The nuances of crude-by-rail becoming a feasible solution to the dire Canadian crude oil transportation situation.

Nicholas Lupick, CFA

Sustained apportionments of pipeline capacity in the Western Canadian Sedimentary Basin (WCSB) has caused inventories in the region to swell to all-time highs, leaving a select few options for upstream producers to reach buyers outside of the WCSB. Evacuating barrels out of Alberta by rail has become a vital solution to the dearth of pipeline capacity and is increasingly being accepted as a longer-term component of the province’s ability to sell oil at more economic prices.

What Do the Numbers Tell Us?
Based on AltaCorp's forecasts of Western Canadian oil production, existing pipeline capacity, known quantities of commitments to transport crude by rail, regional refinery demand, and the likely commissioning of Enbridge’s Line 3 Replacement pipeline, we estimate an implied call-on-rail (the amount of rail capacity needed to clear an oversupply of barrels in the WCSB). Based on our estimate of the build-out of crude-by-rail capacity, the WCSB will likely be able to achieve balance some time in Q3/19, but will be severely oversupplied in H1/19 (beyond domestic storage capabilities) without substantial production shut-ins. Without production shut-ins, we estimate that the WCSB will be oversupplied in Q1/19 by ~280 mbbl/d, but that there is only enough remaining storage in Alberta for one quarter of oversupply of ~125-150mbbl/d—the near term situation is dire for energy producers. 

How Much Crude May be Shipped by Rail?
There have been a growing number of producers (in addition to the Government of Alberta) who have committed to firm agreements with rail network operators. We estimate that by YE2020 there will be ~400 mbbls/d of reliable, contracted, crude-by-rail volumes being transported out of the basin—beyond our estimate for the call-on-rail at that time of 250-300 mbbls/d.

Can the Rail System Accommodate the Demand?
Understanding the call-on-rail is important, but the next question is whether or not the railway system is going to be able to accommodate such a large spike in demand. The greatest longer term concern will be whether the rail network in Canada has the ability to handle such large volumes of traffic. With certainty, the near term availability of locomotives and tank cars are also a concern, but the market’s ability to manufacture tank cars and coordinate locomotives during past build-outs suggest that supply will catch up to demand.

The Punch Line
Crude-by-rail is a viable medium term solution for the industry’s transportation bottlenecks, but in the near term the WCSB is dealing with a transportation crisis. Without substantial near term shut-ins, Alberta’s inventories will reach capacity, leaving oil differentials depressed until enough rail capacity materializes to not only balance the market, but drain inventories to a more
comfortable level.