered a dangerous good by the rail network operators. Additionally, given the greater viscosity of the product (vs Dilbit) the clean-up/remediation cost and impact associated with a derailment should also be reduced.
2. More Efficient Transportation: The ability to boost effective capacity of the rail network by reducing the volume of diluent transported along with the bitumen would serve as a welcome aid to the ongoing egress issues plaguing the WCSB.
3. Cost Savings in Diluent and Transportation Costs: By lowering the blend ratio from 70/30 for Dilbit to 87.5/12.5 for Neat-Bit a producer is reducing the diluent required to ship product to market by 66% (diluent purchases is often the most cumbersome cost in a bitumen producer’s netback). Transportation costs will be reduced on a per barrel of dry bitumen basis as the quantity of condensate required to transport the barrel is reduced, increasing the proportion of dry bitumen production transported per barrel of product.
4. More Desirable Product for the Refiner: The US refineries market is the largest consumer of heavy oil in the world with ~5.2 mmbbl/d of medium/heavy oil refining capacity. The demand for heavier crude grades is apparent by observing the strength in heavy crude benchmarks compared to WTI as refiners look to maximize their distillate yields as opposed to producing more light end products.

The Punch Line
The conclusion of our economic analysis of implementing a diluent recovery unit is threefold:

1. Simple Payout is Roughly Seven Years Versus Dilbit CBR: Based on the assumptions outlined herein, the time it will take for a DRU Neat-Bit CBR strategy to surpass the cumulative FCF generation of a standard Dilbit CBR strategy is seven years. However, this increases to 11 years if we assume a 10% cost of capital needs to be recovered throughout the life of the C$900mm investment.
2. Pipelines are Still Superior: It is very unlikely that the transportation and diluent cost saving attributed with Neat-Bit CBR shipments can compete with the economics of pipelining crude oil to the USGC—underscoring the continued need for increased pipeline takeaway capacity out of the WCSB.
3. Conceding that Additional Pipe Is Unlikely: Given that the netback of a Dilbit barrel shipped on pipeline to the USGC is superior to that of a Neat-Bit barrel railed to the USGC, and the magnitude of the capital investment required to construct a facility, we believe that the decision to construct a DRU must be done in concert with the strategic decision that crude-by-rail (CBR) is a long term part of the shipper’s egress solution.